This is the third part of 4M and Netcore 2.0: A Framework for Exponential Growth, initially mentioned in ‘Mystery of the Missing Profits.’ In the second part of this series, I talked about the criteria required to classify a product as magical and the second M in the 4M Framework (Money). In this part, I will discuss the third and fourth M’s in the 4M Framework, Moat and Monopoly.
The third M in the 4M Framework is the Moat. Building a moat around your product means creating a barrier to entry, making it difficult for competitors to copy the product or offer a better alternative. These could be unique technology, patents, strong brand recognition, or network effects.
For example, Facebook’s user base creates a network effect, serving as a powerful moat. The more users it has, the more valuable it becomes to individual users. This makes it difficult for competitors to catch up. However, this might change with the emergence of platforms like TikTok, although Facebook is fighting back through Instagram and WhatsApp.
Warren Buffet and Charlie Munger popularized the concept of a moat, which refers to the ability of a business to maintain a competitive advantage over its competition and protect its long-term profits and market share. An ‘economic moat’ prevents a business’s market share from its competitors. As Warren Buffet once said, ”In business, I look for economic castles protected by unbreachable moats.”
A moat protects a company’s current earnings and fortifies its future profit potential. It is often the difference between good businesses and those that thrive in the long run. A robust moat can help businesses safeguard their success, withstand the test of time, and remain at the forefront of their industry. Thus, understanding and creating a moat is vital for businesses aspiring to achieve enduring success.
Here are a few quotes signifying the importance of moats.
“Any company whose earnings are growing consistently, or are likely to grow consistently has something unique about it. Positive earning records are an invitation to the competition to sample the cream. If a company has something unique about it, the competition cannot latch on to it immediately. Whatever that is unique acts as a glass wall around profit margins.” – Adam Smith
“As research analysts, we spend our time understanding the competitive moat. We need confidence that competition will not reduce growing cash flows over time.” – Brian Vollmer
“Unless a company has an economic moat protecting its business, competition will soon begin eating away at its profits. Wall Street is littered with the dead husks of companies that went from hero to zero.” – Pat Dorsey
Magical products generate substantial revenue, creating a veritable money machine. These earnings can stimulate further growth and solidify the company’s position in the market. Successful companies reinvest this wealth into exploring adjacent areas or acquiring potential competitors, ensuring sustained growth and relevance.
For example, Google leveraged profits from its search advertising business and acquired YouTube, giving it a foothold in the burgeoning online video industry. The move also helped diversify Google’s revenue streams and added a new dimension to its core advertising business, strengthening its moat in advertising.
Acquisitions eliminate potential competition and open up new avenues for revenue. Apple used the profits from its iPhone business to create a formidable ecosystem consisting of the App Store, iCloud, Apple Music, and Apple TV. This added value to the iPhone, making it indispensable to users.
Companies can also create a moat through technological superiority and branding. For example, Tesla has created a moat around its business with its electric vehicles. Tesla’s vehicles are known for their high performance, superior range, and innovative features. The company’s proprietary charging network also gives it an edge over its competition, and its brand is synonymous with electric vehicles, further strengthening its market position.
When building moats, companies must consider their long-term sustainability. They should create a defensible position that is hard to breach while continuously innovating. By reinvesting their profits into R&D, acquisitions, and customer value, companies can ensure the longevity of their moats, protect themselves from the competition, and keep their money machines humming. A perfect, unbreachable moat leads to the next M, Monopoly.
According to Peter Thiel, “All happy companies are different. Each company earns a monopoly by solving a unique problem. All failed companies are the same; they failed to escape competition. If you want to create lasting value, build a monopoly.”
Monopoly, the 4th M, is about leveraging the moat to create a monopoly. This can be done through several measures such as mergers and acquisitions or by being so good no other company can compete. Once a company has built a solid moat, it can leverage it into a monopoly. This involves outpacing competitors, continuous innovation, and strategic moves to corner the market.
Google is the perfect example of this. Its dominant position in the search engine market is fortified by its unparalleled algorithm and vast amounts of data, a moat competitors find challenging to breach. By leveraging this moat, Google has become a monopoly, gaining control of over 90% of the global search engine market. However, the recent emergence of Microsoft Bing and its partnership with OpenAI could challenge this dominance.
Mergers and acquisitions are another common strategy to create a monopoly. Disney has used this strategy effectively, acquiring Pixar, Marvel, Lucasfilm, and 21st Century. This has helped the company amass an unparalleled portfolio of intellectual property spanning across franchises in film and television. These acquisitions have helped Disney become a dominant player in the entertainment industry and create a monopoly. Disney’s dominance is shown in the chart below:
Excellence in what you do can also lead to a monopoly. No other company demonstrates this better than Apple. Apple’s relentless focus on design, innovation, and customer experience has allowed it to dominate the premium smartphone market. Its ecosystem of products and services has created a powerful network effect, driving customer loyalty and discouraging them from switching to competitors.
Apple is now expanding its dominance into fintech with a slew of new offerings, as shown by the chart below:
Some companies leverage regulatory privileges and patents to turn their moats into monopolies. For example, pharmaceutical companies are given exclusive rights to sell new drugs for a specific period. This monopoly is legally protected, ensuring that competitors cannot undercut them. Pfizer is an excellent example to demonstrate this:
Lipitor, Pfizer’s cholesterol-lowering drug, became one of the best-selling pharmaceuticals ever. Sales of the drug created a money machine, while the patent promotion formed a strong moat, resulting in Lipitor holding a monopoly on its formulation for years.
‘7 Powers: The Foundations of Business Strategy’ by Hamilton Helmer discusses how companies can create and develop moats into monopolies. The book presents a framework centered around strategic ‘powers’ that create and protect a business’s long-term economic value. Here is ChatGPT’s summary of these seven powers.
- Counter positioning – A newcomer adopts a new, superior business model that the incumbent does not mimic, fearing damage to their existing business.
- Switching costs – Switching products is expensive. As a result, customers are forced to use it. This is seen in software services, where migrating to a new system is costly and disruptive.
- Network economics – These are classic network effects where the value of a product increases as more people use it, such as Facebook and Amazon Marketplace.
- Scale economies – Scale economies refer to the declining incremental costs associated with one or more units or output. Manufacturing and software businesses are the primary beneficiaries of these economies.
- Brand – Brand power arises when consumers trust a company and keep coming back. Apple and Coca-Cola are prime examples of companies with this power.
- Cornered resource – This power arises when a business has exclusive access to a valuable resource such as intellectual property, talent, or physical resources.
- Process power – This is gained through unique and superior production or delivery methods that are difficult for the competition to copy.
The journey from a magical product to a money machine to a moat and monopoly isn’t linear or predictable. It requires innovation, strategic planning, and a deep understanding of customers’ needs and wants. However, when executed successfully, it can propel a company to unprecedented success, exponential growth, and longevity. The journey changes the company’s fortunes and redefines consumer expectations, reshaping industries.
Continued in Part 4