Okay! So… bring a prudent entrepreneur involves doing market research. We are all aware of that. And part of that market research is taking a look at what competitors are doing so that you can structure your business to be more successful than theirs. Now, good entrepreneurs will take their learnings and move forward in creating an amazing business that outpaces the competitors. They focus on what Renee Mauborgne calls a “blue ocean” in her book “Blue Ocean Strategy”. This is the drive into untapped markets ripe for growth rather than getting involved in the endless bloodbath of the “red ocean” where rivals battle each other into shrinking profits. But, let’s say you’ve found this blue ocean and you’re building your business and everything is going swimmingly. But now you want to make sure that you can hold on to this market share. You want to make sure that new competitors don’t jump into your waters and start to redden it. What do you do?
Well, frankly, the answer to this is quite easy. How you do it, is the difficult part. So let’s start with talking about the answer itself. This is a concept that than many value investors call an “economic moat.” In other words – a competitive advantage. But, creating an economic moat isn’t enough. Anyone can simply say “our competitive advantage is great customer service” and call that their moat. But the question is, how durable is it? What if someone comes along with better staff, that are more loyal, more knowledgeable, and are paid more? Or what if they have a product that is so superior to yours that the excellent customer service becomes inconsequential? Now you’re stuck.
What you need to build into your business is a durable economic moat. This is something that Warren Buffett and Charlie Munger regularly preach about in their investment strategies. They want to look for good investments, at a cheap price, that have longevity because of the economic moat. In fact, Pat Dorsey wrote a wonderful book called “The Little Book That Builds Wealth: The Knockout Formula for Finding Great Investments” where he breaks down a lot of fantastic economic moats that businesses have built. And that is what I’m going to do right now. Let’s talk about 4 of the most common durable economics moats that you can build into your business that will scare away the competitors from getting in the water with you because they know that they have no chance at surviving.
The first one on the docket is what I like to call “intangibles.” Usually when people hear that word, they think of something like a trademark, copyright, or a patent – a great asset if you’re willing to go to court to protect it. Another type of intangible is a brand. Something recognizable that people always go to because it means something to them. An example of this is McDonald’s. Everyone knows this brand, they know what they will get, they know the service level, and they can depend on it. But don’t be fooled… it took many years, and lots of money, to build this brand. And, I bet a good chunk of that money was put towards muscling out the competition in order sustain the brand. Too many small businesses think that because they’ve created a logo and a mission statement they all of a sudden have a brand that sets them apart from the rest. Newsflash – no one cares! One of my favorite intangibles are any types of customer agreements or licenses. Maybe you have a supplier that has exclusivity to you on product or price. Maybe you have a license of some sort from a governing body like the government that is difficult to acquire. Maybe there is a limit on the number of businesses that can operate or the number of competitors that can exist. These are fantastic!
Next on the list is the sought after “network effect.” Boy, these are hard to acquire but if you’ve got it, then you’ve got something special on your hands. Another way to explain a network effect is a “multi-sided marketplace.” Dating apps have this. No one is going to jump onto a dating app if there is no one else there to date. Similarly, social networks, like Facebook, have a similar moat – who is going to go onto a social media app if there is no one else there. Maybe your business is a literal market place where you are bringing together customers and buyers? Maybe you are providing a home service where bring together people that need work on their house done and the contractors that will do it. If you’ve build a network for your business (which is EXTREMELY difficult to do) you are golden!
The third economic moat that I think is notable to mention is switching costs. This generally refers to how difficult or expensive is it for a customer to switch away from your product to a competitors offering. This frequently happens in the technology space. Think about your smartphone device and how integrated it is into your life. Or even your spreadsheet and word-processing software. What a mess it would be to have to convert everything over and relearn a new system. Boom!
And finally, let’s talk about cost advantages. Contrary to popular belief, this doesn’t mean the cost of goods sold or cost of doing business. But instead, it is the cost of scaling up. For example, take a parcel delivery company like UPS. They already have planes and trucks going to every corner of the globe. So to deliver additional packages comes at a very small or trivial costs. For them to scale up marginally and knockout a competitor is easy.
Okay, so with all that being said, take some time. Analyze your business. Take a look at your industry, the competitors, and the blue/red oceans. And then build a durable economic moat to dominate for years to come!