Just because you’ve identified a customer need, doesn’t mean you can make money solving it. You need to solve the problem in a unique way where you have an unfair advantage. Without this, anyone can copy what you’re doing, and you’ll soon be cutting your prices to the bare minimum to win customers.
A simple way to think about this is that you create value where customer needs and your unique capabilities intersect.
“How will your product delight customers, in hard-to-copy, margin-enhancing ways?”
— Gibson Biddle, ex Netflix, Chegg
Gib Biddle sums this up succinctly in the above quote, and the “hard-to-copy” part of this statement underpins both the “delight” and “margin-enhancing” bits.
If your product isn’t hard to copy, you can’t delight customers, or have good margins. At least, not for very long. Competitors who can easily copy your product will commoditize the market. Users will quickly recalibrate and come to expect what was previously special from everyone as table stakes. What used to be delightful fast becomes mundane.
“Customers are always beautifully, wonderfully dissatisfied, even when they report being happy and business is great.”
— Jeff Bezos
This has immediate implications. Customers will pay a premium for a unique, delightful product, but if everyone is offering the same thing, then price becomes the only differentiator. Without barriers to competition, prices drop quickly and marketing budgets go up, destroying profits in the process.
In this article we’ll run through how you can build a competitive moat with numerous real life examples, and show you how to assess how defensible your business is to different competitors.
Throughout this article, we’ll use the terms “competitive advantage” / “ moat” / “unfair advantage” / “7 powers” / “hard-to-copy” / “defensibility” and so on relatively interchangeably, as they are synonymous in common usage.
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Benefits of defining your competitive advantage
“Monopoly is the condition of every successful business.”
— Peter Thiel, founder PayPal, Palantir
Having some form of unfair advantage is essential for successful businesses. Understanding what this is, and intentionally developing your unfair advantage has a number of further benefits:
- Allows you to sense check that you actually have a competitive moat against different competitors
- Creates internal alignment around the value proposition you’re offering customers
- Helps you identify work that will deepen your competitive advantage vs. work that matches competitors’ features
- Allows you to make intentional trade offs between deepening your moat vs. expanding
The 7 powers
“The forces of competition are incredibly strong….and if you don’t read 7 Powers you’re going to die a lot sooner.”
— Reed Hastings, CEO and Co-Founder, Netflix
There are relatively few ways of creating and maintaining hard-to-copy advantages. Hamilton Helmer cataloged these in his book “7 Powers,” which has become a modern classic on strategy, and widely referenced by leaders across the tech world. The 7 powers are:
- Network effects – Each user enjoys more value as new users join the network
- Scale economies – Unit costs decline as volume increases
- Switching costs – Switching to an alternate product would be costly or painful for users
- Counter positioning – Where a new product’s business model or value proposition cannot easily be copied by incumbents as it would damage their existing business
- Cornered resource – Unique access to a valuable asset
- Branding – An objectively identical offering has higher perceived value
- Process Power – Embedded company culture and process which enable lower costs and/or superior quality
“Hamilton Helmer understands that strategy starts with invention. He can’t tell you what to invent, but he can and does show what it takes for a new invention to become a valuable business.”
– Peter Thiel, co-founder PayPal, Palantir, investor
The goal here isn’t to pick a couple of the seven powers and then build a product to deliver them. This kind of approach will likely fail to address customer needs in a really exciting way.
Instead it’s a sense check that your business has longevity. If you can’t see how your product generates any of these powers, it’s a major red flag that your business might not be viable longer term.
When you’ve got a product that customers love and pay for, reflecting on the 7 powers can give you inspiration for the direction to take so you can build a long term sustainable business.
Investors are particularly interested in how these powers will evolve over time, because it’s high margins that underpin the high valuations of tech companies. Without a plan of how you’re going to develop and maintain power over your competitors, your margins will deteriorate and the value of your company will follow suit. This is inevitable if you can only differentiate on features that are easily copied, as price and marketing spend quickly become the ways that companies compete, and margins are squeezed from both sides.
Decreasing price and increasing marketing both lead to lower margins and profits
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Let’s run through each of the 7 powers in turn:
1. Network effects
Each user enjoys more value as new users join the network.
This might happen directly (e.g. a social network) or by alternating between two user groups (e.g. supply and demand in a marketplace):
Single user type:
- Linkedin – every person on Linkedin increases the chances that you can find people you already know there, as well as increases its effectiveness as somewhere to hire people and find specific professionals you are looking for.
- Whatsapp – The more people there are on Whatsapp, the greater the chance that you can message people you know on the platform.
- Twitter – As more people join Twitter, there are more people tweeting and creating content. That makes your feed more interesting and draws even more people onto the platform.
Multiple user types:
- Just Eat – When a restaurant is added to Just Eat, then the variety of options to customers increases and more are drawn onto the platform. More customers on Just Eat in turn increases the number of orders that restaurants on the platform can get, which brings even more of them onto the platform.
- Airbnb – Every host on Airbnb brings more rooms and homes to the platform, increasing the choice of accommodation. More choice brings more guests onto the platform, who in turn make more bookings. More bookings means more revenue potential for hosts, and encourages more to sign up.
- Depop – Sellers coming onto the platform list more clothes. A great variety of clothes brings more buyers onto the platform. More buyers make more sales, and create an increasing revenue potential for sellers, drawing them onto the platform.
Illustration of Just Eat’s network effects Industries that see network effects tend to favor very few winners – sometimes just one. This is because the virtuous cycle of network effects gives leading players a big advantage over challengers, and this advantage naturally compounds over time.
Maximizing Network Effects
Companies that have network effects can maximize the competitive advantage they have by further growing their network. The larger the network is, the harder it will be for competitors to match its strength, especially when users frequently want to limit the number of networks they are in due to limited time or money:
- Just Eat Takeaway – Raised $2.8bn before going public to fund aggressive international expansion and create network effects before other players could follow suit.
Competing against Network Effects
Taking on companies with strong network effects generally means going after a single segment of users that the incumbent caters to, and delivering a huge amount more value to this segment. For example:
- Targeting a niche – By focusing on a small segment, you can create a better experience that overcomes any network effect enjoyed by an incumbent. eBay is dominant in peer-to-peer commerce, but Depop and Vinted can carve out a position by focusing on fashion, whilst Backmarket has done the same by focusing on electronics.
- Superior value – if you can offer a radically better product, then you can sometimes punch through the network effects that an incumbent has. Skype had network effects when Zoom launched, but Zoom’s video quality and stability is so much better that it has eclipsed Skype as the dominant video conferencing provider.
- Interoperability – Whilst Skype and other internal collaboration tools existed when Slack was launched, Slack focused on integrating with tools such as Google Drive, Github and Dropbox. This convinced a lot of people to switch over, even though Slack didn’t initially have network effects in its favor.
2. Scale economies
Per unit cost decreases with volume
Scale economies emerge when there’s a very large fixed cost to providing a product or service, and this can be spread over lots of customers as the business grows. This means that the unit costs for individual customers are low, even as the investment required to set up a competitor is very high. All content businesses and SaaS business benefit from scale economies to some degree.
Examples:
- Disney – huge investment in making new films and franchises is largely fixed, regardless of how many people enjoy them. The broad appeal and longevity of Disney’s content means that the cost of creating it is spread over a very large user base.
- Amazon – high density of logistics hubs and drivers allows for same and next day delivery, which is prohibitively expensive for competitors to offer.
- Vodafone – massive cost of installing and maintaining cellular and broadband infrastructure means only very well capitalized companies can compete.
- Salesforce – long term investment in developing and acquiring complementary products means that competitors cannot offer as broad a product suite.
Maximizing scale economies
Scale economies are maximized when companies continue to invest in their cost base to deliver even more user value. Any company who has achieved some scale economies will already have a large customer base meaning it can spread further investment over more users, making it even harder to match the experience it’s offering.
- Amazon – continued to invest in logistics to offer same day delivery, even as most retailers struggle to offer next day delivery.
- Netflix – invested $16.7bn in content in 2022, giving it access to a broad library of shows that is difficult for all but the largest competitors to match.
Competing against Scale Economies
Scale economies are very difficult to compete against. Winning against them generally involves developing a completely different cost structure for the product you’re offering customers, or creating so much value that customers are willing to pay a higher price. For example:
- Innovation – Occasionally big technology changes make previous investments irrelevant. For example Skype and other internet-based communication companies didn’t have to build the infrastructure that traditional telecoms companies had previously needed to invest in to allow international calls and messages.
- Licensing – Sometimes companies that enjoy scale economies offer these benefits to other companies under licensing or partnership arrangements. For example, Amazon built AWS and its distribution network for other companies to use.
3. Switching costs
Switching to an alternate product would be costly or painful for users.
Switching costs occur when either there’s a significant setup cost to using a product, or customers invest in a particular product over time. The cost of switching can be money, time or emotional, and prevents customers moving to another product that would otherwise be better.
Examples:
- Minecraft – when you play Minecraft you invest in a digital world that you can’t transfer to another game.
- Salesforce – Deep integration through multiple products makes switching to competitors difficult.
- Instagram – your social graph is constantly enriched as you use the product, and recreating the same graph on another network would take a lot of time, even if it was possible.
Maximizing switching costs
Switching costs are maximized when businesses offer a deeper integration with their customers, often through additional products and services. This has the benefit of providing scope for the business to increase its revenue per customer at the same time as making it more difficult for its customers to leave.
- GoCardless – initially launched as a recurring payments product, but has launched one-off payments and fraud tools as it has grown, deepening its integration with customers.
Competing against switching costs
Companies that compete against switching costs need to make the benefits of switching outweigh the costs. This is done by either developing a much stronger value proposition (a “10x product”) or streamlining the switching process (e.g. setup wizard / white glove service). For example:
- Transition support: Challengers often work hard to reduce the effort required to switch between products. For example, Android has invested significantly in making it easier to move across from an iPhone, whilst Airbnb created a hack to copy hosts’ room listings from Craigslist onto Airbnb in the early years.
- Incentives for transitioning: Sometimes companies offer customers money or other incentives for them to switch from a competing service. For example, Monzo offers a £5 referral for new customers and the people who referred them. This helps to overcome some of the effort involved in setting up a new bank account.
4. Counter positioning
Where a new product’s business model or value proposition cannot easily be copied by incumbents as it would damage their existing business.
Counter-Positioning is where a new entrant in the market uses a radically different business model which existing firms cannot copy without damaging their existing business.
Examples:
- Skype – Slashed the cost of international calls with an internet-based communication model. Traditional telecom companies couldn’t copy this without cannibalizing their existing high-margin international calls.
- Spotify – Provided a subscription-based music streaming service, which record labels and Apple struggled to follow as they relied on sales of individual songs and albums.
- Airbnb – Offered a transaction-based charging model for holiday rental owners, which was attractive because of the zero upfront cost. HomeAway and other traditional rentals directories were tied to their listing-fee model and could not easily follow suit.
In all these examples, counter-positioning allowed the newcomers to carve out a strong market position that was hard for established players to challenge directly.
Maximizing counter positioning
Counter-positioning is unique as a power as it cannot be extended indefinitely. The more successful a counter-positioning strategy is, the more the industry as a whole will adopt the new business model or value proposition being offered, and the less distinctive it will become. As a result, players that rely heavily on counter-positioning need to develop new powers as they grow.
- Spotify – has developed switching costs (playlists and personal taste profile) and cornered resources (exclusive podcasts and audiobooks) as subscription has become the dominant payment model in music, and lost its counter positioning power.
Competing against counter positioning
Responding to counter-positioning can be challenging because adopting a new business model usually means giving up large amounts of existing revenue. Even if it’s inevitable that the industry will eventually transition to the new business model, it can make more sense for incumbents to manage the decline of their existing businesses rather than accelerate the shift.
However, companies can use several strategies:
- Differentiation – The incumbent can differentiate its products or services by emphasizing quality, reliability, customer service, or other factors that might still hold value to the consumer. As Skype and other internet-based communications became more prevalent, traditional telecoms companies started introducing mobile data and bundled services (combining internet, mobile, and TV).
- Adaptation: An alternative is for the incumbent to integrate some aspects of the newcomer’s business model without completely damaging their existing business. This is what Apple did in response to Spotify, launching Apple Music as a subscription-based music streaming service that coexisted with iTunes.
5. Cornered resource
Unique access to a valuable asset
A “cornered resource” refers to a unique asset or capability that a company exclusively controls, providing a long-term competitive advantage.
Examples:
- Opentable – Once a restaurant starts using Opentable, then they are not going to be open to using a different booking system, which prevents competitors from serving them.
- Pixar – Developed an exceptionally talented and multi-disciplined team of creatives that led to a string of hits in their early days. Pixar’s first 10 films averaged 94% on Rotten Tomatoes – far higher than other studios.
- Tesla – Created its own infrastructure of superchargers, allowing Tesla owners to charge their cars very rapidly. This is a major benefit to Tesla owners, which is not accessible to other car owners.
Maximizing cornered resource
Cornered resource power can be maintained and strengthened by continuing to invest in the cornered resource.
- Meta – From an advertiser’s point of view, consumer attention is a cornered resource dominated by a small number of social networks. Meta acquired Instagram and Whatsapp to maintain its lead here, and launched Threads after failing to buy Twitter.
Competing against cornered resource
When faced with a competitor controlling a cornered resource, a company can respond or compete in several ways:
- Partnerships – Companies can negotiate licensing agreements to use cornered resources for a limited time or limited capacity. Netflix, Amazon Prime and other streaming services frequently do this when they negotiate the rights to show movies and TV shows in specific markets for a limited period.
- Acquisition: If you have the money, you can buy the company controlling a cornered resource to get access to it. This is what Disney did when it purchased Pixar.
- Substitution: Companies can find or develop alternative resources. Whilst other car brands don’t have access to Tesla’s supercharger network, the industry is consolidating around Ultra Fast Charging (UFC) which has similar benefits.
- Legal Advocacy: This is often an expensive and time consuming route, but sometimes companies bring legal challenges or aim to change government policy to reduce a competitor’s control over the cornered resource. This is what Epic was trying to do when it challenged Apple’s right to run the App Store as a monopoly.
6. Branding
An objectively identical offering has higher perceived value
Companies get a competitive advantage from a strong brand because it encourages customer loyalty and justifies higher prices. This is particularly important for luxury rather than functional products, where the whole purchasing experience has an effect on the satisfaction of the customer, and not just the functional benefit they receive.
Examples:
- Apple – Has a devoted fan base that will always consider Apple products first, rather than look at phones and laptops from alternative manufacturers.
- Toptal – Focuses on providing access to “the top 3%” of freelancers, setting itself apart from Upwork and Fiverr, which offer a broader range of freelancers.
- Headspace – Created a wellness brand that people value more than the individual meditations it provides.
- Smeg – Creates fridges with a distinct look, which command a premium to other fridges.
Maximizing branding
Companies maximize their brand by continuing to invest in it and further deepen the associations it has with customers. This generally means continuing to invest in the product itself to deliver the brand promises being made, and not just increasing spend on marketing along.
- Apple – Spends significantly on brand advertising and has invested heavily in its privacy credentials (e.g. asking users whether they want apps to track their behavior across the internet) as other tech companies come under fire for sharing user data.
Competing against branding
A strong brand makes customers seem like they are making an irrational choice, preferring a more expensive or less functional product. Tackling this can take a couple of different forms:
- Brand investment – You can invest the time and money to develop a similar brand. The most enduring brands are built up over many years, but incremental gains will still have value. In recent years Samsung has been investing heavily in its flagship Galaxy smartphone range to compete with the iPhone, and has plenty of devoted followers. Brand investment here tends to involve significant product development to deliver on the brand promises, and not pure marketing spend.
- Different brand promise – Rather than tackling a brand head on, you can make a slightly different brand promise, an appeal to a segment of customers who have different values. Signal, Telegram and Whatsapp have very similar feature sets, but Signal and Telegram have much stronger privacy reputations because they aren’t associated with Meta, and both have leaned into this.
7. Process Power
Embedded company culture and processes enable lower costs and/or superior quality
Process power is the way that companies do business, including their culture, processes and organization structure. Whilst it’s difficult to pin down exactly what is better about them compared to the competition, they consistently deliver a better and/or cheaper product.
Examples:
- Getir – Launched in Turkey in 2015, and although a number of competitors sprung up in Western Europe, the operational processes and optimizations that it’s developed have allowed it to thrive.
- Stripe – Focuses relentlessly on documentation, testing and other seemingly small details, which has resulted in a suite of products that developers love to use, and find easier to integrate.
- Supercell – Has an enviable track record of delivering incredibly popular and profitable mobile games. This is based on its unique approach to assembling small, very senior development teams, and letting them build the games they want to.
- Amazon – Has become one of the most valuable companies in the world, and attributes much of its success to its organizational structure combined with its 16 leadership principles that define its hiring process and internal culture.
Maximizing process power
Companies with a strong process power advantage maintain this by continually investing in their internal culture and processes. This often means giving a lot of attention to hiring the right people and retaining the best employees.
- Amazon – Codifies culture into 16 leadership principles, and uses these extensively in hiring. Uses “bar raiser” interviews to ensure quality of candidates is maintained.
Competing against process power
Replicating a company’s process power is at best incredibly difficult, and at worst impossible. It’s often not possible to see which meetings, organizational choices, cultural traits and so on are the ones that make the real difference, or to transplant them effectively to other companies.
Companies often respond by focusing on developing their own competitive powers. For example:
- Uber Eats – competes with Getir by offering mobility solutions and restaurant delivery as well as grocery delivery. This gives it scale and network effects from its delivery network that Getir doesn’t have.
- Adyen – has developed its ability to process payments in international markets. This is effectively a cornered resource that would take Stripe significant time and money to develop itself.
Creating a power map
Establishing which powers you have is a crucial part of developing a product strategy. You can only plan investment in maintaining and strengthening your powers if you understand what they are.
Companies must make a choice between how much of their product development time is split between different types of work:
- Power – work that increases your 7 powers and builds a competitive moat. Allows you to maintain high margins. E.g. proprietary features that competitors can’t easily copy
- Basic – work on functional features which are often common in the market. These will not delight users, but users will become dissatisfied and leave if you don’t have them. E.g. privacy and account settings
- Growth – work that increases the number of users who enjoy your product, or the margin you make on each user. E.g. smoother onboarding, or introducing a new business model
- Scale – work that allows you to build other features faster. E.g. addressing tech debt and building developer tools
This choice is best done explicitly and with strong buy in from across the business. Companies go through different stages and market conditions change. One quarter you might want to focus heavily on growth, whilst another you might want to “clean up” by working on basic and scale work.
Making this choice is best done very early in developing a product strategy, as it will determine which pillars you pick to make up your strategy, and how much capacity you have for them.
How to map your powers against competitors
It’s important to recognize that powers only exist relative to competition. They are not innate properties of a company that exist in a vacuum. You cannot have switching costs if there is no one to switch to. But also your network effects don’t mean anything unless compared to a platform that doesn’t have them – network size and strength is relative.
This means that as you establish which of the 7 powers you want to develop, you need to define the competition you are measuring them against. You might get a sense of the most important competitors by asking yourself:
- Who are the major players in our industry?
- What does the value chain look like? (who are the end-users? Who serves them? What does the supply chain look like?)
- What are the major business models seen in this industry? (e.g. single payments, subscriptions, transaction fees, listing fees)
- Which companies do we talk about a lot internally?
Which competitors you choose will depend on the company you are at, and which competitors seem most worrying. Rather than map the entire market and your powers against each player, you want to create 3-5 groups that you can assess. A good starting point is to consider:
- Traditional incumbents – Most digital businesses are still disrupting incumbent businesses that are not digital-first. Who are the players that are (or were) major players in the industry. E.g. in education, you might want to include existing universities, even if you’re a digital pure-play
- Challengers – Digital-first businesses that have got significant traction. E.g. in education this might include Coursera, Udemy and Multiverse
- Next-gen startups – Any emerging businesses that don’t have significant market presence yet, but seem to be on a very strong growth track, or taking a markedly different approach to the challengers. E.g. in education this might include Kinnu, Maven and MyTutor
Once you’ve identified your key competitor groups, you can map out which powers are relevant against which groups in a matrix. Have a look at our template below.
Matrix to plot your competitive moat vs. key competitor groups Get the 7 Powers Matrix template: Google Sheets
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Developing your powers over time
Although these 7 powers help you create a barrier to entry that prevents competition from doing exactly what you do, none of them are permanent. Given enough time and money, competitors will eventually replicate your powers, or render them irrelevant.
As a result, over a multi-year timeframe, you need to think about how you will continue to invest in your powers, and potentially switch between them as you grow as a company and the market evolves.
Spotify case study: 7 powers
As it launched, Spotify relied on two major sources of power to compete against the major music players which were Apple and various record labels. First was proprietary tech (cornered resource), which made playing music via streaming possible and feel instantaneous – a huge innovation when you otherwise had to wait for music to download before playing. The second was a subscription business model that counter-positioned Spotify against the one off payments for individual tracks and albums that the incumbents used at that time.
Apple introduced a streaming service in 2015, but Spotify had already started to develop other powers. By allowing users to create and share playlists, Spotify had created substantial switching costs to them leaving, as these couldn’t be taken to other music platforms. They had also invested in personalisation and discovery (e.g. Discover Weekly) to create a new technological cornered resource that kept them ahead.
In recent years Spotify has continued to develop its powers. Spotify launched podcasts in 2015, audiobooks in 2022 and has invested in exclusive deals for both to establish a new cornered resource in the form of content.
As a product leader, it’s worth keeping one eye on competitors and the broader market to understand how your powers will evolve. You can then plan your product strategy in response to make sure you adapt existing powers and create new ones over time to maintain your competitive advantage.
Summary
Hamilton Helmer describes 7 powers of competitive advantage that companies can use to maintain high margins. This framework has become very popular within the tech industry in recent years as a way of understanding and maximizing your competitive advantages. By identifying the most pressing competitors you have, you can map out where you can develop or maintain powers against them, and plan how to develop these into the future.
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Resources
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* 7 Powers Matrix cheat sheet: Google Sheets
* 7 Powers Matrix template: Google Sheets
Other Hustle Badger Resources
Further Reading
