Building Defensible Businesses
One of the key considerations that capital allocators look for when investing in businesses is the presence or lack of a moat. I don’t know when the term barrier to entry fell out of favour to the term moat. Like most jargon, I imagine it was conjured up by a languid Harvard Business School professor with too much time on their hands.
Unlike Harvard Business School Professors, moats add value, as they are vital to any business's success. The reason is simple. If you don’t have a moat, anyone can replicate your business. In an environment where capital is readily allocated to businesses addressing problems with big addressable markets, and enterprises such as Rocket Internet exist to literally clone ideas on the cheap, it's more important than ever to build something defensible. It’s the only protection against well-funded competitors.
No one could compete with Google on search because their brand & technology are just too big to overcome. No one will compete with Airbnb on residential rentals as their global network effect is too big. No one will be able to compete with Lithium because, well, let’s find out…
Principles for Building Moats
I think of a singular statement when I think of principles of moat-building. Like most aphorisms I bore my co-founders with, I heard this on some thinkboi podcast (most likely a Navalism).
If you are faced with two paths when building your business. Pick the hard way. If its hard for you, its hard for others. If you solve it, the chance will solve it is much less likely.
Much is made of whether product on its own can be a moat. Product is just code, and code can be replicated by anyone — if they are willing to pay the price. The Instagram app sure is a nice product, but a good engineer could build the whole front end in a couple of days. It’s definitely not Instagram's moat.
I think there are two scenarios where a product can be a moat.
- When product is a temporary moat, that enables another moat such as liquidity (more on that later) to be achieved.
- When the product is so costly to reproduce, or requires such specific knowledge, that the cost is exorbitant.
Let’s look at the first scenario of product as a temporary moat. TikTok is probably a good case study here. TikTok, for all intents and purposes, is Vine. It’s a social video app that uses (very) short-form videos as its medium of communication. The difference is that TikTok made a number of product tweaks that allowed them to build huge network effects that Vine never did. The TikTok UX makes you rate each video, this feeds the algorithm, serving you up more relevant content. TikTok has also built in the ability to replicate memes in their content creation process. These are small changes, but enough to give TikTok an edge that caused the product (short-form video) to succeed where others failed.
TikTok’s product though is easily replicable, it just allowed them to get to scale fast. Figma, on the other hand, is a great example of a company that's used insane product capabilities to build a product that is not at all easily replicable. Anyone who’s used Figma will know it's a 10x solution vs Sketch, Invision and other design tools. The ability to effortlessly create and collaborate on product designs is, quite frankly, a technological miracle.
When it comes to Lithium, I see our product moat as an enabler for wider network effects. We do have the best product in the crypto equity crowdfunding space, but I don’t think this is enough to ensure complete defensibility. Yes, we’ve sweated over tiny UX details other platforms haven’t even thought of. Yes, we’ve created a delightful way for web2 users to get started in crypto. I think our product moat gives us a great head-start, and as we continue iterating we will only move further and further ahead of the herd, but it would be naive to think that with enough cash, another well-run startup couldn’t come along and replicate what we’ve built.
That’s why, for Lithium, product-as-moat is not enough. We need more.
Here, I use the term liquidity to mean matching resource exchange on a platform. YouTube has liquidity as creators upload videos and viewers watch them. Uber has liquidity as drivers use the app and riders hail them. Amazon has liquidity as sellers list millions of items and buyers purchase them.
Building liquidity-as-moat involves the delicate balancing act of adding supply to a platform while maintaining demand for that supply. In the hollowing out of Craigslist mania of the web2 age, a vast amount of startups raised millions on the back of enabling liquidity for a niche service. Some succeeded (Airbnb, Uber to an extent) while many others failed.
It’s notoriously expensive to enable liquidity in a marketplace. The general play book is to start with a small geography or niche, build supply in that area (e.g. paying Uber drivers in SF to use the app), employ some clever marketing to make sure demand is aware, and then scale to either new geographies or niches.
Often, building this kind of liquidity doesn’t make financial sense. If it costs you $500 to onboard an Uber driver, and they only deliver $450 in profit to the company, you are never going to have a profitable business. In large part this has happened to Uber, they will now never be profitable, unless self-driving cars become the norm.
At Lithium, we have built a strong supply-side on our platform. We’ve also got great demand for the projects we launch. But these are bear market times. If we want to keep demand high, we are going to need to tap into a new network of investors. Moving into H2 of 2022, we will be shifting to web2 marketing channels and appealing to the early-majority stage of the adopter cycle. Our target customer will shift from the web3-native to the tech-savvy millennial, interested in crypto, but not quite sure where to start.
If we can become the platform of choice for this customer profile, we can capture untapped liquidity and grow to 10x the size of competitors in the space. This is our bet on how we will cement our liquidity moat.
I know, it's crypto, and we all have a bit of a love-hate relationship with regulation. The space desperately needs it. But we also don’t want to pay the price regulation inevitably brings — stifled innovation.
It’s yet to appear who the legal innovators in the crypto space will turn out to be. Could it be Kadena, the proof-of-work blockchain that actually scales? Or will the SEC rule favourably on proof-of-stake blockchains like Ethereum, going against the popular opinion of classifying them as securities?
At Lithium, we think there is huge potential to make some pioneering changes in the web3 equity crowdfunding scene. From looking at token-issued securities to interesting DAO structures for token offerings, the space is wide open. The ambiguity in how crypto will be treated by nation-states means there is a tonne of opportunity.
While we can’t reveal the exact progressions we are making in creating a strong legal moat in this article, as a team, we are bullish that this could be one of the most defensible elements of our business.
As a team, we are committed to building moats in our business, and the bear market is the best place to do it. During the next few years, or however long this lasts, we can make huge leaps in product, liquidity, community and legal to make sure we build a business that lasts. As always, we’re glad to have you along for the journey, let’s see how deep we can dig these trenches…
Tom, Lithium x