Evaluating Early Stage Companies: Part 4 - Moat

The 5 M’s of evaluating early stage companies are Management, Market, Metrics, Moat, and Meaningful Impact. 

Today, a shallow dive into Moat…

“The most important thing to me is figuring out how big a moat there is around the business. What I love, of course, is a big castle and a big moat with piranhas and crocodiles.”

-Warren E. Buffett

Over the years, I have searched for and tried to create a framework for evaluating the moat for an early stage company with minimal success. Thanks to Ben and David at the Acquired Podcast, I was introduced to Hamilton Helmer’s 7 Powers. This was the framework I was looking for!

The 7 Powers are…

• Power 1: Scale Economies - Declining unit costs with increased size of the business

• Power 2: Network Economies - The value of a product or service to each customer increases as others start using the product / join the network.

• Power 3: Counter Positioning - A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business model.

• Power 4: Switching Costs - The high cost and/or value loss expected by a customer from switching to a competitive product for future purchases.

• Power 5: Branding - Brand power is an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product.

• Power 6: Cornered Resource - Preferential access at attractive terms to a coveted asset that can independently enhance value - unique human capital and intellectual property being the two big ones.

• Power 7: Process Power - Embedded company organization and activity sets which enable lower costs and/or superior product, and can be matched on by an extended commitment.

A company with one or more Powers has a competitive moat, and the depth of that moat depends on the strength of their power(s). 

Later on, I’ll dive deeper into each Power, covering:

• Benefit and Barrier: Each Power has a “benefit” for the company with the Power and a “barrier” to the incumbent or challenger.

• The Potential for Power in Early Stage Companies: At the earliest stages, companies Powers and Moats are typically aspirational and I am evaluating the potential for Powers.

• Examples: I’ll share examples of mature companies that have the Power as well as startups with the Power potential.

Before the Power deep dive, next I’ll cover the fifth M - Meaningful Impact.