There are lots of analogies floating around for how to think about competitive strength.

And I’ve been using a common one, which is calling it a moat.

The analogy is that moats are how you protect your treasure, which everyone will try and take from you. That’s the standard analogy.

Photo by Colin Watts on Unsplash

You can explain moats using economic theory. It goes like this.

If you are making attractive economic profits (say ROIC of 12% versus WACC of 6%), you are going to attract competitors. Other parties are going to see that in your business you can deploy capital at 6% and make 12%. They are going to enter your business to get that gold.

New entrants increase the players. There is increasing rivalry. And the ROIC decreases (say to 10%).

But parties will keep entering as it’s still profitable. And the ROIC will keep falling.

When the ROIC falls to about 6.5% versus 6% WACC, parties (in economic theory) will stop entering. As there is no more “gold” to be had. That is the natural process of a free market.

Unless something stops this process. Unless there is a barrier that stops new entrants and/or puts rivals at a disadvantage. We need structures to stop the natural free market process. That’s how you get long-term protection and maybe larger than normal profitability in a business.

That’s the economic theory. In economic reality, it’s more complicated. It’s messier. Sometimes it’s helpful to make all this theory simpler.

I have a short list of rules for that. I’ve been studying digital competition for +10 years. If I were to summarize it all in a few rules, it would be these 6 rules.

Rule 1: Whenever Possible, Compete Against Businesses that Suck

My standard question (and joke) is what is the best strategy for winning lots of tennis matches?

The answer is you only play against people that suck.

It’s the same in business.

Tesla is currently struggling against highly capable EV producers. From Japan and especially from China. But sister company SpaceX mostly competes against legacy government contractors like Boeing and Lockheed Martin, who have high costs and slow bureaucratic processes. This allowed SpaceX to disrupt the industry much faster than if they had been fighting lean, aggressive startups.

Rule 1 is about seeking out weak competition rather than trying to out-innovate or out-perform the world’s most efficient and effective players. It is easier to maintain high margins and market share when your rivals are slow, inefficient, and/or technologically stagnant.

“The secret to life is weak competition.” – Warren Buffett

“It’s way better to be in securities markets if you have a hundred IQ and everybody else operating has an 80, than if you have 140 and all the rest of them also have 140.” – Warren Buffett

Rule 2: Whenever Possible, Get to a Market Early

Entering a market early means fewer competitors. And no entrenched incumbents. This makes life a lot easier.

And it gives you a window of time to capture mindshare, define the product category, and advance along the learning curve.

A digital example is Amazon, which entered the online book retailing space when the internet was still in its infancy. By the time traditional retailers like Barnes & Noble pivoted to digital, Amazon was way ahead.

But we see this all the time.

Before Red Bull, the beverage market was mostly soda, juice, and water. Red Bull, launched in 1987, spent years as the only energy drink on the shelf. They established their brand, distribution and high price point long before Coke or Pepsi realized people would pay $3 for a tiny silver can. 

Rule 3: Whenever Possible, Avoid Entrenched Competitors and Low-Cost or Free Substitutes

In fast-growing markets, there is usually room to grow. But in slow growth markets, growing means taking customers from rivals. That is almost always much harder.

In this case, it’s much better to fight in a market without entrenched competitors. You’ll have rivals. But you really don’t want ones deeply dug in and fortified. They are really hard to take customers from.

Similarly, you want to be wary of markets with low-cost or (God forbid) free substitutes.

Low-cost substitutes will put a price ceiling on your product. It’s really hard to sell physical encyclopedias, if free digital versions are available (Wikipedia). Similarly, ride-sharing businesses like Grab and Didi struggle because there is low-cost public transportation (buses, metro) available.

***

These first three rules are about avoiding the hard fights. But you can’t avoid them forever. You also have to know how to win the hard fights. So do the following.

Rule 4: It’s Easier to Dominate Small Markets than Large Ones

Everyone wants a huge TAM. Everyone dreams about the big China market. Look at all those potential customers.

But when I see a big market like China, I see a lot of potential competitors.

I like small markets, with lots of interesting and niche characteristics.

I’d rather dominate a niche market than compete as a small player in big fragmented market. Better a big fish in a small pond. And once you control a small pond, you often have the resources to expand into another one. And maybe into the ocean.

Facebook (Meta) is a well-known example of this. It began exclusively at Harvard University. By dominating a tiny, closed market of a few thousand students, they perfected the network effects and social mechanics before expanding to other Ivy League schools. And then the world.

Rule 5 (Towson’s Rule): Never Fight Fair. Always Have a Moat or Other Competitive Advantage.

This is kind of my core rule. Never fight fair. Don’t cheat. But always have an advantage.

And this is even more important in digital business.

Most software apps make no money. How many apps on your phone are you actually paying for?

Similarly, most creators of information goods (YouTube channels, eBooks) get no views. The success rate is very low. And those few that do get views still make little money. My standard joke is that writing books and creating content is like venture capital without the upside.

Software and digital goods are just too easy to replicate. The sea of competition is endless. You need a moat to limit this.

So, you need a clear plan for the moat you are building. Great machines don’t assemble themselves. And nobody builds a moat by accident.

And keep in mind, competitive advantages and barriers to entry take time to build. It usually takes a few years – but winning long-term is impossible without one.

Rule 6: Winning Once Is Way Better than Having to Win Over and Over

This is my last rule.

The average restaurant manager works harder than Mark Zuckerburg and Bill Gates. Those two guys focused on profitable businesses where you really only had to win once. They achieved significant market share in businesses with powerful network effects. And then it was mostly game over. They’ve been cruising ever since (mostly).

In contrast, your average restaurant manager must fight for new customers every single week. It never ends. You have to win over and over again.

Rule 6 is that winning once is way better than having to win every day. And it’s a corollary to Rule 5. That if you have the right strategy and are actively building a moat, you often just have to win once.

That’s it for my 6 rules. I hope this was helpful.

Cheers, Jeff

———–

Related articles:

• What is the Secret of Pinduoduo’s Success? With Matthew Brennan and Elliott Zaagman. (1 of 2) (Tech Strategy – Podcast 45)
• What is the Secret of Pinduoduo’s Success? (2 of 2) (Tech Strategy – Podcast 46)

From the Concept Library, concepts for this article are:

• Competition

From the Company Library, companies for this article are:

• n/a

———-

I am a consultant and keynote speaker on how to increase digital growth and strengthen digital AI moats.

I am the founder of TechMoat Consulting, a consulting firm specialized in how to increase digital growth and strengthen digital AI moats. Get in touch here.

I write about digital growth and digital AI strategy. With 3 best selling books and +2.9M followers on LinkedIn. You can read my writing at the free email below.

Or read my Moats and Marathons book series, a framework for building and measuring competitive advantages in digital businesses.

This content (articles, podcasts, website info) is not investment, legal or tax advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. This is not investment advice. Investing is risky. Do your own research.