“What Are Economic Moats? Types and Real-World Indian Examples”
“In investing, survival and long-term success depend on how well a company protects its profits. The strongest companies build barriers to entry—known as economic moats—that shield them from competition. In this post, we’ll explore the two broad types of moats—demand-side and supply-side—and why they are crucial for sustainable wealth creation.”
FINANCE
In the world of investing there is always one question always comes up every investor that:
What really protects a company’s profits in the long run? How did company really able to survive in the long term ?
This is where the idea of an Economic moat comes in. Just like castles were defended by moats in medieval times, businesses too need defenses to protect themselves from competition.
What is an Economic Moat?
An economic moat is a structural advantage that allows a company to maintain its competitive edge and protect profitability over the long term. For long-term investors, identifying these moats is crucial because they indicate the company’s ability to sustain high ROCE (Return on Capital Employed) and compound wealth steadily.
Warren buffett always says that there are three types of business Great, Good and Gruesome business.
What does Warren Buffett mean by a “Great Business”? Here is the extract of 2007 shareholder letter :
“A truly great business must have an enduring mood that protects Excellent return on invested capital the dynamics of capitalism guarantee that competitor will repeatedly assault any business castle that is earning higher return Therefore a formidable barrier such as a company Having a low cost producer or possessing a powerful worldwide brand is essential for sustained success.”
If a company is generating high rate of return on its capital then according to the law of capitalism the business will soon attract competition which will further squeezes the margins of the business, which makes difficult for a company to keep generating high yields in longer term.
That's why is better to avoid the businesses where the competition is excessive, generating low return and there is no himalayan barrier to entry.
(i) Economies of Scale (Low-Cost Producer)
Economies of scale occur when a company reduces its per-unit cost by producing at a larger scale. In other words, the more you produce, the cheaper it becomes to make each unit, giving the company a cost advantage over smaller competitors. This forms a competitive moat because new entrants often cannot match the efficiency without massive investment. It has characteristics like:
A company may operate with thin profit margins, but because it can control costs and operate efficiently, it still generates high absolute profits.
Competitors with smaller scale cannot match the low prices without sacrificing their margins, which protects the large company’s market share.
Economies of scale can also come from bulk purchasing, efficient supply chains, and optimized logistics, making replication difficult.
Example – D-Mart:
D-Mart is one of the best examples of an economy-of-scale moat. As India’s largest retail chain, it buys products in bulk from manufacturers at lower costs than its competitors, giving it the ability to offer goods at lower prices. This attracts more customers and reinforces its scale-based advantage. Replicating this model is challenging for competitors, as it requires huge investments in supply chain systems, logistics, and store networks.
Types of Economic Moats
“Broadly, every company’s moat can be classified into two types.
First is a Demand-side moat, which gives the business pricing power and helps sustain higher margins.
Second is a Supply-side moat, which allows the company to operate at lower costs and achieve higher turnover through efficiency or exclusivity.”
So whenever you are analysing a company ask yourself on which side the company classify in ? Does the company has Pricing power (Consistent higher margins) or they have Production power (Higher Turnover ratio) and under that what moat company possesses ?
(iii) Switching Cost (Cost of Shifting Products)
Switching cost moat refers to the difficulty, expense, or inconvenience a customer faces when moving from one product or service to another. Companies with high switching costs enjoy customer stickiness, as users are less likely to change providers even if alternatives exist.This can be seen as higher ROE/ROCE.
Switching costs generally fall into three types:
Partner of Choice
Customers build long-term relationships with a service provider, making it difficult to shift to competitors.
Like HDFC Bank has established itself as a trusted partner for both retail and corporate clients. For corporates, the bank provides services like transaction banking, working capital loans, and cash management. Once a company integrates HDFC’s systems into its daily financial operations, shifting to another bank would involve redoing compliance, renegotiating credit terms, retraining staff, and risking service disruptions. This creates high switching costs, making HDFC Bank the preferred long-term banking partner.
Another example is Divi’s Labs is one of the largest manufacturers of Active Pharmaceutical Ingredients (APIs) globally and is a key supplier to multinational pharma giants. Customers depend on Divi’s for quality, reliability, and regulatory compliance. Once Divi’s is approved as a supplier, switching to another manufacturer is extremely costly because it involves regulatory re-approvals, quality checks, and risk of disrupting the global supply chain. This makes Divi’s the partner of choice for many leading pharma companies worldwide, giving it a durable competitive advantage.This can be seen as consistent higher ROCE.
Learning Costs
When customers have invested time and resources in learning how to use a product, moving to another platform involves retraining and re-adaptation.
Example: Microsoft Office,Tally or Excel — businesses stick with it because employees are trained, and shifting to another software means retraining staff.
IT/Service Integration Costs
In technology and enterprise services, switching often means migrating data, reconfiguring systems, and facing downtime. These integration costs discourage change.
Example: Infosys or TCS Have very high repeat business (>90%) due to the presence of switching cost and trust — once implemented, clients rarely switch due to high migration costs and operational risks.
(ii) Network Effect (Webbing Advantage)
A network effect arises when the usefulness of a product or service grows as more people use it. Each additional user makes the network stronger, creating a cycle where scale attracts even more users. Once established, this moat is extremely difficult for competitors to break.
Example – Facebook
Facebook demonstrates the power of network effects. As more users joined the platform, it became the go-to place for social connections, communities, and businesses. The larger the user base grew, the more valuable it became for others to sign up, making it nearly impossible for rivals to compete on the same scale.
Indian Example – IEX (Indian Energy Exchange)
IEX is another strong example from India. Power producers and distributors benefit from being on the largest energy trading platform, as higher participation ensures better liquidity and price discovery. As more buyers and sellers trade on IEX, its network strengthens further, creating a dominant position that competitors find hard to replicate.
(i) Brand Loyalty
Brand loyalty is one of the strongest moats a company can have. It keeps customers committed to a brand even when cheaper alternatives are available. A trusted and aspirational brand not only secures repeat demand but also provides pricing power, allowing companies to charge a premium and enjoy higher margins compared to competitors.
Example – Eicher Motors (Royal Enfield)
Royal Enfield, owned by Eicher Motors, is a perfect example of brand loyalty in India. Despite being priced higher than many other motorcycles, customers remain loyal to Royal Enfield because of its heritage, unique riding experience, and aspirational image. The brand has built a cult-like following, making it difficult for competitors to lure away its customer base. This enduring loyalty provides Eicher Motors with pricing power and long-term competitive strength.
(iv) Regulatory Protection
A regulatory moat exists when government rules, licenses, or approvals create high entry barriers for new competitors. Such companies benefit from a protected environment where competition is limited or even eliminated. This advantage often leads to monopoly or duopoly situations, allowing the business to enjoy stable growth and high profitability.
Example – CDSL and NSDL
In India, the securities depositories CDSL (Central Depository Services Limited) and NSDL (National Securities Depository Limited) are prime examples of regulatory moats. The sector is tightly regulated, and only these two entities are licensed to operate as depositories. This near-duopoly ensures they face minimal competition, giving them consistent business volumes and high operating margins. For investors, such regulatory protection translates into long-term stability and durability of returns.
(ii) Distribution Advantage
A distribution moat exists when a company has built a vast and efficient supply chain that competitors cannot easily replicate. A strong distribution network ensures wide market reach, faster product availability, and consistent visibility in both urban and rural areas. This moat allows companies to dominate shelf space and consumer mindshare, creating a lasting competitive edge.
Example – Hindustan Unilever (HUL)
HUL is a textbook case of a distribution moat in India. With its network spanning millions of retail outlets, including remote rural areas, HUL ensures that its products are available almost everywhere. This unmatched reach makes it extremely difficult for new entrants to compete, as building such a wide distribution network would require enormous time and investment. HUL’s strong distribution backbone reinforces its market leadership and sustains its long-term profitability.
