Of course, you have personal reasons for wanting to start a particular company. Usually, that is because you have a connection to the problem or the market. If your company has a “superpower”—something that makes you extraordinarily well qualified to start the company—consider dedicating some time to telling that part of the story.
Named after the water-filled ditch dug around old castles, in startup land, your natural defense against competitors is known as a “moat.” This moat can take many different forms, and not all companies have one—at least not at first. For example, there were at least seven major search engines active on the Internet before Google came along. These days, Google’s moat is its sheer market dominance. Commanding an impressive 92% of search traffic in the United States in 2019, it’s tough to compete with the search giant, but not impossible. Incumbents are overthrown all the time: at one point, AltaVista had 20% of all search traffic (with Google only taking around 6%), while MySpace dominated the nascent social media market. Both AltaVista and MySpace are mere footnotes in the history of the Internet these days. In 1968, Toyota had about a 0.5% market share in the United States. Today, they are the third best-selling car brand—and they have the #1 best-selling passenger vehicle in the United States, the Toyota Camry. As I am writing this, it seems unlikely that Google, Facebook, Apple, and Netflix will disappear, but, again, not impossible. Consider this: 25 years ago, of those four tech giants, only Apple existed, and it was on the brink of bankruptcy as Steve Jobs stepped back in as “interim CEO” in 1997.
Your moat could be many things that are not related to market share, but if you are going to claim to have a moat as part of your slide deck, it has to be real. It will need to be something that makes it genuinely hard for competitors to come and eat your lunch. Your team is probably the first place to look—if you have a team of PhDs who are legitimately the foremost experts in the world on the product you are building, that could form part of your defenses. A weaker case is to have a team that has spent decades in the industry where you’re starting the business—it’s better than nothing, of course, and in-depth domain knowledge goes a long way. But it isn’t exclusive: there are usually many people who have in-depth knowledge about various industries. Seeing your company be successful may bring them out of the woodwork.
Being first to market isn’t a guaranteed victory either. There were shovel loads of search engines before Google. There was a smattering of smartphones before the iPhone. There were many music-streaming services before Spotify. If you innovate, know that there will be others with better systems, more developed supply chains, and better-resourced research and development teams than yours. Being first to market means you get to define the market, but it doesn’t inoculate you from competitors who get the benefit of learning from your mistakes and missteps.
Other ways of thinking about the moat include a head start on the product; if you’re building something genuinely sophisticated, where it would take a long time to replicate the research and development on your product, that could work. As long as your competitors can’t buy one of your products, “borrow” all of the innovations, and ship a slightly cheaper or slightly better product quickly.
Patents or other protections can help keep competitors at bay. If the potential number of customers you have is small, you could corner the market by signing your customers to exclusive contracts. Trade secrets are harder to defend, but if you’re able to make the case that what you are developing is hard to copy, and a secret worth keeping (as in Figure 11-1), then you’re onto something.
When claiming a “moat” as part of your pitch, be very careful. A lot of the time, when I work with clients, the moats they are describing aren’t as deep and unpassable as they would claim.
Your “moat” is something that makes it hard for other companies to catch up to you. Patents, trade secrets, unusual market dynamics, and deep industry expertise are great examples. Image Source: karandaev/stock.adobe.com
Another excellent example of knowing the problem you are solving is the channel tunnel from the UK to France. The projection was that as soon as the tunnel opens, everything would change. “Faster and more convenient” and “The only way to get to and from the mainland” were the main selling points for the tunnel. But, of course, people had been traveling between the UK and France for thousands of years already—by boat. When the tunnel opened, the ferries responded by refurbishing the fleet and dropping prices to stay competitive. Slower, yes, but cheaper. At the same time, budget airlines continued to do a booming business. All of which is to say, on paper, your solution may seem as obviously the best way to solve a problem, but if your customers disagree, your moat may not be as strong as you think.
Patents are a powerful tool, of course, but they tend to be very specific. Remember that companies build value by resolving a problem for a customer. Your patent will be related to your particular solution, but in the majority of cases, there is more than one way to solve a problem. Put differently, it doesn’t help to have a patent on a tunnel under the English Channel if people just take a plane or a boat to accomplish the same thing.
Powerful moats
There are a few truly powerful moats. If you can tap into them, you are onto something good. One is the network effect, which is the idea that every additional person on the network adds value to the whole system. The telephone is a good example here; if you are the only person in the world with a phone, it’s useless. The more people have phones, the more valuable it becomes to have a phone yourself. Facebook is tapping into the network effect—if you’ve ever tried to stop using Facebook, you realize that a lot of events are announced and organized on Facebook. Without a Facebook account, you risk missing an invitation.
The other lock-in mechanism being aware of is the platform effect. eBay is a great example. Of course, you can go to another platform to sell that bread-maker you got as a wedding present, but you know that the largest number of potential buyers are on eBay. The same goes for Uber or Lyft. You may have a preference for Lyft, but if you are in a city where there are ten Uber drivers for every Lyft driver, you have a problem: if you want to go anywhere, you will probably need to use Uber. The other part of the platform effect is that all of these sales are “conquest sales.” In other words, you only need one driver to take you from point A to point B. When you choose Uber over Lyft, not only does Uber make money, Lyft effectively loses a potential sale. Platform effects are incredibly powerful, and that’s part of the reason why creating platforms is so tricky—and so lucrative, when you get it right.
Network and platform effects are hard to tap into as an early-stage company—per definition, you don’t have that many customers yet. However, if your business relies on these market dynamics, it can be powerful to add to your pitch narrative that you have a plan for how to build and leverage them.