Many of the start-ups that I meet cover areas like value proposition, size of market, how they will monetize and build a large company based on that. A key area that is often not addressed is how long term differentiation is being created in order to protect market share and margins. A business without differentiation quickly becomes commoditized weakening the margins.
While doing things better operationally and creating a great customer experience are good, these might become a hygiene factor in a highly competitive market. Such low hanging fruit are quickly taken off the table as differentiating factor. To create a starting point for the discussion, I have outlined a few ways in which companies can differentiate themselves. Some of the methods create solid barriers based on the business model; others are slightly softer methods of differentiation as they depend on how one executes over a period of time.
When it comes to differentiation nothing beats a unique patented product that no one else can replicate. This is true for many pharma companies and their products. In tech space this is a bit rare and mostly exists in a combination of software and hardware. Apple sued Samsung and delayed the launch of its phones in US and European markets for patent infringement. Samsung returned the favor to Apple in other markets.
Scale advantage / higher utilization
Scale often gives unbeatable cost structure advantages. This could be the ability to source at lower prices than competition can at smaller scale. It can enable a bigger investment in research than competition; as at scale the overhead per unit is far lower than peers. Scale also sometimes brings higher utilization of resources resulting in better unit economics. Hyper-local logistics companies need delivery boys to deliver more packages with minimal down / transit time to become profitable
This is one of the key reasons for the growth of social networks. Every addition of a customer / user adds value to all people in the network. For companies like Whatsapp, Facebook etc, each user’s contributions benefit other users. This is also true for companies like Truecaller where the database gets enriched (both caller identification and spam call identification) by network vetting and contribution. Office productivity tools like Microsoft office facilitate easy exchange of financial models, presentations and documents between users. If a large number of people use the same format, the value for each person in the network grows with every new addition.
Two sided network of supply and demand
Examples include online retail market places and on-demand ride companies such as Uber and Ola. At scale, two-sided networks are very defensible as they provide liquidity on the other side for both suppliers and customers which a newcomer cannot replicate. For a two-sided network to scale, you need to keep one side of the network in good humor while you attract the other side. Keeping one side in good humor sometimes requires billions of dollars.
Marketplaces: This is the defense for the large ecommerce players operating under market place model. A large network of merchants on the platform offers customers a plethora of product choices. In addition, competition between the merchants results in lower prices for customers. In order to differentiate themselves, the merchants try to provide the best customer experience. A market place that cannot be gamed provides strong value for the customer by bringing highly rated merchants to the top. More merchants on the platform increases product choice and variety. The net result is that the lowest price is offered by the highest quality seller on the platform. The merchant (seller) on the network gains access to a large pool of buyers providing him a good opportunity to monetize. India is a curious case with five large retail market places. MNCs and VCs are fighting it out to win the last big untapped market.
Uber / Ola: This is another two sided network with cabdrivers on one side and riders on the other. The more cabs (supply) there are on network, the more likely you are able to get a ride within few minutes from any place. The more riders (demand) are on the network, the more likely the drivers are able to get demand quickly with low downtime. The more likely they are to get many rides in a day.
Creating a customer lock-in through product or through an Ecosystem
Enterprise software typically creates a lock-in by hosting all data and by integrating the companies’ workflow processes around its software. In order to replace such software, not only one has to move all the data to the new system, put in place new processes, but also train all the employees on the new system. Microsoft and Apple have created the lock-in by creating ecosystems of third party products and services around their products. As you allow more and more 3rd party developers to create offerings around your product, the benefits for customer in staying within the same ecosystem scale-up very fast.
For a long time, telecom operators have locked-in people due to their reluctance in changing their phone number. As the customers have shared their phone number widely, it created a sense of lock-in as they might miss out on important connections. Regulation enabled number portability helping a large number of people to switch over
A decade back social networks thought that they had the customers locked in. As the customers have invested significantly with their data in the social network, there was a feeling that they would not leave. But the customer proved fickle and has moved on leaving all data behind.
Brand and Continuous innovation
Zara has been able to use design as a method to continuously differentiate itself. Some companies have become so good that their brands have become a verb – like Google, Xerox etc. Google continues to tweak its algorithm to eliminate noise from its results trying to bring the most relevant results to the top Branding is often the main differentiator in several consumer categories. This works really well when the brand stands for something that is part of the product such as design, taste and product innovation. In cases where significant product differentiation cannot be achieved, brand associations and desirability are created in customers’ minds. This is true in categories such as FMCG, footwear, consumer durables etc .
Some retailers depend on their ability to select the products that might appeal to the customers. This is true to merchandizing categories where customers chose products based on individual tastes. Companies like Hopscotch have been tremendously successful in doing this. The challenge will lie in doing this at scale as seen in the case of Fab.com
Resource lock-in / Resource creation
Companies like Tata steel and some mobile phone operators have created a barrier by locking-in resources such as coal mines and lower band spectrum at a cheaper price. This was risky at the time of acquiring the resources - but paid off handsomely to these players in the long run
HUL has developed a strong competitive advantage by creating the largest reach through a distribution channel comprising of millions of unorganized retailers. HUL overlaid a cost structure advantage on this distribution channel by developing and distributing a large variety of FMCG products. In doing so, it has achieved one of the lowest costs of distribution while ensuring that its distributors are able to generate sufficient money by going exclusive with HUL
Customer Inertia and subscription programs
There are a large number of programs that are subscription based. In a transaction based model, each transaction is different and the customer might switch to a different brand with minimal or no disruption. In a subscription based model, competition is fighting against customers’ inherent inertia. They have to offer a value proposition that is vastly superior to make the customer shift from the existing provider
Coming back to the first para, several companies leverage data to offer a better experience to the customer. Most of the literature is on retaining the customer than acquiring a new one. However, with data sources becoming richer, there is opportunity in making customized offerings to potential customers and make customer acquisition a differentiating factor
I am sure there are examples of companies leveraging other strengths to create sustainable differentiation. Would love to hear those stories.
The advice to entrepreneurs is to experiment, fail, learn and repeat. Try things at a small scale and at a low cost, and quickly assess if they work or not and then take a call on what is worth scaling up. The experiments should either stop or continue based on consumer feedback.