Warren Buffett is well-known for having, among the core tenets of his investment strategy, a preference for companies with serious "competitive moats" -- attributes that give them the ability to sustainably keep ahead of their competition. But based on his rues, Buffett would never invest in an emerging industry like self-driving cars, and his competitive moat ideas don't necessarily hold water in this world. If you're a fan of the Oracle of Omaha, beware of following his investment philosophy into these three mistakes.
1. Focusing too much on size
Economies of scale are an important indicator for almost any company. As the logic goes, the bigger a company is, the greater its ability to cut per-unit costs. Ford's (NYSE:F) ability to keep its car costs lower than Tesla Motors' (NASDAQ:TSLA), for example, isn't just based on the fact that it produces more economically designed vehicles. It's also due to the fact that Ford produced 1.5 million cars in the third quarter of 2016, compared to the 24,800 cars Tesla Motors delivered during the same period.
But scalability in the driverless car industry doesn't necessarily have anything to do with car sales. The automaker with the best technology may ultimately come out ahead. Technology is scalable at almost no cost. When Tesla Motors wirelessly uploads its latest software to its already-sold vehicles around the world, the company pays nearly nothing in per-unit costs. The race to build the best driverless car at this stage has much more to do with technology than with numbers of vehicles sold, and the quantity of cars a company has sold thus far isn't a indicator for which company is best placed to scale in the future.
2. Exaggerating the value of network effects
Network effects are often touted as one of the strongest competitive moats around. Facebook, an actual social network, perfectly defines the allure of the network effect. If everyone is using a specific product or platform, it can be extremely difficult for another company to make inroads.
At first glance, driverless cars seem to be an excellent opportunity to build network effects. If one company's cars all "talk" to each other as they navigate the roads, they'll get to their destinations faster and more safely than competitors' -- right? Wrong. Driverless car technology must necessarily take into account public safety, and unique, exclusionary networks fly in the face of a universal platform for safe self-driving cars. Automakers engaged in this space already know this; it's why Ford, Tesla, and others are equipping their driverless cars with the best real-world object detection technology available.
When Ford announced earlier last week that it would invest $1 billion over five years in Argo AI, it wasn't because the startup has thousands of self-driving cars on the road -- it was because the company's robotics expertise "gives Ford a distinct competitive advantage at the intersection of the automotive and technology industries," explained Ford Chief Technology Officer Raj Nair in a press release. Likewise, Alphabet's (NASDAQ:GOOG) (NASDAQ:GOOGL) spinoff Waymo isn't relying on Google's treasure troves of data to guide its vehicles as they drive around. Instead, Waymo cars are equipped with sensors and software designed to detect obstacles up to "two football fields away in all directions." Ford, Alphabet, Tesla Motors, and others aren't interested in network effects in this arena. They're interested in their cars having the most acute local-area awareness they can contain.
3. Expecting government regulation to limit competition
Regulation can provide some of the widest competitive moats around. If only one company is able to meet all the regulatory requirements of being in a business, it's essentially illegal for others to try to compete with it. The driverless car industry recognizes this, and is making moves to ensure a level playing field for all involved.
Alphabet, Ford, Lyft, Uber, and Volvo Cars joined together last April to create the "Self-Driving Coalition for Safer Streets," a lobbying group whose stated mission is to "work with lawmakers, regulators, and the public to realize the safety and societal benefits of self-driving vehicles." These companies are interested in standardizing national policy with simple and low-cost barriers to entry for all interested automakers. So for Buffett fans looking to back the company with the strongest regulation-related advantages, know that some of the biggest names in the business are working proactively to push policies that ensure no company can ever build a regulatory moat.
Picking the right self-driving car stock
Warren Buffett is an incredible investor, but he doesn't have answers for every industry. There are many open questions around self-driving cars, and some companies are more poised to profit than others. Rather than sticking to one-size-fits-all investment mantras, equip yourself with the facts you need to know, make informed investments, and set your portfolio to auto-pilot for years to come.