Moats

/ Chris Collins / 4.22.2019 /

Competitive moats are critical to develop for any company seeking to become a big player in its industry. Below is a list of important considerations that can help a startup create distance between itself and competitors.

Economies of Scale

• The bigger a company grows, the cheaper its cost structure becomes

Example: Cloud computing – as companies like Box and Dropbox scaled, their revenues scaled exponentially while their cost structure scaled relatively linearly. This allowed them take significant market share while making it difficult for new entrants to do the same.

Network Effects

• As new users joining the platform, it becomes more valuable to each existing and future user

Example: Two-sided marketplaces – while these businesses can be hard to kickstart, generally more supply begets more demand and vice versa. Once the flywheel gets spinning, it becomes incredibly difficult to challenge incumbents. See: Uber.

Bonus I: NFX has outlined the 13 types of network effects

Bonus II: Fred Wilson’s Dentist Office Software story does a great job at illustrating the importance of this moat.

Intellectual Property

• Trade secrets or scientific discoveries that provide an operational edge (and are sometimes protected from competitors copying it through patents)

Example: Meat substitutes – Impossible Foods has been working on ways to create the tastiest plant-based burger since 2011. They have now reached a point where Burger King is testing the product for inclusion on its menu.

Regulation

• Businesses that must jump through regulatory hurdles in order to operate. On the flip side, once they are in compliance, they are in an advantageous position relative to newcomers.

Example: Banking – traditional US banks have long enjoyed an advantage over fintech startups since they are not able to receive banking charters yet. Lack of ability to hold customer deposits is a massive handicap.

Capital Intensivity

• Business models that require very large amounts of capital to launch

Example: Space tech – The first example that comes to mind is SpaceX. The amount of capital required to purchase materials and bring the right talent onboard to solve the incredibly difficult challenge of reusable rockets undoubtedly cost billions of dollars to get off the ground (no pun intended)

Brand

• Strong brands that build affinity over time can promote strong loyalty from its consumer base

Example: Beverages – Coca Cola is a classic example of a company that has built a mainstream following globally, becoming the default beverage of choice for countless meals in the process.

Switching Costs

• A service that requires upfront investment (either time, money, or both) that makes the thought of switching to a competing product painful for a consumer

Example: Music streaming – Spotify has done a great job at curating playlists for users based off of the music they choose to listen to over time. Switching to competitor would entail losing this curation and having to build it up all over again.