Whenever a manager at a subsidiary of Berkshire Hathaway (NYSE:BRK.B) gives Warren Buffett a call to ask for business advice, Buffett's response is usually along the lines of this: "Make the moat your first priority. Protect the business. Then the profits will come."
We see the danger of not heeding this advice across America every day. There are countless stories of men and women who run successful businesses, pass away, and then the children heirs run the inherited company into the ground because they are much more concerned about using the company as a cash cow to fund a lifestyle instead of as a business to protect and grow. That's why I like that Buffett has a record of prioritizing business moats over profits. If you preserve and strengthen a moat, the bigger profits will come. But if your competitive edge starts to weaken, your profits can fall off a cliff in a hurry.
Although many pundits have been quick to lambast Facebook (NASDAQ:FB) CEO Mark Zuckerberg for paying $1 billion for Instagram, I think we should recognize that paying a premium for businesses that threaten market share can be a hallmark of successful moat-building. Pepsi (NYSE:PEP) didn't hesitate to buy Gatorade or Aquafina when the rise of "healthy drinks" threatened to steal market share from Pepsi's carbonated soda business, nor did Coca-Cola (NYSE:KO) hesitate to pay a premium to add Powerade and Dasani to its stable of brands when encountering the same industry trends.
And those are soda companies that work in an industry that has a generally high barrier to entry. Zuckerberg, meanwhile, runs a company in internet land where any group of creative minds can create the next big thing in social media that tosses Facebook into the dustheap of history next to MySpace. If you want to guard an online moat for the long haul, you have to be bold and pre-emptive in warding off rising competition. Zuckerberg has to prevent the 18-34 age group (a fickle crowd notorious for moving on to the next big thing) from moving on to another social media website. An intelligent way to protect that moat is to cut the legs off of any rising competition before it can grow into a legitimate alternative. In the case of Instagram, Zuckerberg was guarding against the possibility that young users would come to upload photos on Instagram instead of Facebook.
A lot of people look at Instagram as it currently is and think, "There is no way this is worth a $1 billion." They are most likely right. But still, I like what it says about Zuckerberg's approach to running Facebook. He identifies a risk to his moat, an upstart photo uploading site, and then sets out to eliminate that risk. The sins of overpaying for an acquisition in the pursuit of maintaining a moat are not nearly as painful as allowing a moat to weaken, which forces a reactionary "too little, too late" form of damage control. That's what I like about Zuckerberg, and companies run by their founders in general. I would much rather read news reports about businesses that are taking actions to strengthen their moat rather than actions to maximize profit. That's because an unassailable moat is the only way to maximize profits in the long haul. Some people look at Zuckerberg and see a kid drunk on money making foolish and hasty decisions. However, I see a man ferociously guarding the moat of the business that he loves.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.