Over the last 6 months, my conversations with entrepreneurs, leading fast-growing startups, have had a particularly common thread – the response to my question “What is your competitive advantage and is it sustainable?” (asked simply “what is different about your company and how easy/difficult is to imitate the same?”) – has been readily relegated to “Look at my topline growth” (accompanied with a facial expression which mostly says “Don’t you already see it?”!) or “I am the category leader” or “I am going to be operationally positive in the next 6 months and then raise more capital”. This makes me wonder if, given the times we operate in, the thought process of these super-smart entrepreneurs is being blurred to think that hyper-growth drives sustainable competitive advantage (or even worse, as long as there is fast growth thinking about sustainable competitive advantage is meaningless!)
I am going to stay away from harping about the benefits of a sustainable competitive advantage – but track the shareholder value creation of Alibaba, Google, Facebook, Amazon. All these companies battled heavy competition not by chasing hyper-growth (or having the deepest pockets fund them!) but executing a clear strategy with the aim of building sustainable competitive advantage – ‘growth’ happened to follow (and has remained committed to them!) The purpose of this blog is multi-fold (1) At the cost of repetition, revisit core tenets of a good strategy which drives a company towards gaining a sustainable competitive advantage (2) Provide a simple framework to better communicate the same (3) Identify key pitfalls that keep entrepreneurs away from investing behind sustainable competitive advantage which I sometimes refer to as ‘The Deception of Growth’.
The core tenets of a sustainable competitive advantage lie in two key things (1) ‘Tradeoffs’ and (2) Making imitation difficult for competitors
- ‘Tradeoffs’ – every company with a sustainable competitive advantage has made ‘hard choices’ (or ‘tradeoffs’) about every activity of their business model across logistics, operations, marketing, after-sales etc. Let’s go through this example which compares the key activities performed by two online commerce companies –
As you see above, both these companies have ‘chosen’ by way of internal policy to conduct activities differently in order to fulfill customer needs. This brings two things to the forefront (1) ‘Tradeoffs’ allow companies to provide a unique value proposition to their customers (2) ‘Tradeoffs’ or these ‘hard choices’ are incompatible with each other and hence, failure to make a choice would end up in disaster – if ‘Company 2’ ended up using in-house logistics it will never make money while ‘Company 1’ would lose customers if they outsourced the delivery function. Not making ‘hard choices’ would result in poor customer experience (read ‘high churn’), poor unit economics (read ‘high costs’) and confusing employees (read ‘broken organization structure’), investors and finally, result in no competitive advantage (read ‘slow death’).
2. Making imitation difficult for competitors – obstacles to imitation by potential/existing competitors are never insurmountable, having said that, it is important for a company to present its competitors with a rapidly moving target. There are 2 ways to do this (easier said than done!) (a) Make ‘Tradeoffs’ incompatible for as many activities as possible, ‘more the merrier’ – which means that competition needs to copy entire set of activities rather than just one or two activities to compete with you (b) Improve activity performance with every transaction – if the performance efficiency of all your activities improves with every transaction, you have a moving target for your competition! – I have not seen many cases wherein an incumbent competitor has fully given up its existing set of activities to chase new set of activities or for that matter catch up with the player who has already set a lead in setting up new processes, systems, best practices and manage costs.
Communicating your company’s competitive advantage –
- Add a slide to your pitch deck which compares activities of competitors
- Talk about how each of them is incompatible in terms of providing a core value proposition to the end customer or unit economics of the business
- ‘More the Merrier’ – more the number of activities that are incompatible, higher the barrier for imitation
- Talk about how the company has built technology systems for creating rapid feedback loops for each activity to improve with every transaction/over-time
Why do entrepreneurs fail to adopt a coherent strategy?
- ‘The Deception of Growth’ – Hyper-growth renders making ‘Tradeoffs’ meaningless. This growth trap is arguably the biggest reason for entrepreneurs to completely miss thinking about sustainable competitive advantage – because it demands ‘tradeoffs’ and ‘tradeoffs’ for a hyper-growth firm are seem to narrow markets and activities. A large round of financing is enough for the management team to go along this rather slippery slope. The outcome of such a situation is that firms in the industry imitate each other and dissipate value that they create to either buyers or suppliers! – race to the bottom begins. Once a company commits to this race, turning back is extremely hard – managing investor growth expectations, excessive fat on the P&L driving high burn, managing employee expectations, questions around sustainability. All these are difficult tasks, imagine trying to solve for them together!
- Role of the Board – this is where I believe a sound investor base/ board should step in to encourage the entrepreneur to think long term about not only creating value but also, capturing that value for themselves. Value capture can only happen if you have a coherent strategy that produces a sustainable competitive advantage.
Key Takeaways –
- Sustainable competitive advantage forms the bedrock of sustainable growth and economics (read’ high valuation’), and not the other way round
- Making ‘Tradeoffs’ and ‘Making imitation difficult’ core to building a sustainable competitive advantage – lay the foundation early on in the evolution of the company
- Communicate your competitive advantage better by comparing each activity and proving how they are incompatible – ‘More Advantage to You’
- ‘The Deception of Growth’ will result in a disaster – good times will be short-lived along this path. Board members responsible for guiding entrepreneurs in the right direction
- Everything starts from Nothing!