A Complete Guide to Business MOATS
In my 10 years in venture I have met many great founders who understood their CUSTOMERS.
Yet, almost no founder on day 1 has thought about arguably the most important thing -- MOAT or long term defensibility of their business.
So what are the business MOATS and WHY are they so IMPORTANT?
1. WHAT IS A BUSINESS MOAT?
MOAT is an ability to defend your business over time. It is a little bit like chess - you create a position from which you keep gaining advantage in the future. MOAT is a sustainable business advantage that accrues over time.
2. WHY IS BUSINESS MOAT IMPORTANT?
If your business doesn't have a sustainable MOAT you can be vulnerable to competition. In competitive markets there are many similar businesses.
The result?
PRICE COMPETITION
EROSION OF MARGINS
RACE TO THE BOTTOM
3. WHY CARE ABOUT MARGINS?
Margins are linked to profits.
If you have many competitors - you all cut prices and no one has good margins so no one wins. Such markets end up consolidating - competitors buy each other out to regain advantage.
Investors care about this A LOT.
4. MONOPOLIES ARE FUELED BY THE ULTIMATE MOATS
While illegal by law, Monopolies of today or Near-Monopolies are businesses with very little competition due to really strong moats - barriers to entry, sustainable advantage that precludes or makes competition difficult.
5. WHAT IS AN EXAMPLE OF A MOAT?
Twitter.
Twitter has a really strong moat called Network Effect.
The essence of it is:
The more people post, the more people read and the more people read the more people post.
The flywheel creates a moat and the users stay because they pull each other back to Twitter.
6. WHAT KIND OF MOATS ARE THERE?
Moats come in different shapes and forms but truly strong moats are pretty rare. Here are typical moats people talk about:
Network Effects
Economies of Scale
Brand Moat
IP Moat
Data Moat
Let's take a look at these.
7. NETWORK EFFECT
This moat is present in networks like Twitter & marketplaces like Uber:
The more participants there are, the more incentive for more participants to come, and the less incentive for any participant to leave.
Each node makes the network stronger.
8. ECONOMIES OF SCALE
This is a classic economic moat that is not applicable to startups (until they scale!) but the essence is -- it is cheaper to make 10,000 things vs 1 thing, this leads to a barrier to entry for competitors.
In today's reality, this isn't much..
9. A BRAND MOAT
Think of why a lot of us love Apple or Nike.
These are iconic brands.
Building a brand is all about great product and a lot of love and marketing until one day it becomes etched in people's brains.
We buy Apple because it is Apple. And we pay up!
10. IP MOAT
This is not really relevant anymore in software, but it is relevant, for example, in biotech.
If you discover a unique molecule you can patent it and if granted, the patent will enable you to sell a drug based on the molecule for 20 years and competitors won’t be allowed.
11. DATA MOAT
Broadly speaking a UNIQUE PROPRIETARY DATA set makes for a strong moat. Why? Because for example, AI algorithms need data and if you have it, but competitors do not, then you have the advantage.
Data moats are complicated but you get the idea.
12. MANY MORE MOATS
My friend Rick Zullo published an excellent and very detailed post on different types of moats - be sure to take a look.
13. BUSINESS MODELS AND MOATS
2048 Ventures is a business model first firm. We focus on specific business models because we believe they have the strongest moat potential:
Platforms
APIs
Marketplaces/Networks
Lets unpack this.
14. PLATFORM BUSINESSES
Platforms have the strongest moats because other businesses rely on them!
Visualize customers using businesses that then in turn use a platform.
Think Shopify -- they have shops, plugins, payments - a massive platform ecosystem -> strong moat.
15. AN API BUSINESSES
APIs are the future because the future is more computers talking to computers crunching numbers.
APIs can be quickly implemented and not so quickly swapped out.
APIs often become platforms -> strong moats.
16. MARKETPLACES AND NETWORKS
Both Marketplaces and Networks have strong moats because of the Network Effect.
They become sticky as participation naturally leads to more participation causing a strong moats.
17. WHAT IF MY BUSINESS DOESN'T HAVE A MOAT?
That’s okay!!!
You should still go for it, IF you are PASSIONATE about building it.
But BEWARE, investors may not like it -- NO MOAT means no sustainable advantage over time and no clear path to VENTURE SCALE OUTCOME.
18. SUMMARY
It is critical to think about creating a MOAT - long term sustainable advantage that increases over time.
Without a moat your business will have low margins and not be venture scale (and won’t be able to scale?).
Your business model is a key to the MOAT. Platforms/Marketplaces have the best moats!
