3 WAYS TO BUILD A MOAT AROUND YOUR BUSINESS
I had Nithin Kamath, a special guest on the podcast and the founder of Zerodha. A company that needs no introduction other than to say that it revolutionized the stock brokerage business.
It was a fascinating conversation that included how startups are not immune to competition, but still, some manage to leave a mark.
I am excited to share some insights here with all my readers.
While talking about his company, we discussed how some companies had stabilized their market position more than others in this competitive world. This is because they built a moat around their business.
So what is a moat, and why is this relevant?
When you build an economic moat, you create a competitive advantage that can be hard to replicate by your competitors. It is possible to divide moats into three main types.
1. Efficacy of Networking
Social media platforms, marketplaces with two sides, and AI-powered applications have made network effects more popular in recent years. Businesses heavily rely on network effects to differentiate themselves from the competition.
Network effects indicate that the value of a product or service increases as its user base grows. All communication media, like the mobile phone, typically become indispensable as soon as everyone owns a phone: the phone’s value is much lower when only a handful of people own it, but it’s essential once everyone has one.
As products become valuable with adoption growth and switching costs rise, leveraging network effects makes user acquisition cheaper and cheaper over time. This will keep users engaged as the product becomes more and more valuable.
Having the ability to reduce the cost of providing a product or service in a way that no other competitor can do, is one of the most common and durable types of economic moat.
Vertical integration, involving gaining direct access to raw materials needed to manufacture a product, is a classic example of cutting costs by lowering overhead. Direct-to-customer models are now popular ways to disrupt industries with extended supply chains.
Many successful companies in the world have built their fortune not on structural advantages but rather on intangible assets that add value to the customer uniquely and intrinsically.
Customer-oriented products and services can create a very difficult moat for competitors to replicate because of what they represent and stand for.
Almost all consumer products on the most valuable brand lists share this characteristic. In objective terms, big companies offer similar products to their competitors, but in terms of value-added to the customer, their logos carry a unique value like Tata or Godrej. A generational turnover can narrow this economic moat since powerful brands generate loyal customers who won’t even consider switching to a competitor.
Companies can build moats by achieving economies of scale, strengthening their brands, or even lobbying the government. Customers will be loyal to them, they will have pricing power, and other companies will have difficulty competing with them because of legal protections.
An industry’s impact on society or its growth should not be assessed, but rather the competitive advantage and, above all, the durability of its advantage should be evaluated.
For more such interesting discussions, listen to my podcast Figuring Out.