Innovation Moats. What are they & why are they important?

Movac Partner David Beard

10th December 2019

David Beard

New Zealand tech businesses are sailing against three headwinds. We’re too small, we’re too far away and we’re too slow. Let me unpick that a bit. Building businesses in a population of just five million is tough and to succeed we have to go global from day one. We also need to deal with the tyranny of distance from major markets, perhaps only being able to travel to them once a month. Doing business on such a cycle can get problematic and one of the ways to solve that is to start building innovation; you don’t have to be the fastest company in the market, you just need to be better than the rest.

This is where the “innovation moat” comes in. It’s an extension of the idea of the business moat or economic moat, a term coined by Warren Buffett many decades ago, referring to a company’s competitive advantage, such as Coca-Cola with its powerful brand. A business with an innovation moat uses the power of innovation to protect it from competitors.

Let’s look at some examples of successful innovation moats. The obvious ones are patents which  generally work well for engineering and science-based companies. Then there are trade secrets, or the “secret sauce” that gives a company its edge. It could be an algorithm, for instance, or a piece of AI or machine-learning that helps the company provide insights.

There are also customer moats, which are typically things like network effects. If you can get into a network effect solution, then it’s very hard for competitors to come in and replace your solution from there.

Lastly, there are what we call soft moats – things that delight the customer. Businesses may think of not providing customer service as a way of reducing their costs, but they should realise that New Zealanders excel at being empathetic and are really good at customer service. We understand and want to help customers and that makes us unique. I think we should encourage more of that.

New Zealanders are also good at understanding complicated problems and working out how to provide simple solutions. We can create end-to-end solutions and provide clear and concise outcomes. That “number 8 wire thinking” that New Zealanders are famous for, is also a soft moat.

Incorporating an innovation moat into your business involves understanding what your point of difference is and then asking yourself if that can be easily copied by a fast follower. If that is the case, then you need to innovate within your differentiation. That can be as simple as providing insights. Many companies can use the data they collect to provide this information and thereby add value for the customer, delighting them further. If you’re using AI, machine-learning or possibly even algorithms in some shape or form, you’ll naturally create your own innovation moat.

If you take a typical SaaS company, you’ll find this type of business does the process side of things very well. They take their customer through a to b to complete their transaction. But how do you differentiate from there? You could for example, help the customer through the process in a shorter period of time or with fewer steps, perhaps using AI to measure habits. If a customer presses a certain button on your website nine times out of 10, you can auto-suggest that and streamline the process for them.

Sometimes customers might not understand fully how to price their products. If you’ve worked with hundreds of builders in the same city, for example, you’ll know roughly what the hourly rate of all the builders are. You can help individual customers by using all that data and suggest what they should be charging and quoting for certain types of jobs. Artificial intelligence and machine-learning can provide really great insights, not only for your company, but also for your customers.

As an investor, Movac likes businesses that incorporate innovation moats as it helps the company differentiate itself from its competitors and provides opportunities for scaling the business. Moving on to the next level of revenue, it becomes easier as those companies with “strong” innovation moats generally achieve high valuations.

We want to assist in the growth of NZ companies. Those that have built innovation moats to protect their businesses are NZ companies that Movac wants to assist overcome those three headwinds.

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