Creating software is not nearly as difficult as it used to be. Somewhat counterintuitively, that makes it much harder for innovators to succeed in building large, successful companies.
Back when developing new technology took years — not to mention a serious investment and unique talents - software creators could be confident that their product would enjoy a significant lead time on the market before having to worry about competition. Today, barriers to entry are much lower. Thanks to cloud infrastructure, toolkits, reusable code libraries and low-code or no-code development platforms, competitors can get imitation software up and running in no time and with little up front cost. This quickly ruins a startup’s chance for establishing a large lead in a market.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
As a result, potential founders wonder from the get-go whether they’ll be able to make a name for their product before a more established company swoops in and makes its own, incredibly similar version.
How To Succeed In A World Of Copycats
Investors, too, are concerned about how software startups can be competitive in such a fast-paced environment. As a venture capitalist, here are the three questions that startup founders should be prepared to answer if they want to convince investors that they’ve successfully protected their business against copycats.
1. What are your proprietary assets?
Given that software is so easy to replicate, you’ll need to demonstrate that your company will have a sustained and meaningful competitive advantage in the market. The best way to do so is to develop proprietary assets that are connected to your software.
With artificial intelligence and IoT exploding, we frequently see successful companies develop such assets in three specific areas:
- By building smart devices such as proprietary hardware
- And by combining their software with proprietary data pools
- By using proprietary analytical methods
All three of these offer a stronger, more complex software business model that is superior to “plug and play” code and becomes much more difficult to replicate.
With that being said, a small database of only a couple thousand specialized objects isn’t enough—it’s too easy to replicate. Put enough effort in to truly differentiate your product and make it hard to copy.
2. Where do you fit into the ecosystem: are you an ecosystem enabler or creator?
In order to be successful in the modern era, software companies need to think more broadly than standalone products. The market is already too crowded, and customers are likely to resist having to learn yet another tool with a limited purpose and limited integration to their existing ecosystems.
Instead, developers need to either figure out how to fit their product into an existing ecosystem to limit purchase, adoption or integration headaches, or how to create an entirely new ecosystem large enough to make learning it worthwhile. A company that can get customers on board with a new ecosystem can be incredibly valuable.
Startup founders that demonstrate an understanding of these dynamics and know where their product fits into the broad ecosystem have an advantage.
3. What are your options for a vertically integrated strategy?
One trend that we’re seeing more frequently is the use of vertically integrated solutions to take greater control of the entire process and to find opportunities to create value outside of the traditional software stack. This is a more sophisticated business model, more difficult to replicate and it pays.
I’ll use my own experience in the world of payment processing as an example of how the market has evolved to favor vertical integration. In the “old days,” I created an ERP software product. Back then, I would have a collection of services attached to that ERP system. With payment processing, for example, I might have a storefront with 20 companies processing on my ecosystem.
In today’s world, a successful competitive strategy might look more like this: a PE firm would buy an ERP company, buy a payments company, and build a strong, integrated workflow all the way from the top down. It would then sell the product as a single integrated solution.
Vertical integration not only helps you grow your business, but also gives you a greater degree of leverage. For example, in an ERP company with tens of thousands of customers, the company can create a new version of the ERP and mandate that customers move to specific integrated services to get the next version of the ERP. You can even give away a free version of the ERP and monetize the incremental services, which in many cases are much larger than the core business.
No matter how you approach your business plan, vertical integration gives you a lot of strategic options to consider that could create higher walls around your business to thwart copycats.
Copycats: Holding back the competition
There’s no way to get rid of competition entirely — substitutes for a new product will continue to exist no matter what. Competition among new ideas is a form of market validation of your concept. However, by addressing the three questions above, founders can make sure that they are well positioned to outrun the competition — not enabling copycats that offer the same service under a different name.
Companies that approach investors with these strategies already built out will demonstrate that they have what it takes to differentiate themselves, keep their competitors at bay and outrun the competition. Investors like me will certainly be eager to hear more.
About the Author
Malcolm Thorne, Venture Partner, 4490 Ventures
Malcolm is serial entrepreneur who made a transition to the fortune 1000. As lead investor and/or CEO he has helped build and sell 3 software companies over the past 20 years. Most recently he spend 7 years at CDK global managing a global team of 750 people covering marketing, strategy, product management and M&A, in addition to running a $150M EBITDA data and analytics business. Malcolm has taught 6 courses in marketing & strategy at the University of Wisconsin and has also taught a life strategy courses to hundreds of aspiring leaders. Today he splits his time between venture capital and private equity.
About 4490 Ventures
Partnering with entrepreneurs to build billion-dollar businesses in underserved markets.