Moats: Patent versus Network Effect
5 ways to make your business unique with a moat… and then keep growing, even from academia
Imagine your business success as a castle, yes you should have a moat, otherwise anybody can enter and take over it, even overnight.
Innovative ideas which can be converted into business can come from anywhere. Most universities have technology transfer offices which are supposed to guide scientists into creation of startup companies or any other form of commercialization from their research. Their steps include pre-disclosure, protection, licensing, etc. Unfortunately, there is a strong focus on intellectual property protection sometimes without a good practical understanding. Moreover, some people are against patents. Indeed, there are other ways, and even if you want to use patents there are ways to handle them without going bankrupt or acting like the CIA.
If you have some pitching experience very often you hard the question “how do you protect yourself?”, competent people will understand if you have “a moat”, people reciting this question off the book with little of practical experience will simply dump you if you don’t have a patent. Assuming you met the first ones, (s)he is asking you about your “moat”. Let me introduce here more the concept, then we review some practical aspects about patents and then we go to solutions patent-less.
An economic moat is a company’s competitive advantage over rivals. Patents are not the only way, there are other moats.
There several types of moats, I list here 5. Their choice generally depends on the fields of the innovation. Pharma industry is strongly tightened with patents, as drug design is a long process, and therefore we need to define something in the long term. On the other hand software house are built in days and their success too, so we need something faster.
1. Patents
This is the most common, tormented, and discussed way. When you have an idea you can submit a detailed documentation to specific offices, which will confirm the intellectual property. A patent is an exclusive right granted for an invention. What is an invention, it depends strongly on the claim we declare to the patent office. Patents are also geographically limited and the costs are also related to which country we are interested in failing a patent. Geography also matters related to the definition of what is an “invention”. In Europe, software or data manipulation are hardly patentable, while in US it is possible. Despite all general obsessions on having a patent before everything, patents cost. It cost to find an attorney to support the process, there are maintenance expenses and it take times to obtain a patent. Moreover, patents do not guarantee any kind of protection against copycats on their own (they have to be used by the applicant in case of suing), and often people are experts in finding solutions to swing around patents. It is a legal nightmare, but it guarantees to investors that you own your innovation. A startup should only follow this path if it makes sense. Moreover, during the process of obtaining a patent there is supposed to be no disclosure as no public presentation, nor publishing papers, etc. How can a company proceed with funding, partnership and so on without disclosure? It is not a nice situation.
Patents can be
Utility patent.
Provisional patent
Design patent
Plant patent
We don’t discuss here Design and Plant patents because they are out of topic. “Utility patents” are what people usually thinks about patents.
Let’s move into your best friend PROVISIONAL PATENTS!
Provisional Patents are patent application that can be used to secure a filing date. It is filed in the United States Patent and Trademark Office (USPTO) or equivalente EU offices, and does not require to have a formal patent claim. They can be filed informally, without adhering to the strict formatting of non-provisional applications. And the best part: THEY ALLOW YOU TO DISCLOSE IN PUBLIC YOUR INNOVATION! A provisional patent expires after 12 months, and then either the patent dies or you file a full utility patent.
So the steps can be:
File a provisional patent
Talk to investors, go to conferences, etc
If the idea is worth the time and money, file a utility patent.
Now, this is not always the case. In some cases other moats are more relevant.
2. Network effect
Many people will agree that network effect is the single most potent moat in practice — especially in the tech space. The more people that are using a product or service, the better it is. You can copy the website of Facebook, but without the people inside Facebook, it will have very little values. Economy of scale is highly associated with networks effect:
Increased numbers of people improve the value of a good or service. If you use advertisements on your platform, you can price the advertisement according to how many user your have in your network. If you are reaching out investors, you can show the value of your platform by the number of your users. And there is no need to have a patent (which in Europe you could not have because a web platform cannot be patented at all).
3. Branding
Consumers may become very attached to their favorite brands. It is like a loose networking effect. People trust a brand because historically they proved to be offering high quality product/services. Therefore, you pay more for something that other customers believe it is of higher value. Often branding is associated to status (e.g. a Ferrari, a Bulgari bag, etc) or a person/character (you love that rockstar or fictionary character as SuperMario associated to a specific company). Generally, branding takes time and it is difficult to quantify numerically. Therefore it is not seen from investors as strong as patents of reported network effect, unless the brand is so strong that the investors already know about it.
4. Pivotal partnership
Maybe you don’t have a big brand on your own. But you can join with strong contract existing strong brand.
Strategic partnerships and contracts with other established brands can indirectly be a moat. If you can have and show that your service will provide exclusive collaboration with famous brands, this will represent a secure way to have customers, and investors may believe you.
5. Counter-positioning
Counter-positioning is a concept introduced for the first time in the book
“7 powers” of Hamilton Helmer. Citing Helmer
“A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.”
In practice, a new company should take advantage of a weakness of an established business, and “try to steal” customers from the established business. For example AirBnB approached users of Craiglist proposing them something more practical. This is also not as strong as patents and network effect, and actually it can be seen as a shortcut to create the network effect.
Let’s close with some final remarks on what is a moat.
A moat is different from a “competitive advantage. A moat is supposed to last a long time, but a competitive advantage may only exist for a brief period of time throughout a company’s development. Obviously, nothing is forever, for example all the network effect of Myspace is gone right now.
Finding a moat is the best available defense that businesses have in hostile and competitive markets, but it is not an absolute guarantee of success. Nevertheless, they allow to enter markets and to be perceived valuable by investors.