Every investor loves asking about a company’s moat. The basic idea is straightforward – what makes you unique, such that another company won’t ultimately eat your lunch by replacing – or even just imitating – your product?
In speaking with other founders and with investors, I’ve heard (and, admittedly, given at some points) many bad answers to this question, and even more egregious stories of mistaken ideas about what a moat is. But the more I’ve reflected on this, the more I’ve realized that this is because your moat, like your company, isn’t static – so any answer that tries to simply state “our moat is X” will be incomplete. Not only does the content of your moat need to change as your company grows, but the very nature of it should be evolving.
Let’s start with the early days. In my opinion, the earliest moats are based on insight. This might surprise you – after all, ideas are cheap. But insight is about more than just having a clever or unique idea. It’s about actually being correctly different – about identifying the free money that’s been left on the table and having the conviction to go and take it.
Of course, just having a great insight isn’t nearly enough for your business to succeed – and just having a moat isn’t the same as having built a great castle. The foundation of your castle is execution. Startups that know how to hustle, know how to actually get their customers engaged and understand that just building a great product isn’t enough to grab peoples’ attention – these are the startups that succeed. It’s a minimum requirement to know how to execute; but that also means execution isn’t a very obvious differentiator. Perhaps a few startups are truly that much better at executing than all the others, but usually, execution can be treated more like a binary. Either startups have it or they don’t.
So the moat is what distinguishes you from all the other early-stage startups that understand what it means to hustle and build a business. Investors might quickly rule out teams that don’t have the execution spirit, but in the end, their hard decisions will be between two startups which claim to have uncovered different insights about the world. And ultimately, the question will be, which of these two insights seems most likely to be real and valuable?
Once a startup has raised some money and started delivering their product to real customers, they need to build the main floor of their castle – they need product-market fit for their core product. Just as with execution, this is a crucial competency. If you can’t find something to build which your customers actually want, you’re dead in the water. But once again, this can generally be treated as a binary. Did you find product-market fit, or didn’t you?
If you have, then you’ll naturally want to build out more of your castle, capturing more of the market. Here is where your moat needs to change. You’ve already proven that your original insight was correct, but the problem is that you’ve done so publicly. The world now knows this money is on the table. Which means you’re in a race with the many, many other companies which are about to emerge to try to capture their share.
So what does a midgame moat look like? Well, the core of the moat is velocity. How quickly can you capture the rest of the market compared to the emerging competitors? Velocity can come from multiple sources – it might be differentiated execution strategies (which you’ve now had the chance to actually build out in a real, scalable way), it might be network effects or deep industry relationships, or it could just be money. That last one is particularly surprising, and often frustrating, to those outside the industry, but elite VCs are extremely aware of the self-fulfilling-prophetic nature of a huge capital injection. Once you start talking about tens or hundreds of millions of dollars being thrown full-force towards capturing a market, most other players in the industry will understand that they can’t really expect to keep up without a similar investment. So at the bare minimum, you keep those that can’t afford it from bothering to try to compete, which often translates to cutting out a huge chunk of potential competitors.
So you build out that new moat, and you build a great castle from which you hold dominion over a vast segment of your market. What now?
Now you go forth and conquer! Specifically, you want to find new industries or new markets to attack, which can become additional sources of revenue for your overall organization. You’re now in the lategame, and have already proven you have what it takes to build one castle; but that doesn’t mean you’re able to repeat the accomplishment. Perhaps your original land was unusually fertile, or perhaps a whole market grew up around your castle without you realizing, and you simply took advantage of the opportunity.
In order to start building new castles, you need to have learned generalizable skills about castle-building from your experience. How does one identify real insights? What does ideal execution look like? What kinds of strengths and weaknesses do your teams have that should direct your attention? What form of ‘customer-obsession’ has served you most effectively, and why? This is the lategame binary filter. The failures will throw money towards wasted efforts hoping to reproduce their original success in a business they don’t actually understand, or which has evolved away from them. The best companies, instead, will identify real opportunities that much more effectively based on their original experience, and become that much more of a dominant force through the self-reinforcing cycle. (Amazon is a great example of this – AWS was not a market they had magical knowledge of, but they knew the fundamentals of business and were able to apply them in a way where their capital would give them a real advantage.)
The problem is, while you’re off trying to build a new castle, your enemies are still besieging your original fortress. So what does a lategame moat need to look like, to enable you to continue to grow the business?
The answer is that this moat is build on slack – or, more directly, time. After all, building a new business isn’t instantaneous, and while you’re working on it, you’re pouring away money that could have been spent maintaining your primary market position. But if you can build a strong enough brand, a unique enough featureset, a skilled enough sales force, or enough other strong assets, you can reach a moment when your opponents are still working to catch up and aren’t ready to compete at full force. Thus, if you have the ability to widen the gap, you’ll be able to strategically find the right moments to expand your business outwards. But if you can’t create a wide enough buffer, then you’ll be locked in eternal, brutal competition with opponents, where each new dollar you earn must be spend simply to maintain your position rather than to generate new income.
(It’s notable that, while all moats are somewhat environmental and subject to your competition, in this last stage, your moat is entirely dependent on other players in the space. If nobody else has invested time and money into your market, you might lots of slack despite minimal investment in creating it. This hints that the truly ideal market is one which is not only large, but not generally known to be large, such that you won’t face as much competition for market dominance. Since people are usually pretty on-the-ball when it comes to market sizing, though, the best way to find such a market is to target markets which are small today but which show signs of growth – if you’re among a small number of people who believe that growth is coming soon, you’ll face minimal competition until it does.)
Obviously, all of these cute metaphors drastically oversimplify things – in practice, business strategy should be intensely focused on the specifics of the individual company, team, and market. But, for better or worse, the ‘moat’ analogy persists and is often used materially by founders, investors, and partners to determine the likelihood of a company’s success. So at the very least, hopefully this overview is helpful in highlighting the ways in which an ideal moat should be evolving – and points early-stage founders in the right direction to start planning not just for their early-stage moat, but also for being well-positioned to evolve to the appropriate types of moats further down the line.