Companies Build “Capabilities” Before They Build “Moats”: America's Greatest Foods Shipped To Your Door

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Jul 22, 2023
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Companies Build “Capabilities” Before They Build “Moats”: America's Greatest Foods Shipped To Your Door
In the competitive landscape of business, companies strive to establish a strong and lasting competitive advantage. This advantage is often referred to as a "moat" - a proven, perpetuating, and permanent unit economic advantage over competitors. However, before a company can establish a moat or even a trajectory towards one, it must first build what we refer to as "capabilities."
Capabilities, also known as "powers" by some, are the intangible assets that a business develops to operate more effectively and earn returns above others in the market. These capabilities serve as the engines of a company's competitive advantage and determine the persistence and scope of its moat. While not appearing on a balance sheet, capabilities are the single most valuable asset of a company.
Renowned economist and strategist Bruce Greenwald categorized competitive advantages into two distinct camps - customer captivity and resource captivity. The strength of these advantages is a function of scale. Scale makes it easier and cheaper to acquire and retain customers or produce a product. But we can further expand upon this foundation by adding two additional parameters for success - network effects and organizational design.
Demand-side economies of scale refer to increasing returns to scale that make it cheaper and easier to acquire customers. On the other hand, supply-side economies of scale lower production costs through higher asset utilization, lower cost of capital, or the ability to purchase inputs at lower costs. Risk variance, another parameter, allows companies to aggregate and manage risk as the cost of uncorrelated volatility minimizes with scale.
Process power is another critical aspect of building capabilities. Companies that pursue complex and challenging goals face fewer qualified competitors and take longer for copycats to catch up, thus entrenching themselves as top players. Speed is also a vital factor, as companies must not only embrace change but also embrace changing quickly. Additionally, companies that become increasingly efficient with their resources enable increasing returns on investment.
Moving on to network effects, these tend to experience exponential returns to scale. Compatibility, standards, and protocols encourage incremental use and adoption of a service as it grows. Cults and reflexivity, where belief in a company transcends fandom and borders on religion, enable irrational pricing and the ability to raise capital. Other network effects include customer network effects, endogenous data network effects, local network effects, user network effects, exogenous data network effects, and platform dynamics.
Organizational design, while previously touched upon within strategy circles, has gained prominence with the availability of venture capital. In the digital age, businesses are no longer defined by geographic territories but can achieve winner-take-all dynamics with cheaper and nearly limitless digital distribution. Small advantages in lifetime value generate globalized advantages over competitors, resulting in winner-take-all or winner-take-most dynamics.
On the resource side, capabilities can include state-granted resources such as patents, intellectual property, and brand trademarks that the organization has exclusive control over. State-granted resources are protected by the government, indirectly or directly, to prevent competition. Brands create consumer perception that increases willingness to pay above comparable products. Systems of record create high costs to multi-homing across multiple services, while sunk costs make customers reluctant to switch due to high investment and costs already incurred. Search costs, uncertainty, and cognitive costs also contribute to customer reluctance to switch.
As we work with early-stage teams, we emphasize the importance of identifying the capabilities they are trying to build. Whether it's being the system of record or owning as much customer data as possible, the core of competitive strategy lies in defining the capabilities a business is creating. Only by building these capabilities can a company lay the foundation for a strong and lasting moat.
In conclusion, the path to building a moat begins with developing capabilities. These intangible assets enable a company to operate more effectively and earn returns above others in the market. By focusing on customer-oriented organizational design, leveraging the power of network effects, and strategically managing resources, companies can establish a moat trajectory.
Actionable advice:
- 1. Identify and invest in building the capabilities that will give your business a competitive advantage. Understand the parameters for success in your industry and focus on developing the necessary skills, resources, and processes.
- 2. Embrace the power of network effects by fostering compatibility, standards, and protocols within your industry. Encourage incremental use and adoption of your service to create increasing value for users.
- 3. Pay attention to organizational design and its impact on your company's competitive positioning. Adapt to the digital age by leveraging digital distribution and embracing winner-take-all dynamics.
Remember, the capabilities you build today will pave the way for a strong and lasting moat tomorrow.
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