Marshmallows and the Cost of a Moat


One of the most frequently mentioned research studies in the field of developmental psychology is the “marshmallow test”. Conducted in the late 1960s and early 1970s, the experiment considered how children’s ability to exercise delayed gratification would affect their success in life. The test was designed like this: children were offered a single marshmallow by a researcher with the option of either eating it right away, or waiting approximately 15 minutes. If they could stave off temptation, they would receive two marshmallows instead of one. (If only compounding were always so easy.) After the experiment, the researchers maintained contact with the original children from the study. Over the course of several years, they took various measures of the success of the participants, including SAT scores and educational attainment. In a nutshell, the study found that children who chose to wait for the second marshmallow were more likely to have better life outcomes. We see a useful business lesson here: delayed gratification is a powerful force and foundational to success.

In our work as investment analysts, we see the marshmallow test at play across the business world. Every day, managers must decide whether to enjoy a dollar of profit this year or two dollars a few years from now.

Many of the things that are good for the long-term prospects of a business are not necessarily good for short-term profits. Forestalling price increases or making investments in the future, whether they are in the form of a new factory or a growing R&D staff, are not short-term profit maximizing activities. Nevertheless, they are often essential to the long-term success of a business. This makes investing a nuanced balancing act. As long-term investors, although we are attracted to highly profitable businesses, do we want our holdings to be maximizing profitability at all times? Might such an approach not lead towards short-termist, single-marshmallow managers rather than long-term thinkers?

A business’s profit is only valuable insofar as that profit is sustainable, meaning that it can be protected and grown well into the future. That protection is provided by a moat, which insulates the business from competition and disruption. But like many good things, moats have a cost – one that well-run businesses willingly pay on a regular basis in order to protect their long-term sustainability. In this View from Burgundy, we will explore some of the ways that moats have a cost, and why that cost is both necessary and desirable despite limiting profitability in the short term. We will explore these costs across three dimensions: restrained usage of pricing power, moat-protecting expenses, and moat-protecting investments. While all three can restrain short-term profitability, they serve to increase the sustainability and long-term value of a business.


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