Beyond Competitive Advantage

Imagine two very different business worlds.

One is a world in which market forces work their magic. If companies are profitable, new competitors enter and profits get worked down to nothing. If there is too much competition, companies exit (or go out of business) so that they neither lose nor make much profits.

The other is a “winner take all” world ruled by monopolies which have a bad name because they are anti-competitive. They make huge profits protected from competition.

If you’re an entrepreneur, which world would you rather live in – the competitive world or the one dominated by monopolies?

That’s a trick question.

We’ve been trained in our society to compete fair and square. Anti-competitive behavior is not only seen as sneaky, it’s against the rules and downright illegal in most cases. The irony is that, in the business world, we gain less by competing more.

A book called Zero to One made me think about this recently. The author, Peter Thiel, co-founder of Paypal and investor in Facebook, advises entrepreneurs to avoid competition:

“In the real world outside economic theory, every successful business is successful exactly to the extent that it does something that others cannot…Monopoly is the condition of every successful business.”

While I disagree with the broad notion that every successful business is a monopoly, Peter’s observation – that great businesses do something other cannot – is absolutely correct. Great businesses are unique. Here is one of my favorite VC quotes by Sequoia’s Mike Moritz:

“I rarely think about big themes. This business is like bird spotting. I don’t try to pick out the flock. Each one is different and I try to find an interestingly complected bird in a flock than try to make an observation about an entire flock.”

Marketers think about differentiation. MBAs think about barriers to entry or competitive advantage. According to Warren Buffett, great businesses are “economic castles protected by unbreachable moats.”

However, Peter Thiel would urge entrepreneurs to go beyond competitive advantage. Don’t think conventionally about beating the competition. Avoid competition and look for opportunities to become a “monopoly” rather than one of many competitors.

Sam Walton figured this out when he built Walmart. He always tried to learn from retail giants such as Sears and K-Mart but he didn’t try to beat them. He avoided them. He stayed in rural markets and grew under the radar for years, even after IPO.

Another great retailer, Jeff Bezos started by focusing on the book market. Amazon’s ambitions were huge but the company stayed focused and dominated its first market before expanding to CDs, DVDs and other categories.

A more recent example is Facebook. Initially, Mark Zuckerberg didn’t set out to connect the world. He just wanted to connect Harvard. After that he added Stanford, Yale and other colleges.

Another example is Tesla. Elon Musk didn’t go after the mainstream car market. He started by making batteries and a tiny sports car targeting a high end niche.

The Small Market Problem when Pitching VCs

Most entrepreneurs looking for VC funding believe that they need to go after big markets. Often, it results in a pitch that falls flat – like “we only need 1% of this $10B market to reach a hundred million dollars in revenue.”

Don’t go for single digit market share. The goal is to get dominant market share.

The problem is that entrepreneurs looking to avoid competition will have to go after small, often overlooked markets in the beginning. Such entrepreneurs will have a hard time raising venture funding because VCs look for billion dollar “unicorn” opportunities.

So how should entrepreneurs go about pitching VCs?

The cold reality is that, for most companies, in the early stages, VC is not the right source of funding. Most companies get started in bootstrap mode, scraping by in the early days funded by personal savings, money from friends and family or customers. Even companies that eventually raise billions of dollars start this way.

Once you own your initial market, you will have options. It’s a great place to start before taking it to the next level. Investors love funding companies that have traction. Make progress and raise funding along the way.

For example, Uber started by going after the limo/taxi market in San Francisco. They then set about expanding to other cities and countries. Now they are looking at the car industry itself (replacing the need for cars) as well as local delivery/logistics.

No matter how big your ambitions, the key is to not only win but dominate your initial market, which has to be small enough for an emerging company to have a chance to win big.

At Altos, when we searched for overlooked markets beyond Silicon Valley, we decided to go to South Korea. We avoided the crowd of VCs going to places like India and China and we’ve been happy with the results. We will grow from our little base. We have larger goals.

In our next post, we will talk about other ways in which we are searching for monopoly profits. One obvious area is in the software industry which some have called “an industry of a thousand niches.” More specifically, we will provide our perspectives on vertical market software as an interesting category of opportunities for entrepreneurs and VCs looking for monopoly profits.