If you spend any time amongst investors you will no doubt hear the phrase “barrier to entry” quite often. Investors fixate on their companies building a barrier to entry. But what is a barrier to entry and how can you build it?
I think we all understand the concept of a barrier: a circumstance or obstacle that keeps people or things apart. It’s “entry” that seems unclear. Entry to what? The concept is that you have dominated a market niche and you want and need to keep other companies out of your market. Investors love monopolies! As one VC told me, We are always seeking an unfair advantage. There’s at least one problem with this concept. It assumes you have created a greenfield market, one that didn’t exist before like vaping, dominated by Juul. But often you will have a new and better idea for an established market, such as the MIT startup that invented a much better car shock absorber. There were already many companies in that market. So how can you create a barrier?
The other question you may also hear is how will you create a sustainable competitive advantage. I find this a preferable way to think. A startup needs some kind of competitive advantage to get market traction in the first place. It may be the typical FCB – Faster, Cheaper, Better – or more to my liking, different. So let’s assume you built that better car shock absorber. How do you maintain your competitive advantage?
I tell startups that for every good idea there may be another half dozen or more companies working on the same idea at the same time. They need to worry less about the competition and more about their customer. It’s when a startup becomes successful that these hidden competitors come out of the woodwork. Failure is an orphan, success has a thousand imitators. Investors worry that either another, better funded startup will copy your idea and overtake you with better marketing or sales or that an established company will decide to copy your idea and compete with you. The best known example of the latter is SnapChat. What originally differentiated SnapChat was its disappearing messages and photos. But Snap kept on innovating and developed stories, an easy way for users to link together images to tell a story about their life. This feature became a big hit. So what happened next? Instagram, owned by Facebook which has a history of attempting to copy startup features without success, added stories to Instagram. Whammo! Instagram took off and SnapChat was wounded seriously, though not fatally.
So how do you build a barrier to entry? How do you sustain a competitive advantage?
- IP – investors love patents, as a successful patent can ensure a monopoly, which they love even more. But filing patents can be expensive, it can take years to win a patent, and in the meantime the patent process forces you to disclose how you implement your idea. Then you may have the cost in time and energy of defending your patent! Patents seem to be more valuable in biotech than in the media, internet, publishing, and software fields where I mentor. Copyrights can be help in protecting you product name or other aspects of your business, but they are far less helpful in building a barrier. There are always workaround for competitors. And you don’t want to spend time in court suing over “copyright infringement.”
- Customers – there is a lot of debate over the so-called “first mover advantage“, means whichever company gets to market first with their idea will win. But there is no arguing with building up a large customer base. However, the old advertising phrase, I’d rather fight than switch! Should be your goal. Gaining customers is not enough, you need loyal customers. And it helps if you make switching to another product a non-trivial task.
- Strategic relationships – The most common reason to develop a strategic relationship is for distribution. At Course Technology not only did we have NACS – the National Association of College Stores – as our exclusive distributor, their parent company, NACSCORP was also an investor. This relationship helped us compete with much larger, better known, and entrenched competitors. While the prime function of strategic relationships needs be creating value in your venture, the second function should be gaining that unfair advantage investors salivate over. While many big companies will tell you they can’t be your exclusive partner I would tell them the same thing. But that I believe in performance exclusivity. As long as you perform really well and deliver value to your partner they are unlikely to want to enter into a similar relationship with one of your competitors.
- Brand equity – brand equates to trust. If you can succeed in building your brand it will become a competitive advantage. Thus much advertising is not for products but to help establish brand awareness. But advice is save your money. Spend it on media relations. Stories about your company are far more credible and more valuable than ads. Too few founders have a PR plan as part of their go to market strategy. They just seem to think having the standard set of social media accounts is sufficient. Twitter, Facebook, Pinterest, etc. may be necessary, but they aren’t sufficient. Ignore the established media – print, radio, TV, direct mail – at your peril.
- Constant innovation – as a successful startup you will have a target on your back. Make that a moving target for competitors. The key is to constantly innovate. We saw this for years in the iPhone market. But the smartphone market has stagnated, basically because yesterday’s phone is just as good as today’s for all practical purposes. Recently there have been no innovations powerful enough to get users to upgrade their phones. Develop a product roadmap and observe your customers closely. Make sure the brilliant engineers who invented your first product have the company equity and resources they need to keep your competitive edge. I’ve seen too many startups become dominated by marketing and sales and their innovation dies on the vine.
- Capital – it is hard to raise money and it is time consuming. I was taught by VCs that the best time to raise money is when you don’t need it. When your product is hot and you have ample cash in the bank, raise more money. Capital can become a competitive weapon, whether in the war for talent or in funding new product development. We’ve seen this playbook with many high profile internet companies like Airbnb and Uber. Don’t worry about equity dilution, worry about creating a more valuable company. Capital is the accelerant for growth.
- Constant learning – I’ve written elsewhere that I consider startups to be learning machines. Don’t rest on your laurels if your product is a hit. The great football coaches criticize their teams more after a win than a loss. Keep in mind it’s harder to stay on top than to get on top. Constant learning will feed constant innovation – innovation not only in product but in business models, marketing methods, and even in sales and support. Learning and innovation should not be reserved for the engineering team.
A single company may not be able to deploy all of these techniques to stay ahead of its competitors. While individuals at companies I worked for held patents, none of my companies ever earned one. But we were masters of strategic relationships. Find where your venture can exercise the most leverage and focus your energy there.
Occasionally I’d get into a disagreement over barriers to entry, usually with an angel, rarely with a VC. Then I’d ask them, “Tell me, what is Bruce Springsteen’s barrier to entry? What about George Lucas?” If a potential investor is fixated on barriers to entry he or she may not be the investor for you. They should be fixated on exactly how they will help you grow the company and trust that once you reach the top you’ll have learned how you can stay there.