Economic Moat - A Startup's Perspective

An age old concept that is relevant even to New-Gen startups

As you build your company, it is imperative to prevent competition from stealing your market share and throwing you out of business. That’s where the concept of Economic Moat comes in.

Investors use this concept to identify a company that would stand the test of time. As an early-stage founder, your focus should ideally be on achieving product-market fit, with 20% of your time going towards making minor tweaks and adding capabilities to build a moat in the long run.

In this article, we expand the concept of a moat to a startup. We will look at the different types of moats with examples of startups using a moat successfully.  

1. Network Effects –

This moat is all about shared value. When one side contributes, the other side gains and vice versa. Thus, improving the entire ecosystem and attracting new customers on both sides. This is a moat you could start building during the early days, as this could probably change your business model.

To add network effects to your business model, there are two steps to keep in mind –

Step 1 - Become an Aggregator

No doubt some product-based companies do great. But the ones that become massive are those that help different groups of people.

Example 1 - Shopify helps small businesses build e-commerce websites and hosts them on their servers. Plugin and Software developers create tools that do specific tasks for these companies on the Shopify server. More new users on Shopify – Creating software becomes much more lucrative – massively improving Shopify. (Two-sided platform Network effects)

Example 2 – Airbnb has homeowners looking to rent their houses and customers looking to stay at an Airbnb rental when they travel. As more customers look for a homestay, it entices more homeowners who have vacant houses to put them up for rent on Airbnb.

Example 3 - Shiprocket is a logistics aggregator where a company can choose from multiple delivery partners. Companies use Shiprocket for their numerous delivery partners, the delivery companies use the platform because they get more access to various companies + get the tech outsourced.

In short, if you aim to grow massively - then innovate and think of ways you can become an aggregator in your niche. All this, provided there is surplus demand and supply.

Step 2 - Value over Quantity

This applies to almost all Industries. As you focus on quality, one rule of thumb is that the value generated should be from effectively solving a core problem that caters to one of the seven sins of people. (Pride, Greed, Lust, Envy, Gluttony, Wrath, Sloth)

Suppose you are starting a platform for job-seekers and you have a list of 10 firms willing to recruit with high packages, the job-seekers would be more than happy to try out your platform. Now, if you have a mechanism to filter out the best candidates for companies to interview, more companies will want to use your platform for the effort and time saved searching. Thus, focusing on the value derived will increase customers on both the demand side and supply side.  

Remarks – Network Effects is a very vast topic, and there are numerous ways to go about it. NfX Blog is a great source of information as their Investment Thesis revolves around funding startups that incorporate network effects.

2. Cost Moats -

This moat is all about Trust. That said, as a startup, cost moats are what you should look to achieve in the future after achieving product-market fit. A few ways to establish this moat are through switching costs, sunk costs or economies of scale.

Switching Costs

Sometimes customers love and get so used to a service that even if the prices increase, they would still use it. When people are accustomed to one application, they prefer not to move to another that has an equal learning curve.

Switching Cost Moat in Tally Solutions

Tally Solutions is an accounting software that small business owners and large firms have been using for a long time. The customers now know it inside out and so there is a natural resistance to change. Although many other equally capable software solutions exist, small business owners are still reluctant to shift.

Sunk Costs

Some companies take upfront payments for using their services. This compels the customer to use the service at least for the duration of having it.

Sunk Costs in Zomato

Back in the day, Zomato used to have an annual "Gold membership" which varied from 750 INR – 1200 INR. Having this membership gives you discounts and free dishes at their partner hotels. A sweet deal nonetheless. Today they have the "Zomato Pro" membership, which not only gives dine-in discounts but also discounts on takeaways.

Economies of scale

This is a cost advantage a company gets as they produce in bulk. Having economies of scale can reduce the costs incurred as the fixed costs are spread over a large number of goods. This helps increase the profit margin and also provides the option to reduce costs to the customer while maintaining profit margins.  

3. Intangible Asset Moats -

This is a moat you can look to start building from day 1. As this is a long process, the earlier you start, the better. With this moat, you can charge a premium for the service offered and still have loyal customers. Intangible assets can include:

• Intellectual Property (IP) such as patents, trademarks, copyrights, government licenses, or business methodologies.

• Brand

Brand Identity in Dunzo

Dunzo provides delivery services across metro cities in India. If you want to send a package, the term used by the tech-savvy people is “Dunzo it” and not the colloquial “Send it.” Your brand name takes over the original word in the local language, positioning you as a behemoth.  

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Ultimately, no matter the moat you choose, each of them has the potential to help you stay one step ahead of your competitors.

After you have a moat set up, the only thing you should never stop doing is R&D and continuous innovation so that you stay relevant.