May 19, 2023

Your startup doesn't have a MOAT


As a founder, one of the words that get thrown around quite frequently in the Valley is "MOAT". When you're fundraising (as early as pre-seed), the investors will ask you about your startup's MOAT. Likewise, your friends will be asking you about your MOAT. If I had a dollar for every time someone asked me about our MOAT, I wouldn't need to raise another round ... ever.

But let's demystify this — what really is MOAT and, of course, the elephant in the room ... does your startup have a MOAT? A MOAT is your startup's defensibility — i.e., your business's ability to maintain a competitive advantage to protect long-term market share and, therefore, make more profits. For your startup to really have a MOAT, it needs to have some type of technological or regulatory competitive advantage over your competitors, both today and in the future. But the truth is, most startups don't really have a MOAT. The key here is to understand that we're talking about startups and not companies like Facebook, Google, Amazon, etc. because there is a clear distinction.

Take Clubhouse, for example. It was one of the most hyped apps at the end of 2020/early 2021, with people salivating to get their hands on a single invite. But their technology (i.e., the app) is relatively easier to replicate — we began to see verticalized audio-first platforms that did precisely what Clubhouse did once they raise their Series A & B from Andreessen Horowitz. So what was their MOAT, if any? (I'll answer this later).

Rule #1 of MOATs: Your MOAT should not be [easily] replicable. Because if it is, then it's not a MOAT in the first place.

True defensibility at a product level is rare because great engineers can build complex products. While product differentiation is critical to a startup's success, it is different from a MOAT. You can offer a unique value prop and have a differentiated brand that resonates with your customers, but it doesn't increase the barrier to entry to your market; thus, it's not a competitive advantage.

Let's take a look at Superhuman for this. I've been using Superhuman for about 1.5 years, and I really like their product. That said, they essentially repurposed keyboard shortcuts that Gmail already supported but designed the entire experience for power users. Of course, they added a lot more features to increase overall utility, but features are not MOATs because they can be replicated. So while Superhuman has a great product, the barrier to entry remains the same.

Rule #2 of MOATs: Your MOAT should make it harder for competitors to enter your market.

By the way, both Clubhouse and Superhuman do, in fact, have a competitive advantage in common (we'll talk about this soon). I'm not trying to downplay their success — I'm trying to highlight ways we've misconstrued this MOAT thing.

So what does an actual MOAT look like? For that, let's talk a quick look at Amazon. You're probably like, "duh," but this is critical to help us shape our definition of MOATs and how they're built. Amazon today has a MOAT — it's the economies of scale of their Supply Chain & Logistics. For anyone trying to break into e-commerce, Amazon is a force to be reckoned with. Amazon is now the de facto standard for shipping & delivery. 2-day shipping is not a nice-to-have anymore — it's table stakes because [most] consumers expect it. And while Amazon can afford to provide 2-day shipping due to its scale & still be profitable, the truth is that 99% of others companies can't. This is at the core of Amazon's defensibility, and it took Amazon a few decades to get here. They didn't have this MOAT until they did.

In the book Competition Demystified, the author Bruce Greenwald outlines 3 types of competitive advantages for a company:

  1. Supply advantage: this is when your company has access to supply, making it harder for competitors to break into your market. This can be a patent or some regulatory advantage that only your company can get. Alternatively, this can also be strategic partnerships and contracts with other brands, hindering your competitor's ability to lure those same customers. Example: Airbnb. They were able to acquire and onboard hosts before anyone else could. By the time Airbnb became mainstream, the supply of houses/apartments became illiquid and difficult to capture by their competitors.
  2. Demand advantage: this is when your product has built user habits or has a high switch cost which makes users captive to your product. There's another inherent advantage here — network effects (refer to this a16z article to learn more). TL;DR: network effect is when your product becomes more valuable the more people that are using it. Example: Instagram. Instagram has built a sticky product with all your friends, and each time you add a friend, it (#1) makes IG that much better for you, and (#2) increases the switch cost by a lot.
  3. Economies of Scale: this is probably the simplest of them all (also because we just talked about Amazon). But essentially, your fixed cost per unit is significantly lower than any of your other competitors, even if they had access to similar technology or equipment as you did. The more units you can produce, the cheaper it becomes for you, and the more of an advantage this can become for your business.

Many of these big tech companies didn't have their respective MOATs from day 1. Amazon didn't have economies of scale from day 1, Instagram didn't have network effects until it reached critical mass. Put simply, MOATs are developed over time. But the least common denominator across all these companies that we've talked about so far is one thing: distribution. It's subtle, but these companies have essentially built a distribution engine that gives them a competitive edge over their competition.

Having a distribution MOAT and building a distribution engine accelerates your startup's ability to launch innovative products and capture more users & market share.

Marc Andreessen puts it really well in his interview with Elad Gil on Where to Go After Product-Market Fit:

In fact, the general model for successful tech companies, contrary to myth and legend, is that they become distribution-centric rather than product-centric. They become a distribution channel, so they can get to the world. And then they put many new products through that distribution channel ... You become a distribution-centric which enables you to launch and test out the next big thing for your startup.

Once you reach some semblance of scale, distribution becomes your competitive advantage. Let's revisit Clubhouse. As we discussed, Clubhouse is not some technological feat, but what they did have over their competitors is their distribution. They had so many users using the product that it gave them the time to get as far ahead as they could from their competitors.

Product innovation is a prerequisite to constructing distribution. For a startup to build distribution, it must offer a product/service that is so compelling and differentiated that it causes a large number of customers to adopt it over an incumbent. Getting initial users isn't sufficient for building distribution — you have to retain them by making your product inherently "sticky" (I'll be writing about retention soon). Once your product has that distribution advantage and early network effects (making it harder for people to switch to your new competitor's product), then you have constructed defensibility.

Distribution MOAT = Product innovation + solves an intense problem + retention mechanism

Whether you capitalize on this distribution advantage or not comes down to vision and execution. Let's look at Google for this. First of all, Google built a search engine that was inherently innovative, but it didn't just stop there. Google spend hundreds of millions of dollar every year to have Google Toolbar distributed across various browsers, like Internet Explorer and Firefox. Then it used its distribution to launch other products like Maps, Gmail, Chrome, and more — it capitalized on its distribution advantage.

Google Toolbar launched in December 11, 2000

Something to keep in mind is that a distribution channel is distinct from building a distribution engine. Distribution channels are hacks to get in front of your customers in a way that other companies may not (PayPal <> eBay, Airbnb <> Craigslist, Zynga <> Facebook). But once you have the distribution, you have to intentionally become distribution-centric — i.e., thinking of your company as a medium to redistribute a variety of new products to capture as much of the market share as possible. This is why big companies acquire other companies — it gives them the distribution to sell more products to more customers (think Facebook → Instagram, WhatsApp, Oculus, or Google → YouTube, Waze, AdMob). So the right way to think about it is that distribution channels are a precursor to building distribution advantage.

Elad Gil talks about this in his blog, How to Win as a Second Mover:

Zynga projected out the ongoing rise of LTV for social gaming users, allowing it to pay significantly more for user installs than its competitors. Once it had a massive market share, Zynga cross-promoted games it developed - effectively using its distribution to bootstrap more distribution. Zynga could then more or less copy competitors' games, launch a month later, but still win on market share via aggressive distribution.

Just because you have distribution doesn't mean you stop or become complacent — you should obviously try to build as much defensibility in your business as possible to make it as miserable for anyone trying to replicate you. This means that pairing distribution with one of the 3 advantages outlined by Bruce Greenwald above is critical to constructing long-term defensibility.

So really, it's not that your startup doesn't have a MOAT. It's just that it doesn't have a MOAT yet because constructing a MOAT is a function of time. It's implied that you have to build a 10x product experience. But once you have the reach, it's a decision to transform that reach into a distribution engine that amplifies your brand and company. Whether you capitalize on this advantage or not comes down to your ability to execute. If you do, it'll give your startup the buffer from emerging competitors to launch new features and experiment with radical ideas. Over time, your distribution advantage should compound, and that's what you need to build a long-term MOAT for your startup.

Thanks for reading! For any questions or corrections, please send me an email.
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