Tuesday, June 7, 2011

Lesson #43: Examples of Barriers to Entry for Your Startup

Anybody can start a business.  But, very few businesses started have long term, defensible barriers to entry to protect against potential future competitors.  That is the one of the key things you need to focus on in terms of building a winning a business model and increase the odds you get a big pay day down the road.  In today's post, we will talk about a few of these barriers to entry: (1) patents; (2) difficulty of replication; (3) exclusive, long-term strategic partnerships or contracts; and (4) high switching costs, to name a few.  I will give examples of each below.

Patents are a double edged sword for startups.  They are great to have to protect your idea and get investors excited about your business.  But, they are costly to set up (around $12K if straight forward filing and process, and much more if not).  And, patents are very costly to enforce, taking hundreds of thousands of dollars in legal bills to protect your idea, which most startups typically don't have.  But, assuming you build to scale with enough of a first mover advantage, hopefully your profits of the business will provide enough defense capital to enforce your patent and keep others out of your space.

Difficulty of replication, typically comes down to complexities of the product or the amount of capital or time required to duplicate the product.  As an example, it is very difficult to knock off a new biotech or pharmaceutical line that has been in research and development for the last 10 years.  Or, it is very difficult to replicate Google's dominance in search technology, given the years of learnings that have gone into refining their search algorithms and the billions of dollars in capital investment required to replicate their international network of high-speed servers and data centers.  Or, imagine replicating AT&T, Comcast or ComEdison's infrastructure investments in wiring and powering all homes and businesses.

Exclusive, long-term strategic partnerships or contracts can also be a game changer for a startup.  For example, at iExplore, we were the exclusive adventure travel provider for five years to the National Geographic audience.  Or, imagine you are Waste Management with the exclusive waste removal contract for the City of Chicago.  Or, Halliburton getting exclusive Department of Defense contracts to rebuild infrastructure projects in Iraq.  Or, maybe you are Lens Crafters, as the exclusive in-store optical departments within a Wal-Mart location, or Chase Bank as the exclusive ATMs inside a Walgreen's location.  Anytime you are talking exclusivity and long term in your contracts for customers or distribution, the better barriers to entry you are building.

Products with high-switching costs are also great barriers to entry.  Once, a Fortune 500 company has implemented a new customer relationship management platform, it is highly unlikely they will swap out that platform in the near term, and have to reinvest in technology and employee training all over again.  Or, once LinkedIn has built the "default business networking site" and users are comfortable using it, it would be very difficult for a new site in the space to get traction, since users will not want to make the change.  Same could be said about YouTube as the default place to store videos, Flickr the default place to store photos or iTunes the default place to store your music, and consumers not wanting to reload all their a content a second time in a second place.

Hopefully, you get the point here:  any startup requires long term defensible barriers to entry to attract investors, protect its turf and increase odds of long term revenue growth.  Critically assess your own business, and look for opportunities to build your own barriers to entry against potential future competitors.

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