Sep 04, 2013
Table of contents:
All companies seem to go through periods of highs and lows. A rising tide lifts all boats, and so it is only in a down economy where the really strong survive.
However all companies are also sensitive ecological organisms that are effected by the world around them. It is really quite rare for a company to continue to survive in the same form for a sustained period of time.
Instead, just like all organisms on this planet, a company has to evolve in order to survive. In a world of survival of the fittest, a company’s barriers of defence could mean life or death.
In this article I’m going to talk about why you need barriers for your company, the importance of a moat, and how you can build barriers of defence for your company today.
Actively thinking about your company’s barriers of defence against the competition might seem a little bit over the top. This is particularly the case when you are the market leader, or you are a new upstart trying to disrupt an established industry.
But you should be thinking of these things from the very outset because your company’s strengths should be rooted into the core of the business.
Even if you face no form of threat today, it doesn’t mean that you will remain unchallenged. If you don’t have a direct competitor pushing you around, this is probably the calm before the storm. Before you know it you could be destroyed by a plucky upstart.
Even if you don’t have an immediate threat, you will probably already be gravitating up market in the pursuit of higher revenues. This is leaving a gap at the bottom of the market where a segment of your customers are underserved.
If a competitor were to come in at the low-end of the market and start stealing your customers, what would you do next?
Warren Buffet once famously said, “In business, I look for economic castles protected by unbreachable moats.”. Warren is of course one of the greatest investors of all times and has literarily made billions from his take on the value investing thesis.
In medieval times, a moat was a deep ditch filled with water that surrounded a castle. This was a formidable form of defence because it would protect against attackers from getting close enough to do damage.
An economic moat is the defence a company has against competitors in the industry. For large established companies things like brand image, market share or economies of scale make it very difficult for competitors to beat them at their own game.
However, for smaller companies who can’t rely on market share or brand image as competitive advantage, they must build defensible barriers into their products and business models in order to keep their competitors at bay.
To read more about competitive advantage, read my review of Competitive Advantage - Creating and Sustaining Superior Performance and my post on Differentiation.
The following 4 methods of building defensible barriers are what I usually look for or advise a company to build in order to create a strong product. However, I think it would be incredibly difficult to build all of these elements into your product or company, and some might not make sense for your situation at all.
One of the greatest forms of business model competitive advantage is if you can take advantage of network effects. Networks are powerful because as each new person joins the network becomes stronger. Metcalfe’s law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system. For example, the only value of having a telephone is if everyone else owns a telephone. When a new person buys a telephone, everyone else’s telephones increases in value.
Network effects are extremely powerful, particularly in online business models that are of massive scale. Companies like eBay or Craigslist continue to dominate their industries because they have a concentrated network of buyers and sellers.
If you want to read more about the power of network effects, read the following articles:
Switching costs can be a bit of a grey area when it comes to barriers of defence. If your product has natural switching costs, this is a great situation to be in. However, some companies create artificial switching costs to try and prevent customers from leaving them. This is never a good tactic and so it is something you should actively avoid.
There are many different kinds of switching costs and not all of them are financial. For example, switching to a new product or service provider might include learning a new product, setting it up to work with your existing systems or the psychological risk of forcing your staff to use an unknown product.
There are of course many unscrupulous companies who make it almost impossible to cancel their services or have harsh financial penalties if a customer tries to leave. If you are resorting to these sorts of tactics, you have bigger problems to face. Don’t be a dick to your customers!
Of course it should go without saying that one of the best barriers of defence against the competition is customer loyalty. If you have a strong relationship with your customers they are far less likely to switch to a competitors product.
Whilst building customer loyalty is certainly not a new thing, I think today represents the best opportunity yet to build that relationship from day one. As more and more consumers go to the internet for their entertainment, research and time wasting, it gives hardworking companies a massive opportunity to connect with an audience.
Customer loyalty is an intangible barrier of defence, but it is also one of the strongest. If you set out to slowly build these kinds of relationships with your consumers, you will be in a much stronger position when a competitor comes a long to attack you.
Hopefully you have created a product that only gets better through time and usage. Historical data can be a very strong switching cost because the customer has invested their time into using your product.
I believe that all products that collect data should have a way to allow their customers or users to export their data. It is also usually in the interest of smaller companies to ensure that they can import this data format to make deflecting customer decisions easier.
However there is a lot to be said for creating value through historical usage that does not tie directly to raw data. For example, the analysis of the data, the workflow for producing the data or the presentation and interoperability of the product into the higher workflow of the individual are all things that are difficult to replicate for a competitor.
It’s not really surprising that some of the strongest companies that are around today benefit from incredibly barriers of defence. Each of the following 4 companies have created their business around these defences and so they remain untouchable.
As I briefly mentioned above, eBay is a fantastic example of a company that benefits from network effects. eBay’s two sided marketplace relies on both buyers and sellers. However, both sides of the marketplace will remain loyal to the market as long as the other side remains loyal too.
Buyers want to search and shop in a market that has the widest selection and range of prices. Sellers want to be part of a market that has the best access to customers.
The network effects of eBay are incredibly and have kept the online auction giant at the top despite any number of competitors.
It’s hard to underestimate the switching costs that Microsoft have created with their suite of Office applications. Almost every company in the world uses Microsoft’s Word, Excel, Access and Outlook applications. This means that in order to transfer documents to another company, the two companies need to use a compatible format.
This huge market domination have kept Microsoft Office as the unprecedented productivity software leader. When two customers need to interact through a common format, it is the company that can establish the standard that will end up taking the majority of the market.
McDonalds fast food restaurants remain one of the highest grossing revenue companies in the world after decades of operation. This even comes despite serious media backlash against the company and it’s unhealthy range of options.
Stories, documentaries and research studies continually blast McDonalds for it’s contribution to the obesity crisis. There is also a huge selection of competitors offering alternatives for McDonalds customers.
But McDonalds continues to remain one of the top brands in the world because of it’s customer loyalty.
Salesforce was one of the first real Software as a Service companies offering their Customer Relationship Management software without the traditional investment in on premises software.
CRM software has a number of switching costs because it is such a pain to transfer intricate data from one system to another. Salesforce is able to lock in customers with a high lifetime value because it becomes more compelling to stay as time goes on.
The ability to offer historical benefits for long serving customers is a huge opportunity for software products as customers become increasingly valuable the longer they stay as a customer.
So how do you go about building barriers of defence for your company? Well, personally I believe you should be thinking about these things from the very first day. Strong barriers of defence are core to the product and the company. I really don’t think any measure will be strong enough if it is not fundamental to the essence of your product or business model.
With that being said, here is how I would build or aim to cultivate the 4 barriers that I have discussed in this article.
You either have network effects in your product, or you don’t, there really isn’t a middle ground. Products or business models that benefit from network effects are very strong, but they are also incredibly difficult to pull off.
If you want to build a product or a business model around network effects you will want to build a two sided marketplace. However, you will be faced with a chicken and egg situation, and if you are trying to disrupt an incumbent like eBay, it will be the network effects of an established giant that you will be up against.
It is therefore a lot easier to find unoccupied space when looking to build a network effects business. AirBnb for example created an entirely new industry instead of directly attacking an incumbent.
As I mentioned above, there are good switching costs and there are bad switching costs. I would never advise that a company start dealing in underhand tactics to prevent customers from leaving them. Whilst you might be able to delay a customer from leaving you, it is only going to comeback and bite you at a later date.
Try to build a product that has natural switching costs such as when a customer starts to use your product, they don’t want to stop. This is achieved by creating a dramatically better product than what is currently on offer.
When you take this path, it forces your competitors to either fragment or differentiate across a totally different axis, or aim to be better than your product by an order of magnitude.
Customer loyalty is one of the best defensible barriers because competitors can’t just copy your feature-set or design in order to nullify it.
Whilst it’s easy to think that customer loyalty is only applicable to consumer facing companies, the same is also true for enterprise companies. You are still selling to an individual and a decision maker or influencer will still have loyalty preferences.
I really like the new crop of online companies that are building up customer loyalty even before their product has launched. It is an exciting time to be building a brand as there has never been a better time to connect with your audience.
And finally, try to build your product so that it only gets better with usage. If your product has only one source of value, and that value can be derived quickly, you aren’t going to have long term relationships with customers.
Historical usage not only promotes customer retention but it is also a strong switching cost when competitors come and try and tap up your customers.
Building features that benefit from historical usage should take advantage of the usage of the user and not easily replicable by importing exported data.
Again, this is not just an opportunity for enterprise companies, consumer companies can also achieve the same effect by building up a user’s profile, social graph or achievements in a game or learning environment.
All companies live and die, but the truly successful ones ensure their sustainability by building strong barriers of defence.
The best type of defence against market competitors is to build these defensible barriers into the core of your product or business model. When you product or business model actively encourages or benefits customers choosing you over your competitors, you are in a strong position to continue to prosper.
Customer loyalty is also an incredibly powerful attribute that seems to be lost on so many companies these days. Just because you have had some measure of success does not mean that you can take your customers for granted. Those that will continue to succeed into the future will have invested in relationships with their customers.
There are a lot of products and business models that have absolutely no barriers of defence against new competitors. The reason these companies are still around today is because they are not challenged. If you your company has no defensible barriers you are in a perilous position. Do not be arrogant that someone can’t come a long a steal your market, because it will happen before you even know it.
Always ensure your economic castle has an unbreachable moat.