I spend some of my time advising startups. After hearing the company’s overall concept, my first question is always how they plan to build defensible barriers to entry against potential competitors. Usually the response I get is that others won’t be able to compete with their first-mover advantage or the strong talent they have, especially on the engineering or product team.
However, while these elements are helpful to a growing company, neither of them is a true competitive advantage. In fact, there are ultimately only a few accepted barriers to entry:
- Fixed Costs: Companies can scale without increasing their marginal cost (Time Warner Cable).
- Network Effects: Customers are locked in because they have created connections that would be hard to replicate (Facebook).
- Switching Costs: Users are locked in because they have stored a tremendous amount of information with the company that would be difficult to move (email provider).
- Proprietary Processes: These provide tremendous efficiencies and economies (Google, Wal-Mart)
- Proprietary Technology: E.g., pharmaceutical companies.
- Patents: E.g., Rovi.
Complicating this situation is that there are other factors that appear to be competitive advantages but actually are not:
- Brand: Brands strengthen and weaken, and companies spend millions of dollars per year shoring them up. The concept of brand is ephemeral, and unless companies continue to come out with strong offerings on a regular basis and win on one or more of the above six elements, they will fade into obscurity.
- First-Mover: Ask Friendster about this one.
- Funding: There’s always someone with more money (or willing to spend more).
- Personnel: Employees move around quickly and often; companies need to be able to move on no matter who is in place. No one should be — or is — indispensable.
Obviously when companies are in their start-up phases, none of them has built true competitive advantages. However, crafting the company’s strategy around these ideals is critical, and the more that founders contemplate them ahead of time, the better the position in which they will find themselves as the company matures.