Power of an enabler

Competitive advantage is a fabulous thing to have in a business, is difficult to build one, and even more difficult to identify the cause if it exists (from investors’ perspective). In this essay, we will try to understand one way to identify it. Before that, it will be good to review the fundamentals of the competitive advantage.

What is a competitive advantage and why every business wants it?

Competitive advantage can be in various forms such as low-cost service provider, network effect, distribution network, faster R&D cycle, brand, and ecosystem. Competitive advantage allows a business to grow its revenue and expand its operating margins faster than the industry rates and for a longer time than the competitors can. Also, during cyclical downturns, companies with competitive advantage can survive the downturn in a better way. The advantage can manifest in various aspects such as gain of market share as weaker competitors shut down their businesses, margin protection due to the ability to pass the cost, customer retention due to better customer experience, or new product development due to strong R&D capabilities. Overall, competitive advantage increases the longevity of the business, helps to deliver higher ROCE, and helps to deliver more free cash which can be redeployed at that higher than industry ROCE and for a longer period. All these factors feed into one another and result in a larger intrinsic value basis DCF model.

Why building a competitive advantage is easier said than done?

Although every company wants to build some form of competitive advantage, building one is a difficult task. The difficulty arises because it could be costly (to build a 2-sided marketplace business model), time-taking (to establish a distribution network), and culture-constraining (to change the way the business is done). In most cases, all these factors can together be the limitations, making the task even more challenging. In my opinion, the first two problems – cost and time – are relatively easier to solve. The third problem of culture which impacts execution is a difficult problem to solve. This is because a lot of factors are in play. I have highlighted a few factors below and how they interact, taking inspiration from my learnings at a strategy course in B-School.

Why is it difficult to identify the source of the advantage?

Investors try to identify the source of competitive advantages in a business. This helps in understanding the sustainability of that advantage - the longer the advantage holds, the better for the business and investors. Although overall it is a difficult task when it comes to exactly pointing out the cause or source, investors get some help from the history and financials of companies in the case of large and established businesses. This help does not exist in the case of either young companies or new business models. In such cases, investors must forecast the type of competitive advantage a particular business model can be built in the future and will it be sustainable. In the next section, I have highlighted one of the characteristics/phenomena which I think is interesting and generally overlooked. One thing to note is that we are not debating why company A can be a winner and not company B. That’s a different exercise or assessment to be done. I want to highlight one of the many characteristics that I think is good to have in a business model, especially early-stage businesses, which will lead to mass adoption and the characteristic is – Ability to transform from being an end-product to being an enabler

To make this phenomenon easy to understand, let’s look at various examples.?

Example 1- Google Maps

Launched in 2005, Google tMaps was a desktop application that helped people to navigate. Today, it is used by many other desktop and mobile applications. As per Google Cloud, the monthly active user is more than a billion, and more than 5 Mn active applications use it (LINK ). From its initial use case, it has not become a utility product. It has become a key infrastructural layer in highly active applications in the food delivery and transportation and logistics sector. The service is so indispensable that Uber S1 says that - Uber believes that there exists no other service similar to Google Maps which can meet its needs globally. Because of this high engagement, Uber is able to monetize via ads (business lists themselves on Google Maps), and by offering APIs to other applications. Both the revenue streams are generated by enabling other businesses which choose to adopt.

Example 2 – Smartphone

The device has now transformed from being a calling device to being a “computing platform” to run a host of applications. The device has become indispensable by enabling humans to perform countless tasks- from routine daily services to high-resolution games. Hence, it is not difficult to imagine that there are more than 6.5 Bn smartphones globally (LINK ).

Example 3 – Digital insurance

Digital insurance category started with the concept of underwriting insurance products digitally with the usage of alternative data to achieve a lower loss ratio. The category has now proliferated into digital ecosystems – online retail, online travel & accommodation (Booking.com, etc.), online cab aggregators, etc via digital micro-insurance products, which is a new category. These applications use the core offering of insurance underwriting services to provide better customer service. These partnerships wouldn’t have been possible in the offline insurance business because traditional insurance infrastructures are not built to underwrite millions of insurance policies in a day and process claims in a short period. The agile nature of this business model allowed it to become a utility for other digital sectors as highlighted above. Moreover, the loss ratio for the micro-insurance product is much better than the traditional insurance products (based on the numbers from India’s largest digital insurance provider). The loss ratio for the micro products is around 50% compared to 90%+ for traditional products.

Example 4 – Zoom

Zoom is slowly morphing from being a just video calling service to being a “platform” to collaborate and to be used by other collaboration applications such as Slack. It is acting more like an infrastructure required for collaboration tools. Zoom works better even in low bandwidth, has more people using it, and is open to collaboration, making it easier to become a utility.

In essence, these examples are a reminder that distribution models have changed in the internet era. It has become faster, cheaper, and better. As highlighted in the diagram below, companies can move easily from 1 to 2 to 3 to 4 with the help of the new distribution models once the product-market fit is achieved.

To conclude, if we can find the seeds of being an enabler in an early-stage business, and if we are comfortable in believing that version of the world, where the early-stage business is powering many other ecosystems, then potentially, we have a winning category. The next set of exercises for the investors will be to back the right company in that category.