All posts in Mental Models

As an entrepreneur, you worry about customers all the time. And you’re correct in doing so. Focusing on customers is obviously important but customers will never ask you to introduce switching costs, which are precisely what you should do in order to continue making profits.

Once you’ve been able to build a defensible business by building a big moat, you can pat yourself on the back. Your business now won’t get killed by competitors.

You’ve successfully thwarted risks from direct competition but your business is now likely get killed as collateral damage to something else where you weren’t even a player. Microsoft Windows had an absolute monopoly on personal computing and that’s why Linux or Mac OS didn’t impact its growth. What weakened its grip, however, was the shift of computing from the desktop to mobile phones that accessed services running on cloud servers (none of which were running on Windows).  ...  Read the entire post →

A business is said to have network effects if each new customer increases the value derived by all other customers. Take a telephone network. Each new customer with a telephone line helps increase the value of the network for all other customers because now more people can talk to each other than before. Contrast this to other businesses such as the appliances manufacturing business. It’s obvious to see that if I sell one toaster, none of my other customers benefit from that sale.

A business with strong network effects gains a competitive advantage over time because new entrants have to start from scratch and a customer choosing between two alternatives will go with the one that delivers more value, which is often the one with stronger network effects. Because businesses with network effects keep attracting new customers who make such network effects stronger, these businesses soon become almost impossible to beat in their category. Think Facebook, WhatsApp, and Instagram.  The value of these apps is not in the technology they provide but in your network of friends using them. ...  Read the entire post →

Business opportunities that seem easy, or those that require minimal effort or investment are easy for everyone (and not just you). Most people naturally gravitate towards work that’s easy, enjoyable, or sexy. This is why you have so many entrepreneurs make mobile apps because coding an app is fun and relatively easy. 

Real advantage, however, lies in doing what others aren’t willing to do.  Such work is either really hard, or takes an enormous amount of time or requires enormous capital, or is extremely boring or is unsexy. The fewer number of competitors in these less popular domains usually translates into a much higher chance of building a profitable business. ...  Read the entire post →

Capitalism rewards rare and valuable. Making something that customers value is important, but so is making something rare. Markets are competitive and initial success usually leads to other companies or new startups trying to copy and replicate such success for themselves. The last thing you want is for someone else to come along and capture your entire market for themselves.

It’s true that copying by competitors may or may not happen, and such copying by others may or may not be successful. But why leave that to chance? In fact, companies that are copying your business will likely use all their unfair advantages to crush you. If they have more funding, they can out-market you. If they have better engineers, they can develop a more stable product. If they have a brand name, they will use it.  ...  Read the entire post →

Entrepreneurs have to be confident in their abilities, otherwise, they’d never take the risk of starting a business. However, this confidence can backfire if it’s adopted as a company strategy. If you think you’re smarter or more hard-working than your competitors, your competitors are also thinking the same.

Competitive advantage arises out of true and exclusive advantages that give you an edge over competitors. Believing you’re the best or the most hard-working is probably neither true nor exclusive to you. Invest in actually building some real, hard-to-copy advantages in your business. ...  Read the entire post →

Proven physical theories are called laws because they dictate how our world operates. If there were such a “law” of capitalism, it would probably be the fact that profits attract competitors who try to eliminate it by offering customers either a lower price or a higher quality. This law thus allows for only two types of businesses to exist: cost-focused business or quality-focused business. Think of a McDonald’s v/s your neighborhood gourmet burger restaurant. Any business that tries to be both doesn’t work out in the long run. ...  Read the entire post →

Switching costs determine how valuable your business is because investors value a business equal to its expected future profits. If your customers are able to switch easily to a competitor, potential investors see that as a risk, and hence will not value the business highly as potential future earnings of a business can easily be taken away by a competitor.

If building a business is hard, building a defensible business is harder and that’s why they’re rare. Warren Buffet’s top criteria for evaluating a business is the presence of moats. In old times, castles were protected by trenches filled with water which were known as moats. Such moats protected against an enemy attack as they were not easy to cross. In business, moats are whatever deters a potential competitor from taking away your customers.  ...  Read the entire post →

End customers typically get value through a series of businesses adding value on top of each other. For example, imagine the value chain required to bring a laptop to the end customer. The production begins with suppliers of metals and raw materials which are used by computer part manufacturers to build components like CPU, screens, and disk drives. These components are then assembled to build a laptop. The laptop needs software that’s typically written by some other supplier like Microsoft. And, finally, the fully functional, ready-to-use laptop is shipped by a logistics company to a warehouse. Customers transact with an online or offline seller of laptops which is typically yet another company (Amazon or BestBuy).  ...  Read the entire post →

Picking problems to solve is a function of attention. Wherever and whatever you’re paying attention to is going to reveal problems in that domain to you. Solving such revealed problems is going to absorb you and will reveal even more problems worth solving in that domain.

So this creates kind of a feedback loop.

Because every domain of life has such richness, it’s easy to get lost in this feedback loop and spend an entire life solving problem after problem in that domain. In fact, this is what (traditionally) is meant by a career. There’s nothing wrong with going deeper into a niche if one is mindful and conscious of it. However, in my experience, few people consciously choose what problems to solve because very few consciously choose what to pay attention to. ...  Read the entire post →

Can an app built on top of Facebook become bigger than Facebook itself?

It’s easy to believe that you will get limited by how big is the businesses on which your business is built. But that’s not true. An app built on top of Facebook can become bigger than Facebook because the customers and desires that Facebook serves are very different than customers and desires that the business that’s built on Facebook is trying to serve. Facebook, in this case, is simply an enabling platform while the real value to the customer is being created by the app. ...  Read the entire post →