Circle Of Competence And Why It Matters In Business

The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.

Understanding the circle of competence

It is useful to think of the circle of competence as a small circle within a much larger circle. The larger circle represents what an individual thinks they know but are far from an expert in. Conversely, the smaller circle represents what they actually know and could be considered an expert in.

Buffet’s strategy for success in life using the circle of competence relatively simple. Firstly, it is important that individuals know where the boundary of their inner circle is. Once the boundary has been established, it must not be crossed. 

Buffet’s business partner Charlie Munger took the circle of competence one step further. He argues that a person must clarify their individual strengths and then play to them to have a competitive advantage. If a person not playing to their strengths comes up against a person who is, they will most likely lose.

However, it is a natural tendency for many individuals to deliberately step outside of their circles or attempt to broaden them. The circle can be expanded to an extent, but skills are usually industry-specific and non-transferable to other industries. 

In business, this is why some organizations divest or outsource operations that don’t align with their core business

Examples of the circle of competence

In a 1991 lecture to university students, Buffet reflects on the circle of competence of a Russian immigrant who built the largest furniture store in Nebraska. Buffet noted that this woman understood cash and furniture selling. Therefore, her circle of competence was furniture and specifically a talent for buying large amounts of furniture to turn a profit. Despite also being a business partner of his, Buffet noted that this woman had no interest in the stock market.

The circle of competence explains why. She was disinterested because she did not understand how it worked. Indeed, Buffet would later exclaim that “she wouldn’t buy 100 shares of General Motors if it was 50 cents a share.”

Furthermore, consider the Olympic athletes Michael Phelps and Hicham El Guerrouj. The first is a gold medal-winning swimmer, the second a gold medal-winning runner. Despite the athletes differing in height by 7 inches, the length of their legs is almost identical. Phelps with relatively short legs and a long torso that is perfect for moving through water. El Guerrouj has relatively long legs and a short torso that is perfect for long-distance running. 

Each man operates within his circle of competence, and each has been highly successful. If the two were to switch sports and move beyond their circles, it would be highly unlikely that either would succeed to the extent they have.

Key takeaways:

  • The circle of competence describes the skills that a person has mastered throughout their careers or lives. Outside of this circle are interests, skills, or abilities that they do not competently understand.
  • To be successful, individuals must know the boundaries of their circle of competence and stick within these boundaries at all times.
  • Depending on the context, a circle of competence can encompass very broad or very specialized skills and abilities in a certain field or industry.

Connected Business Concepts

Economic Moat

Economic or market moats represent long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.

Golden Circle

The Golden Circle attempts to explain how certain businesses can inspire others and differentiate themselves in the market. Originally developed by author Simon Sinek, the concept helps businesses identify their purpose and then communicate that purpose to consumers in a meaningful way so that the brand can be highly differentiated in the marketplace.

5 Whys Method

The 5 Whys method is an interrogative problem-solving technique that seeks to understand cause-and-effect relationships. At its core, the technique is used to identify the root cause of a problem by asking the question of why five times. This might unlock new ways to think about a problem and therefore devise a creative solution to solve it.

First-Principle Thinking

First-principles thinking – sometimes called reasoning from first principles – is used to reverse-engineer complex problems and encourage creativity. It involves breaking down problems into basic elements and reassembling them from the ground up. Elon Musk is among the strongest proponents of this way of thinking.

Second-Order Thinking

Second-order thinking is a means of assessing the implications of our decisions by considering future consequences. Second-order thinking is a mental model that considers all future possibilities. It encourages individuals to think outside of the box so that they can prepare for every and any eventuality. It also discourages the tendency for individuals to default to the most obvious choice.

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