What are Your Barriers to Entry?

This question arises in every meeting with a prospective VC investor.  It is also the most vexing issue for the both the VC and the company looking for an investment.  If taken literally, both sides are looking for some impenetrable advantage that assures a monopoly, however tiny, for this new company.  The “barrier to entry” is the small company’s insurance against annihilation.

Ain’t no such thing. 

Any cursory examination of the literature on the economics of industrial organization will confirm this fact.  There are no sustainable barriers – capital, brand, cost advantage, etc., all evaporate over time. The evolution of technologies and buyers’ tastes assures that no competitive advantage endures forever.  Even government regulations and patents are not a barrier, particularly in a world awash with multiple technologies for accomplishing the same tasks. 

We all know this. So what do we really mean when we say what’s your barrier to entry?  I think what we mean is really the reciprocal. What’s everyone else’s obstacle to imitation?  Competitive imitation erodes your uniqueness as in Unique Sales Proposition. It raises the cost of differentiation and it gives the customer more perceived choices.   You have to spend more to stand out and get less market share for it.

Imitation comes in many forms. It can be a current claim, as is “we do the same thing.”  It can be a future promise, as in “we will have that feature, too.” Worst of all, it can be a rapid replica of your actual product.  It is the latter that most investors care about when they fear competitive “entry” or imitation.

Re-casting the question as obstacle rather than barrier also points to how to address the issue.  There is rarely a single obstacle that is so insurmountable as actually to be a barrier.  However, you can often outline a series of speed bumps that will slow down even the fastest fast follower. 

Obstacles are not always intellectual property land mines.  They may include assembling the right interdisciplinary team, achieving one or more early unique distribution relationships, or even having a novel understanding of the customer’s needs.  Ideally it is a full constellation of these obstacles, and more.  Whatever the argument is, it must be compelling.  You need to outline why all these gates are both necessary for any follower to imitate your business, and why each obstacle is non-trivial. 

Early stage VCs differ from other private equity investors in one important respect.  We don’t invest in businesses.  We invest in people who create businesses. The quality and rigor of your self-analysis and your assessment of vulnerability to imitation is a key facet of the assessment about whether you really have a barrier to entry.  In the end, the only thing that is unique to your business is you.  Your only real barrier to entry is your ability to stay ahead.  That’s what the “barrier to entry?” conversation is really about.

Comments

[Andrew Fife]

Peter:
What a great post! I agree 100% and find that most entrepreneurs I meet are focusing way too much energy on erecting patents as barriers. Does any investor want any of their capital being used for patent litigation? You might be interested in the non-patent barriers (although I prefer your term obstacles) to entry that I’ve suggested here:

http://andrewbfife.blogspot.com/2006/04/barriers-to-entry-patents-non-patent.html

IMHO, the best obstacle to imitation is a sharp understanding of the evolving nature of pain and the ability to translate that knowledge into new benefits, which solve customers’ problems.
-Andrew

[Dharmesh Shah]

I like to call this the "valley of fire" concept. I ask myself the following questions:

1. What is the valley of fire I had to walk through to succeed? (i.e. what was difficult about what I did)

2. Am I sure that others that follow/compete with me will have to walk through that same valley?

Basically, I try to make sure that I'm doing something that's reasonably hard (could be distribution, could be technology) and make sure that there are no short-cuts that let others easily circumvent this obstacle.

[rosny]

great post. Since the hardware much more cheaper now, also the maturity in technology. The barrier of entry in techology is much more easier.
Like www.opida.com, to imitate digg, just take two days to code.

[audibletype]

wow! thank you very much for this great post. i've been asked the very same question, and I thought that I've always answered it well. This article really made me reflect upon many things.

[Simon Brocklehurst]

This is a great post, Peter.

One that that's always amused me in all this, is that one of the best ways to build a lead over the competition is, of course, to actually make the decision to get going and execute the plan.

And yet, few people, entrepreneurs and investors alike, seem to have any real sense of urgency about closing a financing and getting the money in the bank. It amazes me just how many people are prepared to spend months finessing terms sheets, and generally "dotting the i's and crossing the t's" to actually get the money in the bank and start accelerating the business.

All the while, the lead over the competition is being eroded. Fortunately, because this lack of urgency is the norm, few competitors can take advantage of this.

Nevertheless, that months are wasted from the moment the decision to invest has been taken, to actually starting to spend the money on the plan, seems rather sub-optimal.

[Gaurav]

I think for an early stage company the only real barrier for entry is its team and how well it executes. At least in the domain of software products, differnetiation on the basis of features or price is no longer possible. Anybody can create a flickr clone, but can they build a matching community?

[Anil Gupta]

Thought of your blog entry while re-reading The Innovator's Dilemma.

"The most powerful protection that small entrant firms enjoy as they build the emerging markets for disruptive technologies is that they are doing something that it simply does not make sense for the established leaders to do"