Part 1 : Moats and why do we need one?
Build moat as a means to fend of competition and build a sustainable business
A business moat is a key competitive advantage that sets a company apart from the competitor and provides a way to reinforce its competitive advantage. Warren Buffet emphasized the importance of moats, his famous quote being “The most important thing in evaluating businesses is figuring out how big the moat is around the business”[1]. The key to evaluating a early stage startup is how big and defensible the moat will be in future. Moats take years to build[2] and moats that are built in a year only accrue a small amount of defensibility.
Factors that define a Moat
Following factors define the defensibility of the moat and form the basis of competitive advantage [5]:
User acquisition: For a defensible moat the cost to acquire new users/customers decreases with scale.
Switching costs: A strong moat makes it difficult for customers to switch to another company for the same service
Engagement: An engaging product which becomes stickier and more
engaging as it grows will make for a strong moat.
Some types of Moats
Moats come in various forms, some of its types are as follows:
Network Effects: Network Effects is the phenomenon where a product becomes more valuable to its users as more people use it. This can create a "moat" around a business, making it difficult for competitors to gain a foothold in the market. For example, social media platforms such as Facebook, Instagram now have a large user base which it turns makes it may be more attractive to new users than a competing platform with a smaller user base. This in turn serves as a moat to prevent new entrants with similar products from entering the social media space.
Speed of delivery [3]: Speed of delivery is an important moat for companies which operate in space where customers value convenience and timely service. Zepto made speed of delivery its moat and grew in size very rapidly, with rest of the firms playing the catch up game.
Customer Service: Amazon developed it moat by providing exceptional customer services that sets the bar for rest of the industry. This moat also develops customer loyalty and satisfaction.
Marketplace Network Effects: A marketplace network effect exists when a company derives a durable competitive advantage from bringing together customers and suppliers in some kind of marketplace. Example: Amazon was able to bring together supplies and buyers in a marketplace driving lower prices and better selection for buyers and a large buyer pool for suppliers.
Data Network Effects: Like Google, a company thrives on this moat when it collects more user data to make the product(s) smarter, which in turn drives more users to it.
Platform Network Effects: A platform network effect exists when a company builds a durable competitive advantage by keeping its users engaged in its product
ecosystem [5]. Apple and Windows are an example. The users are kept engaged by apps developed for the particular ecosystem.
Next article, in the card below will focus on types of moats in detail.