You’ve finally built a successful business. But what’s stopping it from falling down? What’s stopping a younger and more innovative new entrant from stepping on your territory and claiming the market for themselves?
The short answer is: not as much as you think.
The reality of business is that you’ll always have competition and you’ll need to be always prepared for newcomers to aggressively take market share from you or try to edge you out.
For this reason, if you haven’t built a long-term competitive moat, you’re leaving yourself seriously exposed to the likelihood of invasive competition sooner or later.
What does competitive moat mean? What are the different types of competitive moat? And how do you go about building a defensive moat for your business?
Let’s dive in!
What does a competitive moat mean?
In short, a competitive moat is defined by Charlie Munger as “the intrinsic characteristic that gives the business a durable competitive advantage.” Capability of a business or its product that makes it untouchable to competitors.
The term was first coined as an economic moat by US billionaire Warren Buffet when describing how businesses can and should set themselves apart from their competition over the long-term. In describing a moat, he said:
“The key is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.”
In layman’s terms, a competitive moat in business can become a unique, sustainable selling point and provide a strong advantage if it is well constructed. It offers an advantage that competitors can never get overcome.
What does a competitive moat look like in practice?
The core purpose of a competitive moat is to build up high defensibility and give the business a competitive advantage, which can be manifested in higher sales, margins, or better customer loyalty.
If you think about it, any successful business around the world will have established ways of protecting their business by developing a competitive moat. Let’s now explore how businesses build their moats and how they differ.
Types of competitive moats
If you look closely at any major business brand, you’ll see how their moats are constructed in different ways.
For example, Nike’s moat is built around its iconic branding. On the other hand, Twitter’s moat lies in its networking ability. With Walmart, it’s the company’s pricing strategy.
There are different types of economic moat that a business can build around itself.
1. Network effect moat
As the modern world becomes increasingly more digital, brands are realizing the huge advantage that can be gained through “network effects.” In this scenario, a new user switches to a brand in order to interact with an existing customer of that brand.
As more users adopt that brand, new users are increasingly incentivized to sign up too. The exponential growth brought about by this network effect can really reinforce a brand’s competitive advantage (sometimes in a short space of time).
But what does that look like in real life?
One great example is the universal adoption of social media. You’ve got Instagram, your mum’s got Instagram, even your dog’s got Instagram. As more people join a social network, the more likely others are to join in order to stay in contact and interact with their (demographic) peers.
More users means more value – not just for the brand – but for potential users ready to join the platform.
The big question is – how do we build a “network effect” moat?
- Maintain focus on customer and user retention, so that acquisition develops naturally
- Develop word-of-mouth channels and possibilities around the platform
- Develop different product features that appeal to different audience niches
2. Switch-cost moat
This moat is build up around ensuring there are costs involved when switching from one provider to another.
The costs can be either direct or indirect. Direct costs are incurred by the actual switch themselves and include cancellation costs, or implementation costs, etc. Indirect costs are usually incurred through secondary activities, such as training costs or time spent on learning a new system (learning curves training or other related administrative tasks).
When switching providers, consumers are always looking for a smooth transition. But when the cost of making this transition exceeds the proposed value of the switch itself, then that switch no longer makes sense.
What does a Switch-cost moat look like in real life?
Let’s take a B2B example, where your startup business purchases and implements a CRM platform.
To recap, a Customer Relationship Management (CRM) system is essentially software designed to organize and automate businesses. As your business grows, your CRM software is designed to grow alongside it. For example, personalized features are so standard across the CRM industry these days, whereby the CRM system is entrenched so closely to customer’s processes that they have no choice but to maintain their subscription with a certain provider. From a cost and administration perspective, it would simply be too much of a headache for a startup business to start all over from scratch.
How do we build a Switch-cost moat in business?
- Personalized feature implementation and product-customer integration
- Regular, world-class, sustained customer support
- Continuous training on product usage, especially around new features
In B2C markets in particular, many service providers such as telecoms providers, insurance companies, and computer operating systems maintain wide-ranging cost-switch moats.
3. Brand recognition moat
As the business owner, you know all about the power of a strong brand name. In fact, it’s likely to be one of your main goals – to become a household name through the sale of your products or services across the globe.
Once customers attach themselves to a certain brand to the extent they become advocates and evangelists, it’s very hard to dislodge that type of loyalty.
Name value is more than just value. It’s true power. Think about it! You walk by a store and see two pairs of sneakers that you really like, displayed side by side. They’re both made from the same material, they’re identical in colour, and they’re priced the same.
Yet only one pair has that big, distinguishable Nike tick on them. You buy Nike sneakers every single time. No question about it. Why? Brand recognition.
Band-Aid, Dyson, and Pampers are all examples of how a brand can be so powerful that they become synonymous with a certain product. They are the product.
How do we build a powerful brand name?
- Consistent messaging across your entire brand. Let customers know what your story is all about
- Longevity. A brand moat isn’t built overnight. It’s about the product’s prolonged success and presence in the market
- Communicate your product’s unique advantage. Stand out and explain why
- Become a thought leader for your industry, developing narratives and new ideas
4. Access to capital moat
The access to capital moat makes the most sense, but it is the hardest to achieve from a business owner’s perspective.
It’s the idea of cost leadership – access to capital allows you to build up sufficient cash reserves, which in turn allows you to influence your investor’s IRR. That is thanks to the effect high reserves have on your discounted cash flows.
Multinational businesses often process hundreds, thousands, even millions of transactions per week and each of those transactions costs a small amount to process.
The sheer volume of transactions that a huge company, such as, say, a Fintech startup, can process in a day, means that each transaction costs less. Likewise, goods bought in higher volumes can be bought for less per unit than those bought in less.
The access to capital moat basically comprises the overall economies of scale of your company.
Simply put, this means that a capital-efficient startup is simply better at offering their customers more for less.
Cheap, mass materials; cheap, mass labor; cheap, mass resources can only mean one thing for business: sustained, protracted success.
A case study: Clubhouse vs. Twitter
When the pandemic hit, Clubhouse was the most sought-after app in the App Store. Potential users were falling over themselves to get an invite and start using the audio-first platform. There was a problem – their technology was very easy to replicate.
Audio-first platforms started popping up everywhere, and these days Twitter Spaces is the dominant player in the audio-first app market. Why? The Network Effect; everybody is already there and they recognize the Twitter brand name. Even taking into account the current controversy surrounding Musk’s management of Twitter – their moat is holding up.
What’s the significance of this?
When was the last time you joined a Clubhouse call?
Wrapping up, we can’t stress enough how paramount your competitive moat is to the survival of your business. Even a year ago, when valuations peeked, poorly communicating your competitive moat to investors was not an option.
Your competitive moat affects the core of your business model, and thus how your investors see you. Even if after reading our article you’re confident your business has achieved a defensible competitive moat: are you sure you’re communicating it well enough in your deck?
Here at Waveup we worked with hundreds of founders globally and in almost every case we had to significantly upgrade their competitive moat narrative in order for the project to successfully fundraise.