Wednesday, December 27, 2006

Great ideas vs. Sustainable competitive advantages

It's a painful lesson that most young entrepreneurs must learn the hard way. One day you wake up with an idea so perfect, so world-changing, so unusual that you are sure it'll be the foundation of a billion dollar company. Maybe it is "rent-a-pet", pets for people who can't keep them. You've never heard of anyone doing the same thing, so you assume you were the first to think of it. Inside your head you rationalize "sustainable competitive advantages" like first-mover advantage and capturing all the good locations for rent-a-pet stores. But this brilliant idea will hit a wall the moment you try to get smart funding.

Smart investors, either who have been angels for a dozen companies or who work professionally in venture capital, have seen every brilliant idea past their door already. Sometimes a quick Google will find the idea. In the worst of cases the idea already lives, widely discussed, on Even when there isn't a direct counterpart today, there are new entrants who could copy any idea at a moments notice. The rule I've always applied when discussion new companies is simple: "If your "magic" can be lost by telling me a single sentence, then you don't have a sustainable competitive advantage".

So whether the idea is rent-a-pet, spray-on-gravy, or a web-spider that aggregates classified listings, if your only magic is captured in the description, you are in for an unpleasant fund-raising process. So what is a sustainable competitive advantage? It's very hard to pin down what "magic" makes some businesses succeed long enough to build other strengths. Most people use a description much like Associate Justice of the Supreme court Potter Stewart's description of pornography: "I know it when I see it".

Here are the types of "magic" I've seen:

1) Cornering the intellectuals - Take a PhD, his thesis advisor, and any preeminent researchers in the space and found a company around them. So long as the value they create for customers is driven by having technology that is just a little bit better than the competition, the company can derive a sustainable competitive advantage from the competitors being unable to catch that bleeding edge of technology.

2) Market share - if the technology is used by one million people, and the user base is growing at 20% monthly, is generally doesn't matter what has been created, the momentum will carry it forward. If you've created this user base by selling a $1 for fifty cents or illegal activities, other forces may doom the company. However if your business model isn't fundamentally flawed, the growth rate can build a great company before competitors catch up.

So when you are evaluating whether or not to quit your job and start a company, first consider a few simple tests:

1) Google the idea. Then have three friends Google it for you. If someone wrote about it on half-bakery or it's the basis for a dozen half-dead startups, it's probably a bad idea. If it's been funded for 10M or is the basis for a billion dollar business, the idea is probably good, but you likely aren't the one to do it.

2) If you told everyone in the industry exactly what you plan to do, you could still be successful. If describing the idea ruins it, you won't be able to keep your secrets long enough to succeed.

3) Are you talking with the three smartest people in this field of research? If you aren't, or don't know, then you are probably behind the curve.

For those technology ideas that don't require a huge investment to start, go ahead and start them. Don't spend more than $100 or a week implementing the idea, but if you start seeing exponential growth in users, you may have hit on something. Otherwise, quit as fast as you can so you can spend your timing developing the real "magic" that can build a billion dollar business.


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