Buffett’s Opinion of Microsoft’s Moat

I have been recently thinking about my purchase of Microsoft (MSFT) stock. I have been struggling with how to explain its economic moat, until I ran across an email written by Warren Buffett on this very same topic!

Microsoft is the 800 pound gorilla of the software industry. In the recent past, the company had such a competitive advantage that it spent many years defending itself from antitrust litigation. In fact, Microsoft just settled one of these cases with RealNetworks a few weeks ago.

There are not many companies out there that have been accused of being a monopoly the way Microsoft has. Microsoft had created such a deep broad moat around its core operating system, Windows, and its Office software suite that it actually resulted in a dangerous legal liability. I remember at one point there was talk that Microsoft might need to be broken up like AT&T.

During Microsoft’s antitrust litigation, an interesting email from Warren Buffett to Jeff Raikes of Microsoft was revealed. Shai Dardashti just uncovered a copy of this email message on CNET’s servers. This email message written by Buffett in 1997 provides an amazing peak into Buffett’s thought process in this candid and unguarded message. Here is what Buffett wrote about Microsoft:

“In effect the company has a royalty on a communication stream that can do nothing but grow. It’s as if you were getting paid for every gallon of water starting in a small stream but with added amounts received as tributaries turned the stream into an Amazon. The toughest question is how hard to push prices and I wrote a note to Bill on that after our December meeting last year.”

Wow, I never really thought of Microsoft as having a royalty on electronic communication. I especially like the notion that the hardest question facing Microsoft (at least in 1997) is how high to raise prices. I guess the danger in increasing their prices too high is that it will push people into using and developing other alternatives, such as open source software.

Buffett goes on to compare Microsoft to Bell and Coke. Buffett notes, “Bill [Gates] has an even better royalty-one [compared to Coke’s royalty on swallows] which I would never bet against but i dont feel i am capable of assessing probabilities about, except to the extent that with a gun to my head and forced to make a guess, i would go with it rather than against.” So according to Buffett, the real question with Microsoft is how sustainable into the future is their competitive advantage. Will Microsoft still be the dominate software powerhouse in 20 years? I am confident that they will be for the next 10 years, but 20 years it is a bit harder to predict. I think the key for tracking my investment in Microsoft will be to closely monitor its competitive position even more than its financial performance. In the near future, I think Google is the only significant threat to Microsoft but they have a long way to go before they can actually threaten to breach Microsoft’s moat.

Warren Buffett is the ultimate fat pitch investor. In this same email he goes on to say, “… I prefer to structure investing as a no-called-strikes game and just wait for the fat one.” Buffett draws on the wisdom and writing of baseball superstar Ted Williams and his reference to his batting “happy zone”. “Your happy zone, because of the business experience you have had, what you see every day, your natural talents, etc. is going to be different than mine,” notes Buffett. This makes me feel a bit better about my Microsoft decision. However, I still wish I could have the opportunity to ask Buffett what he now thinks of the future of Microsoft’s competitive advantage.

I strive to develop the same discipline that Buffett has to let decent pitches go past him and to wait for that perfect fat pitch before swinging.