Last week I was honored to be on The Software Engineering Daily discussing economic moats for enterprise companies. We also dug into to some case studies of competitive markets including cloud cost optimization, observability, and CI/CD. You can find the episode here. Since not everyone has time to listen to an entire podcast, I wanted to pull-out some key takeaways that may be helpful for entrepreneurs.
What’s a moat?
An economic moat is a business’s ability to maintain its competitive advantage over its competitors. It’s really based off of the idea of a medieval fortress. You have a fortress that is in the business, and the moat that keeps the competitors out. Raising barriers that make it harder for them to overtake you, and it’s mostly considered a defensive measure for the company.
The fortress, the company, should generate the latter, the economic moat. It’s important to set out at the beginning thinking about both in conjunction, not one or the other.
What’s an example of a moat?
Moats can actually come in a lot of different forms. We traditionally think about them more on the product-side as early-stage investors. Moat can be an innovation, like a differentiated technology that competitors can’t really replicate.
Some businesses try to crystallize their product moat through certification programs. I worked at Cisco. Cisco CCIE was notorious for this by giving people credit for learning the tech. Once they do, they don’t want to move off those products.
We also see high switching costs, the idea that once a team uses a solution, people don’t want to leave it. You can use the data here to create moats, like superior workflow or institutional knowledge.
A really great example of this that we think about all the time is Jira for bug tracking. It’s ubiquitous. Everyone knows it. People use the workflow every day. Maybe not everyone likes it, but they still use it anyway because there’s a high switching cost of retraining the people on a new system, exporting and then importing data from the old and to the new. The lag time in switching systems can be long. You don’t want developers to be unproductive so this cost creates inertia that keeps users on existing solution and slows the growth of new ones.
[listen to the podcast for a full list of moat types]
What forms can a moat come in?
Moats can be both wide or deep. A wide moat relies on several factored ones like product differentiation and great branding. While a deep moat is more difficult to overcome, but is isolated to a single characteristic.
Tell me how a venture capital firm thinks about these highly competitive markets?
There’s kind of two flavors of competitive markets we think about. Oligopolies, where a small number of firms. Usually the top five vendors in this space representing over 50% market share. Some oligopolies that I used to invest in were the storage industry, EMC, NetApp, and Pure Storage. There are only a few competitors, but they had high influence on each other.
The second category we think about in terms of competition is monopolistic competition, a whole bunch of firms all selling very similar products, but they’re not perfect substitutes. Observability and CI/CD are great examples of that, and each of those we’ve categorized 20 plus vendors in them.
How does fundraising change when you are operating in established vs. new industries?
For established spaces, like logging, databases, or network security, we have a pretty good sense of how the company’s product portfolio market can evolve over time. There are precedents we can rely on and we can paint our own vision of how the business evolves. But if you’re category creator, you have to be a masterful storyteller. You have to kind of hold our hands and paint a vision that is both logical, pragmatic, but also magical in the way to help sell us on what you’re trying to create.