In investing, the idea of an “economic moat” has long served as a shorthand for durable competitive advantage. Popularised by Warren Buffett and later formalised by Pat Dorsey during his tenure at Morningstar, the concept remains central to long-term equity investing. Yet, as markets evolve, so too does the interpretation of what constitutes a moat.
An a recent interview, Dorsey offers a timely reassessment. His arguments challenge several widely held assumptions, particularly around metrics, management quality, and the durability of competitive advantage.
What is a moat, really?
Dorsey defines a moat simply: a structural feature that makes a business hard to compete with and allows it to exercise pricing power. These features vary by industry. Consumer brands rely on brand equity; enterprise software often depends on switching costs; platforms may benefit from network effects.
The nuance lies in sustainability. A strong product is not the same as a moat. Investors often conflate the two. A product may be popular today but easily replicable tomorrow. The real test is whether a company can maintain demand and pricing power over time.
This distinction aligns with broader academic and practitioner thinking. Research from institutions like Harvard Business School has long emphasised that competitive advantage must be both valuable and difficult to imitate to persist.
The limits of traditional metrics
One of Dorsey’s sharper critiques is directed at the over-reliance on quantitative metrics such as return on invested capital (ROIC). Historically, sustained high returns signalled a moat. Today, that signal is weaker.
The reason is structural. Many modern businesses, especially software and internet firms, derive value from intangible assets like code, data, and networks. These do not sit neatly on balance sheets. As a result, traditional accounting understates invested capital and inflates returns.
This concern is echoed in research by McKinsey & Company, which has highlighted how intangible-heavy firms distort conventional financial ratios. In such cases, qualitative assessment becomes more important than mechanical screening.
Moats are not all “inevitable”
A common misconception is that a moat implies permanence. Dorsey rejects this. He distinguishes between “inevitable” moats, slow-changing businesses like consumer staples, and more dynamic moats in sectors such as semiconductors or software.
The latter may be less stable but offer greater reinvestment opportunities due to faster industry growth. The trade-off is clear: stability versus growth. Investors must decide which suits their strategy.
The experience of companies like PayPal illustrates the risk. Once seen as a strong network-effect business, it lost ground as payment ecosystems evolved and competitors like Apple and Google integrated payments more seamlessly into their platforms. The moat did not disappear overnight; it eroded as the value delivered by the network declined.
Network effects: overestimated and misunderstood
Network effects are often treated as the gold standard of moats. Dorsey urges caution. Not all networks are equal, and their durability depends on the value they provide.
A large user base alone is insufficient. If alternative platforms offer better functionality or integration, users can migrate. The lesson isstraightforward: a moat must be evaluated in terms of user benefit, not just scale.
This perspective is consistent with work by Geoffrey Parker, who notes that network effects can weaken if multi-homing, users engaging with multiple platforms, becomes easy.
Management: the overlooked variable
Beyond business economics, Dorsey places heavy emphasis on management quality. The traits he values are not glamorous: humility, openness to dissent, and disciplined capital allocation.
He is particularly wary of founder-led firms. While founders can be visionary builders, they do not always transition well into managers of large organisations. Micromanagement, which may help in early stages, becomes a constraint at scale.
This view contrasts with the market’s tendency to idolise founders. Evidence suggests a more mixed reality. Studies by Stanford Graduate School of Business indicate that founder-led firms outperform in some contexts but underperform when governance and capital allocation weaken.
Pricing power and its limits
Pricing power is often cited as proof of a moat. Dorsey adds an important caveat: price increases must be accompanied by value creation.
If companies simply extract higher prices without reinvesting in the product, the moat weakens over time. What appears as strength can become a “melting ice cube”.
This aligns with the broader concept of customer surplus in economics. Firms that consistently deliver value retain loyalty; those that exploit it invite disruption.
Process over prediction
Dorsey’s investment process avoids rigid screens. Instead, he focuses on narrowing the universe to industries where moats are more likely, such as software, semiconductors, and aerospace, while largely ignoring areas like commodities or highly competitive financial services.
He also advocates for a “premortem” approach: assume an investment fails and work backwards to identify why. This helps distinguish signal from noise and sharpens decision-making.
Perhaps most striking is his emphasis on behavioural edge. In a world where information is widely available, the advantage lies less in knowing more and more in thinking differently, and patiently.
The bottom line
The idea of economic moats remains relevant, but its application requires adaptation. Traditional metrics are less reliable, network effects are not foolproof, and management quality can make or break even the strongest business model.
The implication for investors is clear: analysis must move beyond checklists. It requires judgement, scepticism, and a willingness to revise assumptions as industries evolve.
In that sense, the moat is not a static feature of a business. It is a dynamic one, built, tested, and sometimes eroded over time.
