Go-to-moat
Competition on the internet is savage.
Any idea that smells like money will have all sorts of organisms attacking it.
There are:
- The old way of doing things
- A genuine competitor team from somewhere else in the world that started at a similar time
- Direct clones — ones that pop up after seeing the raise announcement and try and recreate the code, the business and the even the GTM
- Rocket Internet (enough said)
- A fledgling Series A company with slow growth numbers looking for a pivot or a dominating one looking to expand
- A Tech Titan (often the most formidable competitor)
- An incumbent public company looking to defend eroding market share.
From the outset (1) & (2) are inevitable.
Many startups will be allowed to quietly acquire customers up to around $5M in revenue before (3), (4) & (5) come knocking.
Things get worse as the startup scales past $20M in revenue. Now (6) takes notice. And then eventually (7).
You can’t hide if you are making money on the internet. There are proxies to figure out every firm’s revenue — product reviews (Reviews/ratio x Unit price), LinkedIn headcount (headcount x $150,000) and even SEMrush (web traffic x industry conversion rate).
So, what are the consequences of this competitive reality?
Companies and products without a moat die.
A moat is some form of defensibility that inhibits new entrants from stealing or gaining market share.
It’s a very old business concept, but in the realm of startups, a lesser acknowledged component is the speed at which a moat can be built. A go-to-moat.
Some types of products and business models have clear paths to building a moat, while others do not.
The strongest moats are network effects, SEO domination, embedment, and user generated content or reviews.
Network Effects
Network effects are when every new user to the network adds more value to existing users. Basically, as more people use the product it becomes better by virtue of more people using it.
The clearest example of a network effect is a social network. As more people use LinkedIn, it becomes more valuable to LinkedIn’s existing users. There are more people to connect with and more opportunities to message prospective employers or employees. More users means a better experience, which leads to more users.
People love to talk about this as a growth flywheel, but it’s actually more about defensibility.
Why does no one try to create a new professional networking platform even though the market’s growing? Because LinkedIn’s network effects act as a moat. A moat that is so large, even the bravest person won’t cross it.
SEO Domination
You want to buy some flowers for your mum. You Google, ‘Flower Delivery Sydney near me’.
Who comes up first?
It might seem innocuous but ranking first in a search engine is one of the best moats for internet businesses. It’s called the art of Search Engine Optimisation (SEO). It’s basically about your website or digital materials in such a way that is easily picked up by a search engine, primarily Google, and you come up in a search before competitor. It’s such a moat that you can sell a completely undifferentiated product (flowers) and still charge a premium if you rank first.
However, it’s only a moat for a very particular type of business. No one cares if your quantitative trading firm ranks first on Google, but your competitors sell by playing golf with C-suite execs.
For an SEO moat, the key ingredients are:
- A market where customers primarily use search to find vendors,
- A market with low average order value, where the buyer & the user are the same person.
If these two factors are at play, a business can build a very large moat by optimising search engines to rank on the first page.
Learn more about how to win at SEO.
Embedment
Any new startup is in a race for their product to become so embedded into their customers’ life that they can’t switch to a new competitor because it is too difficult to do so.
This is commonly called switching costs. It’s where another product may be cheaper but the cost of switching to a competitor would be greater than any discount they could offer. Google Cloud may be cheaper than AWS but migrating all your code off the platform is going to cost an arm and a leg.
In the context of a go-to-moat, embedment is a more useful concept as it is a race to get embedded into workflows. Switching costs are a secondary effect of this.
For a company that sells to B2B, here is the basic idea. The most embedded product is the most defensible. In this case, the most defensible is the operating system for the entire company. Think Atlassian or Microsoft. Then we have a department OS, it might be Hubspot for marketing or Xero for the finance team. Next, we have the company-wide app, it’s not the operating system that orchestrates key workflows. It could be the HR platform that all staff use. Finally, the department app. Think Mailchimp for marketing.
Products that don’t have a path to expand up the value chain are in trouble from incumbents who can easily expand down it.
We love product wedges that have ambitions to be company-wide operating systems. Mr Yum, is possibly the best example of this.
User Generated Content/Reviews
Imagine starting Wikipedia again.
Businesses that can get their users to generate content/reviews create a moat that expands with each user.
There are some obvious cases where user generated content would lead to a moat — IMDB, Yelp, Wikipedia, Reddit, Psychology Today etc.
But there are many examples that have more subtle moats. Think about Canva: users can actually create and design templates which are then used by customers.
The same applies for product reviews. Having the most product reviews in a product category can lead to an enduring competitive advantage, no matter how many new entrants in the market.
Getting this engine started early can quickly lead to a moat for a startup.
Honourable Mentions
In the interests of this article not being a dissertation, I have just focused on the most relevant moats, but there are some other great ones I forgot to include:
- Scale Economies (very important and very obvious)
- Brand (less relevant for startups and speed to moat as brand takes time)
- Product Excellence (important but not really defensibility as requires constant product excellence over time)
In software, most code becomes commodified over time. Distribution moats will protect this (SEO, Reviews) as will product moats (network effects, embedment).
To quote Peter Thiel, you don’t want to be the 1,000th restaurant in San Francisco.
