Let's imagine for a second that you have successfully developed a genuinely innovative product that more elegantly solves the significant customer problems in your chosen market than any other existing products. The small test markets to which you have exposed your product have enthusiastically embraced it and there is a real buzz building amongst the industry and amongst consumers about your business. A window of opportunity has opened up and you are perfectly placed to exploit it. As wonderful and as exciting a prospect as this is, it's important at this point to consider, "how wide is your window of opportunity"?. In other words, when you are poised to turn on the tap and spend large sums of money on the marketing and infrastructure that will be required to take your product to the early and late majority which make up the vast bulk of any given market, according to the theory of the diffusion of innovation, it's important to assess whether or not scaling the business in this way will provide the desired return on investment given the likely length of time you will be able to sustain a competitive advantage. For many business owners, the end game is a trade sale and this is certainly the way you are most likely to maximise your financial return on your investment of time,money and effort into your business. Sustainable advantage is what will ensure the possibility of a successful exit.
A product that offers superior customer benefits at the outset is no guarantee of the ongoing viability of your enterprise. Imitation occurs quickly in most industries, both from existing competitors and from new young upstarts looking to hitch their wagons to your star. Many larger businesses act as "fast followers", letting the smaller, more entrepreneurial companies take the risks of developing demand for an innovative product and then simply steal the show by outgunning the smaller company with their superior resources in copying the product, perhaps with a couple of tweaks, and taking it to market faster. Jim Collins summed up this problem with his pithy phrase "best beats first". For smaller companies, you absolutely cannot rely on "first mover advantage". An innovative product serving what looks to be an attractive market may not enough to guarantee optimal financial returns. You will need to know that the advantage you enjoy at the outset is durable enough to thrive until market conditions are favourable for the sale of the business.
Your competitive advantage is likely to be sustainable over time only if your business benefits from some or all of the following characteristics:
You will have heard arguments about the non-defensibility of patents but these are still one of the best ways to sustain competitive advantage. Industries such as the pharmacutical industry that has huge R&D costs could not exist as they do today without patents. My brother works as a patent solicitor for Eli Lilly, the huge firm responsible for bringing Prozac to the market. He tells me of the fight that they had to be awarded a patent for the drug in 1987 and of the panic that gripped the company when it became apparent that the legal department could not successfully defend the patent till 2004 as they had initially anticpated. In 2001, when Barr Labs successfully challenged the last of the four patents Eli Lilly had help for Prozac, it ended the uninterrupted stream of $22 billion in revenue that they had earned in the 14 years for which the patent stood. This kind of revenue for a company that was a $600 million a year business before Prozac is testament to the importance of real intellectual property, and the loss of what was at the time a $2.4 billion a year product to a host of cheaper generic versions was the bitter pill for them that teaches us what losing a patent or failing to create real intellectual property in the first place can cost.
Other intellectual property of lesser importance in terms of establishing and sustaining competitive advantage than a patent includes trademarks, trade secrets, copyright, and long term contracts. However, nothing offers the protection to your competitive advantage that a solid patent can provide. When assessing how wide your window of opportunity is, you need to ask yourself what intellectual property you might have and how defensible that intellectual property is.
For too many companies, successful innovation is episodic. An example of this would be Motorola, which got so caught up in its design marvel MOTO RAZR that it lost ground to the feature rich 3G and touch screen phones being produced competitors like Sony Ericsson, HTC and Apple. They had no disciplined, repeatable or scalable process of innovation and consequently when their big hit fell out of favour, they suffered. They sold a remarkable 130 million units between 2004 and 2007 but lost $4.3 billion between 2007 - 2009 as it tried to produce a phone that could compete with it's rivals.
Compare this with Apple who have managed to stay at the forefront of their market with a great initial product in several categories (iPod, iPhone, iPad), with a number of follow on products to keep ahead of the competition. Clearly, in order to prevent your business's window of opportunity from closing, it is necessary to be more than a one-hit wonder. Professional investors talk about "hit risk" when evaluating a company for investment. You need to minimise "hit risk" in order to sustain the competitive advantage you enjoy in your market place.
When we talk about a significant cost advantage we are not talking about those businesses that are working a bit harder or more efficiently than their competitors. This may be the source of an advantage but the kind of cost advantage that leads to sustained competitive advantage is the kind of order of magnitude cost reduction that results from a technological breakthrough or from developing a new, more efficient business model. An example of what I mean is Procter & Gamble when they opened up a sustained competitive advantage in the disposable nappy market by investing heavily in the development of low priced synthetic fibres produced in Europe which helped create the nappy at a significantly cheaper price than had been possible previously.
Great people are always a source of real competitive advantage. If you can build and retain this team, this could become the source of a sustained competitive advantage. Of course, competitors will try to poach your best people and your ability to retain and develop your people will determine just how sustainable the competitive advantage provided by your team will prove to be.
Some businesses are able to establish an almost monopolistic dominance of their market due to the superiority of their business model. Amazon, for example has emerged as a the market leader in the burgeoning e-book market. They control 60% of the market, and such is their dominance of the market that they have been subject to antitrust lawsuits in the US and across the globe. The truth is, however, that Amazon has emerged as the dominant seller of e-books as a consequence of overwhelming customer preference rather than through any malignant business practices. It developed an ingenious system by which it delivers books to readers at low prices in a manner that makes it easy and enjoyable for readers to browse for books online, purchase what they want immediately, and receive the books they want seconds later. Customers imply like and trust Amazon and therefore chose to do business with them. It was not easy to imagine, develop and actually operate such a business, but now Amazon enjoys an almost unassailable advantage in this market (and many others besides). If you can create a superior business model, you too can enjoy in your chosen niche the kind of sustained competitive advantage that Amazon enjoys in theirs.
Creating a business with a competitive advantage in the first place is hard enough, but to sustain that advantage for long enough to sell the business in optimal conditions is particularly difficult. That's why so few small businesses make it all the way to the trade sale and why many of those that do fail to achieve the kind of valuation that they had initially hoped for. If you are looking for some help in assessing the sustainability of your competitive advantage, contact us today. The last thing you want to do is leap through a window of opportunity that is closing before your very eyes.