Investor: “Are Y and Z your competitors?”
Founder: “No, not really!”
Founder:“You know…, because, we do X, Y does x and Z does x.”
This is how some of the conversations between an investor and a founder regarding competition go as founders, typically, magnify the level of differentiation in their company’s offering/strategy compared to A, B, C and so on . Sometimes, it’s intentional because that is what the investor wants to hear if the company is the 10th entrant in the space and the entrepreneur knows that the true picture isn’t rosy enough. But, sometimes, the entrepreneur’s perception about the intensity of competition is distorted due to a combination of endowment bias, over-confidence in one’s own abilities and delusional optimism. This distorted perception leads entrepreneur into believing his/her company is different from existing players even when it’s not. The entrepreneur, then starts categorising a company Y or Z not as his/her competitor based on differences in product, business model and monetization strategy or similar parameters on the basis of which the company is different but that do not necessarily result into a differentiated value proposition. That categorization is then fed into the entrepreneur’s own mental framework to determine the vision, decisions and strategy for his company. Therefore, this distortion ends up in a severe understatement of the competition and hence, translates into a weak offering with not enough differentiation.
Peter Thiel, in his book “Zero to One” and in this blog, perfectly captures how companies typically define competition:
“The confusion comes from a universal bias for describing market conditions in self-serving ways: Both monopolists and competitors are incentivized to bend the truth. Monopolists lie to protect themselves. They know that bragging about their great monopoly invites being audited, scrutinized and attacked. Since they very much want their monopoly profits to continue unmolested, they tend to do whatever they can to conceal their monopoly — usually by exaggerating the power of their (nonexistent) competition.
Non-monopolists tell the opposite lie: “We’re in a league of our own.” Entrepreneurs are always biased to understate the scale of competition, but that is the biggest mistake a startup can make. The fatal temptation is to describe your market extremely narrowly so that you dominate it by definition.”
A framework that I have found useful in defining competition while evaluating businesses is looking at the dollar pool of revenues or profits that the company is vying for and identifying the players who are competing for the same dollar pool. In the early stage, a company might get away by defining competition narrowly and attain upto 1–2% market share but as it scales, competing for an additional percentage point of the dollar pool becomes tougher. The error in narrowly defining the competition hampers the growth trajectory of the business as the competitors take notice and fight tooth and nail for gaining or maintaining their market share.
A good example of the tendency to define competition narrowly is apparent in the restaurant business. Since, opening a small restaurant takes less capital compared to building businesses in other industries and product offering is perceived to be quite simple requiring low expertise, every year, thousands of new restaurants are started. And, what entices most of the restaurant owners into opening a restaurant is expectation of a large profit pool that is significantly overestimated owing to a narrow definition of competition. However, here is what the thought process should be like — If you want to open a North Indian restaurant in a locality and there is no North Indian restaurant within a radius of 3km from the proposed location, it doesn’t translate into “no competition” for the business. You are competing with the South Indian restaurants and the Italian restaurants, the dine-in restaurants and the home-delivery enabled Domino’s outlets, the road side restaurants and the food courts in malls, and so on. Everyone is competing for the “eating out dollars” of the same consumers living in the locality. Once you have defined the competition in this manner, you can go on to determine how your positioning will be different from the existing alternatives. You can still go ahead with the belief that there is no to little competition and build a relatively small business, however, the impact of the competition would be felt more severely as you look to scale the same restaurant in size or open more restaurants in that locality and start impacting the revenue dollars of the nearby restaurants.
In an world where companies like Uber are going global in less than three years after starting up, companies like Amazon are entering new industries every year and capital is ready to back goliath ambitions of entrepreneurs thousands of miles away in pursuit of humongous returns, narrowly defining competition can prove to be a very costly mistake.