Why having high barriers to entry in your business doesn’t matter as much as it used to anymore

In the startup world, before any VCs invest a typical question they ask is “What are the barriers to entry for your future competitors?”. Often the answer is scale in which the entrepreneur will then explain is why they need to raise money, grow fast at all costs and achieve that scale before anyone can beat it. That’s how I always thought of business. That’s not how I think about it anymore.

First let me argue against the notion that barriers to entry make a business unassailable. There are two types of super high barriers to entry that businesses can have: Government licenses /concessions awards to a company or companies with an immense network effect.

  1. Government Licenses / Concessions

I know this guy who’s very wealthy and made most the money in his life from getting government jobs in a developing Asian country. I used to tease him about how great it is to have a business like his with the license to print money. Unlike many other companies, he doesn’t have to worry about sales or how big a market is going to be. He’s already got all that covered in the form of a concession.

One day I decided to open my mind and ask him if indeed his business was difficult and he said yes. Why? He explained that while has had the concession to do what he did and print money for many many years, there is always someone else trying to get it from him. Someone else who can give a better price or if a bribe is necessary pay more or someone else who always knows some other powerful politician or all of the above. This is made harder because politicians come and go all the time so he has to constantly stay on top of it.

What happens if he loses it? He loses a lot of money. In many concession businesses like him, it requires a huge upfront investment to build something big that will have a long payback period. To come up with the money he often has to both find investors and take on a lot of bank debt. Now if something happened midway and his concession was canceled or renegotiated, he would stand to lose a lot of money and these things happen too.

So while government concessions from highways to power producers have turned our well for some people and made some rich, it’s still a business that is constantly challenged by others who want to get into the game. The barriers to entry aren’t as high as one on the outside might think it is.

2. Strong Network Effects like Google or Facebook

Okay what about companies that don’t have high barriers to entry because of government but just because they have an insane network effect. They have far more pricing power, far more distribution, far more everything. How would you compete with that?

I remember some 10 years ago I was sitting in the audience in the Web 2.0 Summit in San Francisco. Up on stage for a fireside chat was Mark Zuckerberg himself. Facebook then was getting a lot of press for its immense growth and people were saying the network effects they had were unassailable. I mean who else would join another social network if everyone was already on Facebook?

At one point of the chat, the moderator put up a map of all the other social networking companies that existed at the time. On that list was MySpace, Friendster, Bebo and more. The moderator then asked the magic question:
“Which one of these companies are you afraid might eat your business?”.

Mark Zuckerberg took a few seconds to think and then replied that he wasn’t afraid of all the companies in that list that existed today. He was afraid of the companies that he didn’t know yet existed that may come out of nowhere and eat his lunch. He was particularly conscious of his blind spot.

Years later it all added up. He ended up making some of the most brilliant acquisitions of all the time. Imagine what Facebook as a company would be like today if it didn’t own Instagram and WhatsApp. Or imagine if both these companies were owned by Tencent or Google or if they were large independent companies in their own right challenging Facebook for the social networking pie.

Ok so what about businesses that have no barriers to entry? Don’t they suffer from pricing pressure and increasingly lower margins?

Not too long ago I met someone who owns what he calls a transportation business in Penang. Their business model was to provide factories the service of vans and small busses to ferry workers from their homes to the factories. They started not too many years ago and now have a fleet of hundreds of vehicles to do just this. I was very interested when I heard about this because if anything this was a very highly competitive market with low barriers to entry (anyone with a van). They were not the oldest provider so what made them so big ?

As I dug deeper the answer was simply, they were simply run better than everyone else. That was a lesson to me. That there exist many many companies out in various industries there be it in logistics or F&B or manufacturing that don’t have a moat or huge barriers to entry, have lots of competition and still do very well and make a lot of money. Their secret? They just make sure they run things better than everyone else.

That was a mindset shift for me. From instead of thinking of how to build a moat that would eventually get broken down anyway to how do I make sure Colony is constantly at the top of its game, running things the best?

We live in the world where even huge businesses with far more economies of scale than any of its competitors are falling to disruption. History has shown that the time always comes when the disruptors get disrupted.

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