Key Takeaways

  • Brands aren't all equal: some lower search costs (like Coca-Cola or Gillette), while others build consensual status and command high defection costs (like Hermès or Moody's). Understand which type your company aims to be.
  • Luxury brands like Hermès succeed because we all agree they signal status; a no-name $100,000 watch fails this test because there's no collective consensus around its value.
  • Network effects, often put on a pedestal, can degrade as users leave the platform, and they often lead to limited growth opportunities once a market saturates, as seen with companies like eBay.
  • Blindly chasing the "widest moat possible" can actively stunt your company's growth, which might look good on paper but proves poor for long-term investment success.
  • Prioritize growth runway and the potential for reinvestment opportunities over just the sheer width of your competitive advantage for enduring business success.

The Moat is Dead, Long Live the Moat

Founders often hear about moats as the holy grail, but Pat Dorsey, an investment veteran from Morningstar and Dorsey Asset Management, isn't buying the simplistic version. He pulls apart the idea of a brand moat, challenging us to look closer. “It's useful to kind of distinguish brands in terms of you know, the classic Coke or Gillette kind of lowering your search costs,” Dorsey says. You grab it, you know what you're getting. Low defection costs. If Coke changes, you just pick up Pepsi. Easy.

But then there's the other kind: the luxury brand, or what Dorsey calls "consensual" brands. Think Hermès, or even a credit rating agency like Moody's. These brands thrive on a shared understanding of their value, where the cost of leaving isn't just a lost product, but a lost signal. Dorsey uses a blunt example: "If I decide one day to say I'm going to wear some no-name watch that nobody's ever heard of that cost $100,000 cuz I want to signal my wealth, if nobody's ever heard of it, I don't achieve that." The power comes from collective agreement, not just perceived quality. Without that consensus, the moat evaporates.

The Network Effect Trapdoor

If you're building a tech startup, you've probably heard "network effect" whispered like a magic incantation. Many founders treat it as a guaranteed path to a "30-bagger," as Dorsey puts it. But he pushes back hard, pointing out that this powerful competitive advantage comes with a hidden trapdoor.

“Network effects are often held up as kind of like the end-all, be-all of moats. But, network effects can degrade, right? People leave the network, the value of the community diminishes,” Dorsey explains. Think of social networks or online marketplaces where user churn or declining engagement erodes the very value proposition. What happens when your early adopters move on, or a competitor offers something slightly better, pulling away chunks of your network? The value diminishes. Dorsey points to companies like eBay, or many European online listings companies: “once you kind of get that market, now what?” The network reaches saturation, and suddenly, growth stalls. The moat is still there, perhaps, but it's now circling a pond that isn't expanding.

Growth Trumps Widest Moat Possible

Here’s the gut-punch from Dorsey that should make any ambitious founder pause: chasing the "widest moat possible" might actually be killing your company's future. It sounds counterintuitive, right? Don't we all want the strongest defense against competitors?

Dorsey argues that a massive, impenetrable moat that offers no avenues for reinvestment or growth is, ultimately, a stagnant business. “You can't sort of say like, you know, I I want the widest moat possible. It's like, 'Well, then the company may not grow.' You know, that may not be great for your portfolio,” he says. A wide moat is great, but a wide moat around a shrinking or non-growing pie isn't where you want to be. The real competitive advantage often lies in the ability to consistently reinvest capital at high rates of return within your market or into adjacent opportunities. If your moat is so wide it prevents you from innovating or expanding, it becomes a cage, not a fortress.