Why are VCs interested in a Business Defensibility?

Defending?against competitors is on the agenda of most businesses; be it a board of a huge company contemplating the next step to cement its?position in the market, or a startup explaining to VCs how it will be defensible in the long run.

No company can be eternally defended from the tentacles of innovation. All have to keep looking over their shoulders and innovate in order to stay relevant. Even Google has to.

“But more important, someone, somewhere in a garage is gunning for us. I know, because not long ago we were in that garage.” – Eric Schmidt

While companies hope to survive and ride the next wave of innovation and disruption in their markets, they follow certain strategies to stay defensible in the predictable future.

Defensibility emerges from differentiation. A strong differentiator is something in the company’s product/service offering that cannot be easily replicated or eclipsed by a competing company.

In the old days, the business literature listed many ways to create?defensibility: unique access to raw materials, favorable geographic location, government regulations like tariffs, patents and licenses, etc. In the digital world, however, these have largely melted away. In software, information transparency is much higher, geographic borders mean less, it’s easy for customers to click to a competitor, etc. What we’re left with are a short list of competitive advantages and just a handful of true defensibilities.

Network effects have emerged as the native defense in the digital world. James Currier

If you build a business with good competitive advantages, your?value?grows linearly as you grow revenues. That’s good.?But if you’re able to move past competitive advantages to true?defensibility?— to really being able to protect your business from competition — your?value?grows exponentially. This is shown a graphy below by James Currier.

As Peter Thiel tells in his book “Zero to One” to build a sustainable?Monopoly?it′s needed to start in a?Niche Market, then gradually expand into related markets with a clear long-term?Vision.

The four defensibilities of the digital world

Economies of scale?(example: Amazon). When you get bigger, a host of advantages accrue to you.?More users means more volume, means you can get cheaper prices from suppliers, means lower prices for customers, means higher conversion rates, makes your advertising more effective than your competition, etc. Recurring revenues?are one of the best measures of a startup’s health. It shows how your product is adding value to its customers. Every investor will check this when analyzing your company and it will depend on the business model. For example, customer retention by cohorts, upselling, LTV:CAC, negative churn, MRR, ARR etc.The numbers all move in your favor, and math is hard to compete with.

Brand?(examples: Booking.com, Google). With brand, a certain company can stand top of mind when we think of something we need, like?booking.com?when I need a hotel room. Priceline, the owner of Booking.com, spends more than $2 billion per year in advertising to make sure that’s true. Further, people come to identify themselves with brands. People who want to associate with Apple products?will not comparison shop. Those psychological barriers make it very hard for competitors to break in.

Embedding?(examples: Workday, Oracle, SAP). Embedding works when you integrate your software into a customer’s operations so the customer can’t rip you out and replace you with a competitor. This is obviously more prevalent when customers are organizations, not individuals, and is typically accompanied by a direct sales force to drive the embed.

Network effects?(examples: LinkedIn, Alibaba, Craigslist). Network effects are the incremental benefit gained by an existing user for each new user that joins the network.?As more users play Codigames games, they receive more value, so the same users are responsible for bringing more users through word of mouth. These recommendations usually come from members-get-members actions.

There are five major types of network effects. Direct (LinkedIn, WhatsApp, Facebook); two-sided (eBay, Craigslist, Microsoft, iOS); data (Google Maps, Waze); tech performance (BitTorrent, Skype); and interpersonal (Slack, Apple). Each of these makes your business hard to catch once it gets going. They make it defensible. Network effects have emerged as the native defense in the digital world. Fortunately, creating network effects are available to startups from Day One. As such, we consider network effects the?most?important type of?defensibility, and thus, the surest route to?value?creation.

If you’re starting a business, don’t start it until you’ve thought thoroughly about how to design it with one or more of the core network effects. Then think about how every new feature you build could add?value?to the other users of your product. That way of thinking about business and product design puts you on the road to true?defensibility?and massive impact and?value?creation.

Some insights have been acquired in articles below:

• What Makes a Business Defensible?
• Competitive Advantages & Defensibility; How to Achieve and Maintain a Startup’s Market Position
• Network Effects in Marketplaces
• Defensibility Adds the most value for Founders
• Network Effect Manual
• Chicken or egg problem
• All about network effects
• Anu on Network Effects