By Sajjad Hussain on The Capital
In the business world, competition is an eternal normal, and it will always be the wave of the River. There are always new companies spying on other people’s territory, and existing companies are always trying to protect their markets. In this regard, Building a moat is a powerful means of protection. So what types of moats are there? How should we build our own moat?
Value can be created through innovation, but how much value an innovator can accumulate depends partly on how quickly competitors imitate innovation. Innovators must stop competition in order to reap some of the value they create. In various situations, these ways of preventing competition are called barriers to entry, sustainable competitive advantage, or in layman’s terms, a moat. There are many different moats, but their roots are only a few different principles. This article attempts to classify the most famous moats based on these principles so that they can be systematically evaluated when the company is established.
I will try to focus only on obstacles that seem to have structural causes. This does not include things like management talent, founder’s vision, company culture, etc. These things are usually not imitated, but the reason is not because they cannot be imitated in many cases, they are just a sign of some seemingly rare ability. Although ability may be the ultimate competitive advantage of an individual, it is the property of the individual, not the company. (Some things belong to corporate culture and not just personal abilities, which will be discussed later.)
The last point of this long-winded preamble there is no inventions here, just classification. Every business strategist seems to have its own list of moats, including Porter, Rumelt, Helmer, Greenwald, Mobsen, etc., and can even be traced back to Adam Smith. This article is not very interested in the moat catalog or the benefits that a certain kind of moat can bring; this article is more interested in trying to summarize the common mechanisms of the moat to determine the difficulties that startups may encounter when establishing barriers to competition.
When you were in high school, you probably already knew that in a perfect market, excess profits exist because company competition will squeeze it out. However, if an innovation can create better products or launch products in a cheaper way, innovators can get some excess profits from innovation. This excess can only last until competitors catch up and imitate their innovations. One of the strategic tasks of innovators is to prevent others from imitating as long as possible.
This applies not only to companies in mature markets but also to startups that establish new markets. If a startup is clearly successful and customers are rapidly adopting their products, then more existing companies and other entrepreneurs will soon imitate them, thereby taking away part of the innovation value and eventually eliminating the innovators can Excess profits. Startups must also try to prevent others from imitating.
Innovation is a type of competitive advantage (although not all competitive advantages are innovations), and the strategic work is to maintain the sustainability of this competitive advantage (Michael Porter, “Competitive Advantage”), so as to maintain competition as competition Advantage of the fortress. In layman’s terms, the mechanism that prevents or slows others from imitating is called the moat.
The moat relies on one of the following four basic sources to prevent imitation:
- Special knowledge,
- Scale, or
- System rigidity.
The following is a classification of the most common moats, sorted by source.
These four sources are either a special non-commercial force or a self-reinforcing mechanism. I will demonstrate the point that startups with high growth potential rarely have a sustainable competitive advantage from the beginning. In most cases, a sustainable competitive advantage must be gradually established. However, the conclusion of this conclusion depends largely on how the moat is obtained and what the potential sources are.
In each section, I will discuss the sources of competitive advantage and the resulting more common moats. These are not exhaustive lists. I will also briefly discuss how useful these moats are for early start-up.
Conceptually, the simplest barriers to entry are those granted by the state. The government directly or indirectly protects the company from competition. Governments choose to restrict competition for various reasons, such as encouraging certain behaviors (for example, patents), economic protectionism (tariffs, national champions), and political reasons (in exchange for fear of disappointing powerful voters, Or even simple political preferences.)
A common form of monopoly granted by the government is patents and other protections provided to companies through intellectual property laws. Usually with the purpose of encouraging inventors or preventing customer confusion. Patents are the most relevant to startups and can be a huge incentive because they can prevent competition for a period of time. For example, if the government does not allow an exclusive period, pharmaceutical companies may not invest heavily to develop and test new drugs. Because of the poor efficacy of similar drugs, Warner-Lambert has invested heavily in the development of a drug that may lower cholesterol. If it is effective, it will have a huge return. However, they can only get a huge reward if they can prevent others from copying any successful drugs they find. With Warner Lambert’s success rate, Lipitor became one of the world’s best-selling drugs, with sales exceeding US$125 billion during the US patent period.
The government can also grant monopolies more ambiguous policy goals. In the United States, for mysterious reasons, the government granted immunity to the antitrust laws of Major League Baseball. Get rid of the restrictions that any competitor must face, so that MLB has an advantage that no entrants have.
Some policies may not prevent competition but will hinder competition. Tariffs may make it non-economic for non-local companies to participate in competition. Licensing may result in time-consuming and costly entry into the market, and the standards imposed by regulations on new entrants may make it difficult to meet. What the government grants may not be monopoly, but oligopoly. For example, only a few electric scooter licenses or thousands of taxi licenses are issued.
Regulation may be an attempt to protect citizens, but it is usually also a means of rewarding political loyalty. Other means are sometimes more direct. Politicians may lead the government to support companies whose success is good for themselves, either because they have their own interests in the company or because the company has an influence on the power of the politician. In the United States, laws that favor car dealers fall into this category, as may the choice of government suppliers.
The government has other ways to reduce competition, such as designating national champion companies (for example, national airlines), or favoring certain companies through financial support or priority purchases, making it economically infeasible for others to enter the market. Airbus is an example in this regard.
Another kind of moat granted by the state is that companies control scarce resources through property ownership and contracts. This kind of control is granted by the state, and in a sense is implemented through state power. This is a different kind of government behavior than before the government did not give it an advantage, but defended it for it-an advantage created by a company that was smart or lucky enough. There may be a lot of overlap between them-the company may buy a patent, and then the government is both the patent granter and the defender of the company’s ownership-but this is an independent function.
The most direct control of resources is the ownership of real estate that can create economic benefits such as the ownership of gold mines, crowded retail locations, warehouses located in transportation hubs, etc. Companies can also control without having to own resources. Companies may be able to sign contracts to give them the right to use certain raw materials exclusively or preferentially. Or guarantee to get a contract with a certain amount of output from the supplier. Or sign a contract with the municipality or other partners to become the only telecommunications provider or one of the few companies that can use key APIs. Or, it may have signed a contract with the distribution network, making it very difficult to distribute competitive products-Pepsi and Coca-Cola make the most of this. Although this is different from full ownership in law, the results are similar.
Ideally, the moat implemented by the state belongs to a non-market system. This means that the sustainability of the moat is the same as what the government said. In some cases, this leads to a lack of predictability, while in other cases, it leads to considerable predictability. However, in order to win the favor of the government, it is usually necessary to do something that can greatly promote government policy (such as investing time to invent a thing that can get a patent); buy something, or have the political power to obtain the support of the target government.
Startups can start with this type of moat, and some people do. Many biomedical start-ups were created to further carry out research that was engaged in and patented in universities. This is also the case with technology patents, although they appear less frequently technology patents are usually easier to bypass, and the predictability of the value of a technological breakthrough is usually higher and earlier than pharmaceutical patents, so companies defy The cost/benefit analysis of patent law plagiarism innovation is usually different. For example, in 2002, Google publicly copied Overture’s (GoTo.com) pay-per-click auction business model, infringing several of the latter’s patents. Google finally settled the lawsuit against Overture’s then-owner Yahoo! for compensation of approximately $300 million in Google stock. Overture’s intellectual property protection did not prevent it from being imitated.
The value of Google’s own intellectual property, including the value of the PageRank algorithm patent that made its early search engines very efficient, was not obvious when it was patented. Page and Brin managed to sell to the search engine company at the time shortly after the technology was deployed, only because they could not find a buyer willing to pay such a high price.
Similarly, because these moats are negotiable, once the moat they have built cannot create excess value: they can immediately sell the moat at a price equivalent to the value that can be created in the future (if known). It was the establishment of the moat that created value, not ownership.
Knowing what others don’t know is a good way to prevent imitation. It restricts access to scarce but necessary resources.
For example, the hedge fund Renaissance Technologies has used a proprietary mathematical algorithm to create an annual rate of return of 71.8% for its Medallion Fund for 20 consecutive years. These algorithms were invented by Renaissance Technologies employees and are strictly protected. If everyone knows these algorithms, Renaissance’s profits will quickly disappear.
Only when you have the right to control access can you have exclusive access to something. Confidentiality must be used to limit access to knowledge or know-how. But how? Proprietary technology must be in the hands and minds of the holders, and apart from confidentiality agreements and the prohibition of competition in a few cases, employees are usually entitled to change employers.
Companies can protect certain knowledge by mastering it closely KFC’s secret spice recipe is locked in a safe in the vault at Louisville, Kentucky headquarters. This is a frequently cited example, as is Coca-Cola’s “secret” recipe. A better example is the trading algorithm used by hedge funds like Renaissance to earn returns that outperform the market. If these algorithms are not firmly grasped by the company, once the junior employees learn it, they will take it to companies with lower profits in exchange for salary increases or career development.
In the 1700s, the British government tried to maintain a national monopoly on technologically advanced cotton spinning mills by prohibiting the export of designs. Samuel Slater started working in a textile factory in England at the age of 10. He remembered the mechanical details of the textile factory and then immigrated to Connecticut to provide advice on the construction of the textile factory there. The design taken away from the United Kingdom established its own factory, which annoyed people in his hometown. Although it is difficult to quantify, such as “theft” of knowledge often occurs.
Although the government sometimes tries to prevent this from happening through trade secret laws, and companies can try to impose competition bans on it, it is common to spread knowledge through employee turnover. This is one of the reasons why the industry is concentrated in specific places: For example, the blood relationship of many car companies in Detroit is intertwined because of the flow of employees and founders. The same is true of many semiconductor industries in Silicon Valley. A study on the dissemination of knowledge of new industrial technologies found that “information about the detailed nature and operation of new products or processes is usually leaked in about a year.” Knowledge mastering is usually a temporary competitive advantage.
Implicitly held knowledge is a more sustainable advantage. Tacit knowledge refers to knowledge that is not easy to convey. It is not easy to pass it orally or in writing. Bicycling is a classic example: you can’t learn how to ride a bike by reading a book or watching a video. To learn to ride a bicycle, you must try to ride a bicycle (of course it is best to be under the guidance of a person who has ridden a bicycle before.) In a company, tacit knowledge can include manufacturing technology and other process knowledge (this is in It is very important in strict environments such as integrated circuit production), customer insights, supplier dynamics, and the path of continuous innovation. Tacit knowledge may be important in any field of “art more than science”. Competitors cannot obtain this kind of knowledge through industrial espionage, and they may not always obtain it through recruiting employees.
Examples of tacit knowledge in the company are everywhere — from engineers who can adjust processes to improve efficiency in chemical plants (although they can’t tell you exactly how they did it), to mechanics who can run any engine, to complex reading. Documents and pick out lawyers with questionable clauses. Complex tacit knowledge is usually mastered through trial and error and hands-on control over a period of time and maintained within the organization through an apprenticeship.
Although individual tacit knowledge is always valuable, as the scale of the organization expands, it is difficult to expand, so its competitive advantage is weak. Its sustainability can only be maintained until the competitor hires the individual who owns it.
Some tacit knowledge is not in the mind or hands of the individual but is reflected in the organization. All companies have no instructions and no documents to complete the work. Two people (or three people, or even the entire organization) may have tacit knowledge on how to cooperate with each other to be most efficient. The organizational practice of these companies is an advantage that is difficult to replicate because it cannot be described clearly in language, and it does not exist in one’s mind.
Although individual tacit knowledge is passed on every day, collective tacit knowledge is more durable and more difficult to obtain or imitate by competitors. Goldman’s continued success in the highly competitive investment banking industry is partly due to the transfer of common tacit knowledge from senior employees to more junior employees through long-term supervision. Some of this knowledge is about how to do the work itself, which is then transformed into personal tacit knowledge. But there are also some about how to cooperate effectively within and between companies. This knowledge is only useful when other people in the same company have complementary knowledge. Otherwise, even if the celebrity individual or the entire team is dug, only part of the tacit knowledge will be transferred with it, resulting in a greatly reduced usefulness.
For startups, special expertise is a weak moat. The founders often set up companies because they know something that few people know: they may be experts in a cutting-edge technology field, they may have learned valuable knowledge from their previous work, and realize that few people know It or they may have come up with a novel solution that no one seems to have thought of. However, if knowledge can be easily transferred or imitated, any advantages it brings to startups will be short-lived, unless the secret can be effectively kept for a long time. Practice has proved that this ability is very rare in the real world.
Even the tacit knowledge mastered by one or several people is difficult to control. In both cases, if the value of the knowledge is obvious, the holder may take it to an existing company to get a better return, because the latter may be willing to pay a higher price, and in this part, If knowledge is more widely spread, it can also open up a career path.
On the other hand, common tacit knowledge is important, but it takes time to build up. Therefore, startups need to find some temporary methods to prevent competition.