Warren Buffett coined the phrase economic moat to describe those aspects of a business that provide competitive advantage. What is often stated within definitions of Buffett’s economic moat is the requirement for the advantage to be ‘sustainable’; as a value investor, Buffett does not want to buy into a company that wins today but loses tomorrow. His objective is long term performance.
I work with technology companies – the vast majority using a significant element of software within their overall offer. How does Buffett’s concept apply, when software is by its nature replicable – often by cheaper resources in other countries? You make the mistakes, others imitate with a much lower cost of establishment. Have a look at the Samwer brothers in Germany for the textbook case study.
So what to do? The obvious answer is legal instruments – patents and the like – but do all companies have the time / energy / finances to both create and protect intellectual property in this manner? I would argue (in a highly successful manner) not. There are enough things to do in the early stages, many of which will be the start of digging your moat, without recourse to lawyers.
Consider the component elements of a company selling software. These can be broken down into two categories:
- Revenue generation and retention capability
- Technology capability
When defining and refining your business, think about each category and ask yourself ‘what can I do here to develop my economic moat?’. Some examples might include:
- Revenue generation and retention
- Dominate a specific market – either a vertical (e.g. supermarkets); a horizontal (e.g. human resources); or geographical (e.g. Italy)
- Ruthlessly pursue customer retention strategies – a business that does not lose customers grows
- Create revenue momentum – a series of wins shows the market you will dominate it
- Create network effects – leverage your users to dominate areas through networks (e.g. Facebook – there can be only one personal social network at any one time)
- Develop technology which will naturally expand its footprint within the customer, e.g. SAP – it reaches out across the enterprise
- Ensure accessibility – if technology is easy to acquire and use, it will stick
- Get multilingual quickly – think of the Samwer Brothers
You’ll note as you read through these points that there is significant overlap. Often the technology enables the revenue generation and retention objectives, and conversely the revenue and retention objectives will dictate (to an extent) what technology development must take place. Get out a sheet of paper and write these down for your business. Are they compelling? Do they link back to the objectives you set out?
Reflect on this exercise, and bring the thought processes into your day to day work – an economic moat creates sustainable long term advantage, enabling valuable businesses to be built.