In this question, the important words are “if successful”. We are seed stage investors and it’s rare for a startup to have a strong and defensible unfair competitive advantage when we invest, especially since we don’t tend to invest in startups where a patent or trade secret would be meaningful. I’m typically skeptical about the defensibility of software patents and we are predominantly software investors.

This doesn’t mean that I’m not looking for the seeds of a future unfair competitive advantage. I need to believe that, if you execute successfully, it will be difficult for someone else to come along and replicate your success later.

A common unfair competitive advantage in Birchmere’s portfolio is a startup having a network effect, where a product or service becomes more valuable as more people use it. A well-developed network makes it difficult for your customers to switch to another provider who doesn’t have a comparably valuable network. It is essential to establish your network before your competitors do to gain this advantage.

I observe that network effect is often confused with an economy of scale, which is different. A network effect sees an increase in the value of the entire network with each new addition. Classic examples are communication platforms — phones, fax machines, email, social networks. Much of the customer’s value is the network itself.

An economy of scale is about cost advantage, not value. For example, if you are manufacturing something, creating the first unit may cost considerably more than the 1,000th unit. While an economy of scale is great and often critical for scaling a business, it doesn’t give you the defensibility of a network effect, where your customers can’t leave because the uniqueness of your network is not easily replicable.

I’m shocked by how often students use these terms interchangeably, even at a place like Carnegie Mellon. This is part of why we added both an entire night dedicated to network effects in my Science of Growth course and and as a chapter to my book on the same topic.

Coming back to the question of your unfair competitive advantage, I need to see the potential for some element that your competitors can’t easily replicate if you succeed. A real network effect at scale would be a great answer to this question. Of course, the obvious follow-up question to be prepared for is how you get to scale before having that network effect.