JD Logistics, Coupang and Entry Barriers That Even Tech Can’t Breach (Tech Strategy – Daily Article)

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Competitive moats (i.e., structural advantages) tend to be viewed as one thing. But it is usually two. And it is helpful to view it this way when looking at the impact of various digital tools. Here is how I separate it.

  • Competitive advantages
  • Barriers to entry and other soft advantages

See the green part below.

A few comments on this distinction.

Some businesses are easy to enter but hard to win. There are low barriers to entry – but strong competitive advantages in the market. Incumbents use their competitive advantages to keep new entrants small or drive them out of business.

Virgin Group founder Richard Branson discovered this when he launched Virgin Cola in 1994. It had great marketing, a good taste and effective distribution partnerships. And his cola got traction with consumers, in the UK in particular. It later entered the USA and Virgin Cola even appeared in an episode the TV show Friends. But eventually Coca-Cola responded and began to ground them down over time. By the early 2000’s, Virgin Cola was effectively gone.

In contrast, some businesses are hard to enter but easy to survive in. Sometimes there is only a big barrier to entry. You can’t sell a single product and earn a single dollar until you have overcome a fairly big first step. Entry barriers can be actual costs. But they can also be other difficulties as well (more on this below).

Entry barriers can be about actual challenges. But they can also be about new entrants just being unwilling to try. They view the space as too hard. They are afraid of an incumbent with a history of responding aggressively. In practice, barriers to entry are a mix of “unable” and “unwilling”.

And, finally, some businesses are both hard to enter and hard to win at. They have big barriers to entry and incumbents have strong competitive advantages. Mobile networks are a good example of this.

  • The entry barrier is massive. You have to get spectrum licenses. You may have to get one of a few operating licenses, depending on the country.
  • You also have to build a nationwide network of base stations and other hardware. Plus software. And you have to build the entire mobile network before you can sell to a single customer. Because nobody wants a mobile service plan that doesn’t cover anywhere. It’s a huge first step.
  • And then, once you enter, you are a new player facing off against several large competitors with formidable advantages. It is a never-ending fight in terms of maintenance capex spending, continually required network upgrades and big marketing spend. It also happens to be next to impossible to move the revenue line, as consumers want ever-increasing speed and capacity but are never willing to pay more. It’s a tough fight and the large players have major advantages.

Ok. With that, I am going to focus just on barriers to entry.

Assessing an Entry Barrier: What is the Cost, Difficulty and Timing of Entry?

When assessing a barrier to entry, my standard question is:

“What is the cost, difficulty and timing of entry for a well-funded, well-run competitor?”

That is really where the rubber meets the road in all of this barrier analysis. Are well-funded and well-run competitors going to be jumping into this business on a regular basis or not? If they are, it is going to change the dynamics and make it much harder. If they are mostly unable and /or unwilling to do so, then the dynamic is different. And almost always better.

Estimating the cost of entry is usually pretty easy.

This is just a standard reproduction valuation. What would it cost to reproduce all the key assets (tangible and intangible) of a viable business in this market? What assets would you need to put up a reasonable fight? And what would that cost?

I make a list of the assets and price them out.

  • Tangible assets. For example:
    • T-Mobile’s mobile network infrastructure.
    • BNSF’s fleet of railcars.
    • BNSF’s railway network.
    • InterContinental’s fantastic resort on the beach in Hua Hin.
    • InterContinental’s fantastic hotel on the Hong Kong waterfront.
    • Starbuck’s +4,700 retail coffee outlets in China.
    • JD Logistics +800 warehouses in China.
    • FedEx’s global express delivery network of warehouses.
  • Intangible assets. For example:
    • Marvel’s rights to Iron Man.
    • Starbucks’ +17M US rewards program members.
    • The New York Times’ +7M subscribers.
    • Coca-Cola’s +100 years of accumulated global marketing spend.
    • McKinsey & Co’s client relationships.
    • Apple’s +10 years of accumulated R&D for smartphones.
    • Huawei’s culture and HR policies for organizing +194,000 staff, mostly engineers.
    • The alumni network of Columbia Business School.

This is standard reproduction value. But you can see, we are trying to estimate the costs of lots of things that aren’t explicitly on the balance sheet.

The second part of my question is where this gets more interesting. What is the difficulty of reproducing the assets?

Look at the same list of assets again. Could you actually just write a check and buy or build them?

Tangible assets.

  • T-Mobile’s mobile network infrastructure? Yes. You can buy it. But it’s big and expensive.
  • BNSF’s fleet of railcars? Yes. And you can lease them.
  • BNSF’s railway network? No way. Securing all the land rights for a railway network that covers half the USA is impossible now. You needed to do this a hundred years ago.
  • InterContinental’s fantastic resort on the beach in HuaHin? Probably. Beachfront in Thailand is abundant.
  • InterContinental’s fantastic hotel on the Hong Kong waterfront? No way. Waterfront land in downtown Hong Kong is impossible to get.
  • Starbuck’s +4,700 retail coffee outlets in China? Yes. Luckin Coffee, for better or worse, did this in 2 years.
  • JD Logistics +800 warehouses in China? Yes, in theory. But it’s expensive.
  • FedEx’s global warehouse express delivery network? Yes, in theory. But very difficult and expensive. Especially as the network gets bigger.

Intangible assets.

  • Marvel’s IP rights for Iron Man? No. It can’t be bought from Disney. And it is exceptionally difficult to build globally popular IP.
  • Starbucks’ +17M US rewards program members? No. You can’t buy loyalty from customers. And you can’t buy the members of another company and transfer them. Even a simple, attractive discount program is difficult to build.
  • The New York Times’ +7M subscribers? No. It can’t be bought or built easily. Virtually every newspaper is trying to do this and only a few have succeeded.
  • Coca-Cola’s +100 years of accumulated global marketing spend? Not really. This is tens of billions of USD spent across hundreds of countries.
  • McKinsey & Co’s client relationships? No.
  • Apple’s +10 years of accumulated R&D for smartphones? Yes and no. Accumulated R&D in science is difficult to buy. But technology in consumer electronics goes obsolete fast.
  • Huawei’s culture and HR policies for organizing +194,000 staff, mostly engineers? Yes. It could be copied. Probably for free.
  • The alumni network of Columbia Business School? No.

Most of my favorite businesses have key assets that can’t be bought and are really difficult to build. It can be an interesting mix of assets.

  • Reputation and customer relationships. This is a complicated bucket. Loyalty, trust, enthusiasm, etc. But you generally can’t just buy them.
  • Intellectual property and creative projects. It’s hard to create the Beatles or U2. You can’t just buy one. Outstanding investment and insurance underwriting teams are also hard to replicate.
  • Some technology. China has been attempting to design and manufacture high-end semiconductors for decades. And has been spending billions. But it’s really difficult. Getting through clinical trials with a new drug or biotech device is also exceptionally expensive and difficult.
  • Various physical assets. Land and physical assets can be surprisingly difficult to acquire.
  • Physical and digital networks tend to be difficult to reproduce. Especially global ones.

The final part of my question is something that is often overlooked. What is the timing for reproducing the asset? Can you do it fast? Is it something you can force? As Buffett says, you can’t make a baby in a month by getting 9 women pregnant.

Look at the list of assets again. How long would it take to buy or build each asset? Could you force it? I won’t go through the list again. But think about which assets would take literally decades to reproduce.

  • FedEx’s global warehouse express delivery network? This would probably take 10-20 years to recreate. Alibaba has been working on this for +15 years.
  • Coca-Cola’s +100 years of accumulated global marketing spend? Legacy brands take a long time to build. Every human being alive has been seeing Coca-Cola ads every day of their life.
  • Starbucks’ +17M US rewards program members? This probably takes +10 years.
  • McKinsey & Co’s client relationships? Decades of meetings, proposals, projects and dinners. Plus, McKinsey alumni become clients.
  • The alumni network of Columbia Business School? Decades. It’s a slow network effect.

There are certain types of barriers that can’t be forced. They are a long, slow path.

Overall: I really like entry barriers that are expensive, difficult and take a long time.

However…

Digital Is Wreaking Havok on Entry Barriers

Which brings me to the point for today.

Digital tools are just taking down entry barriers left and right. Companies like Alibaba and Google are dedicated to creating tools that let SMEs do all the things big companies can do.

  • Amazon Web Services has effectively eliminated the entry IT costs for small digital companies, especially those in software and mobile apps. You don’t need servers, software or IT staff before you can enter a market with a digital good.
  • Shopify has done the same for small merchants with physical goods.
  • Social media is creating new ways to connect and engage with consumers, eliminating the big marketing spending advantage of larger brands.
  • Anyone with a laptop can be a newspaper now.
  • Anyone with a camera phone can be a news or media company. Note: Joe Rogan sat at a desk in his basement, smoked weed and chatted with his friends. And he became the next Johnny Carson.

Digital tools are laying waste to lots of traditionally powerful entry barriers.

 

However, there are also new assets emerging that need to be reproduced. Digital goods and services are created by people and intangible assets. What is the reproduction cost of?

  • Intellectual property. Think patents and copyrights. What about R&D not formally recognized as IP?
  • Organizational capital. Think business processes, techniques for production, organizational forms and business models. When a company buys an ERP system, the money spent on business processes is 3-5x cost of the hardware and software.
  • User generated content.
  • Human capital. How many years of training is required for a data scientist? A software engineer? A team doing deep learning?

My current position is that many, perhaps most, traditional barriers to entry are under assault by various digital tools. Especially if you are in an information business. But other new ones are emerging.

Which brings me to my last point.

JD Logistics and Coupang Have Awesome Entry Barriers

JD Logistics has just gone public. And this follows the IPO of Coupang a few months ago. Everyone calls Coupang the “Amazon of South Korea”. But it’s much closer to a mini-JD.

What do you see if you look at those companies and ask my barrier to entry question?

“What is the cost, difficulty and timing of entry for a well-funded, well-run competitor?”

I’m not going to repeat my summaries of these companies here. You can see that for Coupang at:

You can see my notes on JD Logistics at:

And both companies have lots of competitive strengths and structural advantages. But it should jump out at you that they have big, big entry barriers that would be very expensive,  difficult and time-consuming to breach. It would take a long, long time. Probably a decade. So even if the moat was being breached, you would see it coming a long ways off. A new Kuaishou or Clubhouse could emerge next month, despite their network effects. But I would see a new JD or Coupang emerging 5 years in advance.

Both companies’ barriers are digital-physical hybrids.

  • They have lots of physical assets (which I like).
  • They are digitizing and connecting them. So they have a lot of the above mentioned digital assets that are hard to reproduce.
  • And these digital-physical assets are forming a connected network.

I like all of that.

All three of those factors meet my costly, difficult and time-consuming criteria for barriers.

That’s it for today.

Cheers from the El Paso airport, jeff

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