2021: The Great Acceleration of the Rise of the Rest (Part II): Does your City have a Moat?
What’s the secret sauce for emerging tech hubs who want to seize this shake-the-snow-globe moment of tech talent redistributing across the country? I’ll frame my response in the same context that I used for Part I of this series: first, we must appreciate that cities are just like startups. And to take full advantage of this moment, cities need to act more like the breakout startups who forge their own identities instead of staking claim to being a “Silicon X” city.
But the key to success is about more than just clever branding and a good elevator pitch. It’s also about establishing a competitive moat. What makes up a moat? Let’s use Morningstar’s 5 Factors as a framework. The framework was originally created to help public market investors determine whether or not an investment opportunity afforded a defensible moat that would contribute to a superior return-profile. Morningstar outlines these five factors of a company’s moat: the network effect, intangible assets, cost advantage, switching costs, and efficient scale.
When we as venture investors conduct due diligence on startups for investment consideration, it is our job to not just consider the startup’s technology or platform in isolation, but to also examine it in the context of its peer group. Who is your competition? What is your moat? These are recurring questions in a diligence exchange. When exploring an investment in a tech hub — i.e., where to build your business or where to invest your fund’s money — Silicon Valley always got a pass on the “competitive landscape” section because it was long-considered to exist in a class of its own. But the consequences of coronavirus are reshaping the competitive landscape in the industry of cities; specifically, Silicon Valley’s moat is weakening and the ability to create new moats in emerging startup cities is strengthening.
Once startups establish their brand identity, they need to establish their competitive moat. Here’s how I think about those five factors in the context of startup hubs, if we continue to think of cities like startups.
1. The network effect: a network effect occurs when the value of a company’s service increases as more people use the service.
The “network effects” of Silicon Valley have been lauded for years. There is a deep density of investor, entrepreneur and tech talent concentrated in the city with a strong risk-taking appetite. It has been a key driver of increasing the value of Silicon Valley’s “service” — i.e., living and working in the city. But as the talent migration outflows from San Francisco increase and more people leave “the network,” its value — both real and perceived — may decline.
2. Intangible assets: patents, brand names, or ‘goodwill’ are all examples of intangible assets.
The legacy of the Silicon Valley brand has grown to near-mythic proportions in recent years, enlarged even in its parody, as portrayed in its eponymous HBO series. But equally important, the opposite has also largely been true. While there has been tremendous progress, development, and startup success in startup hubs across the country, the cities themselves have not enjoyed the same degree of brand value and attribution.
3. Cost advantage: A cost advantage can drive competitors out of business by either reducing pricing to squeeze the competition or by being able to raise prices without worrying about losing the bulk of its customers.
For cities, this cost (dis)advantage is mostly tied to the cost of living and the related cost of doing business (rents, salaries, etc). For years, prices to live and work in Silicon Valley skyrocketed without consequence; they rarely or publicly lost any key “customers.”
4. Switching costs: How much of a burden (real or imagined) will it be for a customer to switch to a new technology, even if it’s better? It isn’t just the cost and time to switch but also the risk of lost productivity when rebooting best practices onto a new platform.
The “switching costs” to move to a new city have never been lower for the tech industry. Now that business is conducted largely over zoom irrespective of a company or fund’s HQ city, the risk of productivity losses have nearly evaporated. And as more people relocate to emerging startup hubs, the benefits of “low switching costs” and “increased network effects” positively collide: more tech opportunities emerge in the new city, further de-risking the switching costs of taking a risk in starting or joining a new startup.
5. Efficient scale: Efficient scale means you have a market that is limited by size. A limited market can be efficiently served by a smaller number of companies; by default, this keeps a lot of competition at bay.
Regional cities are a natural fit for the “efficient scale” theory. The fact that so many cities have small but mighty startup communities can actually help the cities rise, as a more manageable, accessible, and founder friendly market can attract top talent and startups to the region.
Regional cities all across the country can build defensible strategies to help their startup communities rise and thrive. This framework can offer a helpful shared language for community stakeholders who want to explain why their cities has a competitive advantage. Defining and defending your “moat” will be critical for cities who want to continue to attract and retain more investment dollars and tech talent as the great acceleration of the Rise of the Rest continues.
