Build Yourself a Moat

The moated manor house of Baddesley Clinton in Warwickshire, England

In the ancient and medieval periods, cities and castles were often built with moats to protect them from outside enemies.  These deep trenches were built next to the outer walls and often filled with water to make it more difficult to reach and breach the walls.

The metaphor of moat building is often applied to business. In 1999, Warren Buffet pointed out that “The key to investing is . . . determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”  Those moats protect the company from excessive competition and allow them to provide above market rates of return.

In their 2014 book, Why Moats Matter, Heather Brilliant and Elizabeth Collins identify five major sources of competitive advantage or economic moat:

• Intangible Assets include brands, patents or licenses that limit the ability of other companies to compete against you.
• Cost advantages allow you to provide your products or services at a lower cost than your competitors.
• Switching costs are the inconveniences or expenses a customer will incur to move from your company to a competitor. 
• Network effects cause the value to of your products or services to expand as more people use them.
• Efficient scale is a situation where a market has a size limitation that discourages competition.

As business people, we need to find ways to build these types of moats around our businesses.  As investors, we need to seek out and buy companies that have strong and increasing competitive moats already in place.

What type of moat are you building?

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Innovation at Eric Scott

In 2007, Eric Scott, a private label manufacturing company in St. Genevieve, Missouri, identified a big problem. Eric Scott’s specialty is making high quality leather products and about 80 percent of their revenue came from the financial services industry. They make checkbook covers and they make them so well that they control 90 percent of the high end checkbook cover market.

However, fewer people are using checks.  Debit cards and online payments have reduced check usage by 3 to 5 percent per year between 2002 and 2008. People who no longer write checks don’t need a nice leather checkbook cover. The drop accelerated in 2009 and 2010.

Fortunately, Eric Scott is a great example of leveraging a core competency to develop a new business opportunity. They understood that their tools and experience made them experts at manufacturing high quality leather goods.  They had also developed a method which allowed a consumer to upload an image and have it printed on a leather checkbook cover. So they began to explore opportunities in photo gifting.

In 2008, they decided to focus on the photo gifting opportunity, adding marketing staff, expanding their marketing research and attending photo industry events like PMA, DScoop, Imaging USA and WPPI. They developed a beautiful new line of genuine leather photo gifts and opened a webstoremto test the concept. True to their private label roots, the products are also offered through retailers and professional portrait labs.  Sales are growing and they expect that photo gifts will soon generate 25 to 30 percent of the company’s revenue.

“We have always had a focus on manufacturing and operational excellence,”  explains Dana Viox, Eric Scott’s Vice President of Business Development. “But going from making 10,000 units of each item to manufacturing in units of one has changed everything.  We have upgraded our cutting tools to reduce setup times and increased our use of barcode tracking to make sure each order goes to the right person.”

“Viox summarizes her experiences in the innovation process as “really challenging and really fun to get in on the ground floor of an industry that is evolving and growing so rapidly.”

What are your company’s core competencies?  How could they be used to develop a new business opportunity?

Your Business Model is Broken

Your business model is broken!   If not, it will be soon.

 I can make that statement with confidence because every business model becomes obsolete with time and today’s rapid rate of social and technical change means every business has to evolve more quickly.

Peter Drucker, the famous management guru and social ecologist, described a business model as the answer to three questions:

    Who is your customer?

    What does the customer value?

    How do you deliver value to that customer at an appropriate cost?

In other words, it’s what you do, who you do it for, and how you do it.  When you make a change to any one of these areas, you are implementing business model innovation.

You are probably aware of the four stages of a product life cycle: Introduction, Growth, Maturity and Decline.  These same stages apply to business models as well.

In the introduction phase, there are a limited number of customers and a limited number of competitors.  Typically, the companies in the introduction phase of a new business model are spending more on development and marketing than they are generating in revenue.  It usually isn’t clear whether or not the new model is going to be a success or a failure.  

An example of a new business model still in the introduction phase is creating personalized wearable 3D portraits by converting portraits into 3D models and printing the models using a 3D printer. The technology exists and the product is wonderful, but very few people know that the product exists yet.

In the growth phase of a business model, the consumers have discovered and like what you are doing and your sales and profits are growing rapidly.  Competitors are jumping in and copying or improving upon the business model, but the expansion of the market means there are opportunities for lots of companies. Selling of photo books and photo gifts online is an example of business model in the growth stage. Sales in the entire category are growing rapidly and so are the stock valuations of the major players.

Eventually the growth slows down and the model enters the maturity phase. There is a lot of competition and capacity which pushes down prices and profits. Companies with strong brands and excellent operations will generate positive cash flow which can be invested in looking for new business model innovations. Selling digital cameras through big box retailers is a mature business model.

In the decline stage, the volume of business is shrinking and too many companies are chasing what is left.  Weaker companies go out of business and the stronger ones make acquisitions to keep their volume up. Silver halide photo finishing and commercial offset printing are businesses in decline.

Successful companies develop, test and introduce new business models continuously to keep the business growing.  They find new products and services that customers value and better ways to deliver those services.

In the Harvard Business Review, Matthew Eyring, Mark W Johnson and Hari Nair identify three steps to successful business model innovation.  First, you need to identify an unmet job that a target customer needs done.  Next, blue print a model that can accomplish that job profitably for a price the customer is willing to pay.  Finally, carefully implement and evolve the model by testing the essential assumptions and adjusting as you learn.

Is your business model broken yet?  What innovations are you introducing to generate growth?