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Rupert Hargreaves
Rupert Hargreaves
Articles (489)  | Author's Website |

Warren Buffett Can't Escape Unethical Strategic ‘Moats’

Not all moats live up to Buffett's folksy image

May 15, 2018 | About:

A few days ago, fellow GuruFocus contributor John Engle asked the question: Are Warren Buffett’s Strategic ‘Moats’ Unethical?

Engle was commenting on the recent spat between Warren Buffett (Trades, Portfolio) and Elon Musk over the notion of business moats. As I have discussed previously, Musk started this argument before Buffett responded to the Tesla (NASDAQ:TSLA) founder's attack on strategic moats, which he believes are "lame" and "sort of quaint in a vestigial way." After Buffett responded to Musk's assertations at the Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) meeting, Musk then continued the argument on Twitter, eventually making a claim that "moats are essentially unethical, sheltering oligopolies from the competition."

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This isn't the first time Buffett's love of moats has been attacked. Berkshire Hathaway has been criticized for its business practices, which seemed to put profit over customers, particularly at its Clayton Homes division.

The key differences

In his article, Engle notes there's an essential distinction between moats and oligopolies. Specifically, he writes: "Moats are maintained through excellence of product or service while oligopolies are sustained through price-fixing and manufactured structural barriers to entry."

It could be argued that some of Buffett's businesses fall into the latter category.

The classic example of this is Buffett's Buffalo Evening News, which he originally purchased in 1977. For several years, this business struggled to compete with its primary competitor, Buffalo Courier-Express, but eventually, Buffett prevailed by launching a Sunday edition and finally taking over the entire market. You could argue the Buffalo Evening News built its moat by investing more in its content, but that would leave out a large part of the story. Buffett used a significant amount of money and influence for the rest of his empire to help transform the business, cut costs and fight legal battles. Trying to compete against this would certainly qualify as "manufactured structural barriers to entry."

Other businesses in the Buffett empire exhibit similar traits. Clayton Homes, for example, the largest builder of modular and manufactured homes in the United States, has been accused of relying on "predatory sales practices, exorbitant fees and interest rates that can exceed 15 percent, trapping many buyers in loans they can’t afford and in homes that are almost impossible to sell or refinance." Evidently, if the company were looking to expand its moat naturally, it would be trying to achieve the best reputation and results for customers rather than price gouging -- a tactic only the largest nonopoly businesses tend to get away with.

These are just two examples of the expansive Berkshire empire, and they are not representative of the whole business. Nevertheless, in recent years Buffett has been moving into industries such as railroads and utilities, which generally tend to exhibit qualities similar to oligopolies. BNSF has undoubtedly built structural barriers to entry around its operation by becoming one of the largest railroad companies in the United States.

Before Buffett's acquisition, the business was already well-known in the industry for running a highly efficient railroad, which certainly qualifies as building its moat. But the company also operates virtually unopposed in individual states, giving it room to charge whatever it fancies. Then there's Buffett's ownership of Texas utility firm Oncor. Utility companies are known around the world for dubious pricing practices, and it would be naive to believe Oncor is any different.

Difficult to avoid

As mentioned above, these are just a few of the many companies that make up the Berkshire Hathaway empire, and they are not representative of the whole group. However, they do show there is some truth to the statement moats can be unethical, especially in some industries and markets.

But this is not a problem exclusive to Berkshire Hathaway. Rather, it is more of a negative side to the business world. In a truly competitive environment, this would not be the case, but the world is not a perfect place. In some Industries, it is impossible to be entirely competitive.

Disclosure: The author owns no stocks mentioned.

About the author:

Rupert Hargreaves
Rupert is a committed value investor and regularly writes and invests following the principles set out by Benjamin Graham. Prior to his investing and writing career, Rupert was as a proprietary currency trader. Rupert holds qualifications from the Chartered Institute for Securities & Investment and the CFA Society of the UK. He covers everything value investing for ValueWalk and other sites on a freelance basis.

Visit Rupert Hargreaves's Website


Rating: 3.0/5 (2 votes)

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Comments

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Hmmm, where is it written that every business has to be completely competitive? As long as a company is complying with the law, it can be argued that the company has an "ethical obligation" to its shareholders, not its competitiors. Ethics work in a variety of ways; is being ethical to one subset [competitors] at the expense of ethics to another subset [shareholders] truly being ethical? By what definition? In fact a company has a legal, fidiciary duty to its shareholders, which trumps any subjective ethical duty. Perhaps Mr. Musk will want to give away his technologies and advancements in the interest of "ethical competitiveness"; if so, clearly a reason to avoid TSLA. The fact that Musk has picked on one of the most ethical corporate CEOs of our time says a lot. And as usual, Buffett has taken the high road.

Tony
Tony - 1 week ago    Report SPAM

Rupert Hargreaves has raised an important point about Buffett’s Berkshire and a monopolistic Moat exemplified by Clayton Homes. But it should be noted that their sister brand in manufactured home lending - 21st Mortgage Corp - also demonstrates monopolistic practices, at odds with the ‘folksy image.’ Here’s evidence:

MHProNews.com/blogs/daily-business-news/smoking-gun-3-warren-buffett-kevin-clayton-clayton-homes-21st-mortgage-corp-tim-williams-manufactured-home-lending-sales-grab/

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Tony, did the company break any laws?

ed_l_grey
Ed_l_grey - 4 days ago    Report SPAM

1) And of course there's Wells Fargo. They also own Edina Realty, which is fairly small but indulges in some unsavory business practices, and there's a lot of that in real estate.

2) Utilities are regulated monopolies. They can't raise prices without getting permission from their regulators. It all depends on the quality of the regulators. Good utilities offer a steady dividend and some growth in share price. If they're in a growing market, they offer more growth than average. I have much less problem with BRK owning utilities or a railroad than with Clayton Homes or Wells Fargo. Or Coca Cola, for that matter, since its main product is very unhealthy.

latonyk
Latonyk - 1 day ago    Report SPAM

Stephenbaker That's for the justice system to decide. But there are several reported investigations underway of Clayton.Homes and their Berkshire Hathaway related affilates, such as 21st Mortgage and Vanderbilt.

http://www.MHProNews.com/blogs/daily-business-news/seattle-times-federal-investigations-berkshire-hathaways-clayton-homes-gurufocus-spotlights-buffetts-claytons-unethical-monopolistic-moat/

stephenbaker
Stephenbaker - 23 hours ago    Report SPAM

Ltonyk: What mature company has not been investigated at one time or another? Not sure I understand your point or the point of the author. He states:"Berkshire Hathaway has been criticized for its business practices, which seem to put profit over customers"... This is a blanket statement that says absolutely nothing about those doing the criticizing and the substance of their complaints. The author contends that moats can be unethical but does not explain who precisely is making such "ethical" deteriminations, and why. Candidly it is not surprising that the author owns no shares of Berkshire - perhaps if he did, he could see the other side of the issue.

ed_l_grey
Ed_l_grey - 13 hours ago    Report SPAM

I had forgotten about Monsanto. That might be Berkshire's worst holding. They make Coca Cola look like the healthiest drink you could ever find.

latonyk
Latonyk - 1 hour ago    Report SPAM

Stephenbaker, we're experts in the field. The impact of Berkshire Hathaway in manufactured housing is unmistakable, see comments from MHARR, linked below.

http://www.mhmarketingsalesmanagement.com/blogs/daily-business-news/mharr-points-to-needs-underscored-by-washington-post-article-on-huds-manufactured-housing-program-related-woes/

stephenbaker
Stephenbaker - 40 minutes ago    Report SPAM

You are "experts in the field"? That explains a lot. Maybe your real beef is with capitalism.

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