Barriers to entry and start-ups

I’ve sat through more start-up pitches than I would like to admit over the past two years, and there’s one question that invariably comes up during every one: “What are the barriers to entry?” In other words, What will prevent someone else from doing exactly what you’re doing? It sounds great, right? Like, barriers to entry should be a good thing that every business should strive for. The problem is that the entire concept is premised on businesses operating in a monopoly environment. What people are really asking is, “Will you have a monopoly over your market?” And we all know monopolies are bad, right?

Look at industries with high barriers to entry and compare their stocks with those of other industries. You’ll find that those industries with high barriers to entry—automobiles, airlines, pharmaceuticals—have consistently underperformed the American stock market as a whole in recent times. Compare these industries with Internet businesses, which have fairly low barriers to entry. Could it be because the absence of barriers to entry drives competition, which drives innovation, which drives growth, which drives—well, you get the idea.

If you’re evaluating a business with high barriers to entry, you can almost assume that it’s doing to be slow, boring, and not particularly innovative. Fortunately, what many venture capitalists mean when they ask about barriers to entry is, “Do you have a patent?”

Let’s take Apple and the iPhone as an example here. The iPhone has been successful because Apple did something better than anyone else. They weren’t the first to make a smartphone or to make a phone with downloadable apps or email or maps. They just did it better. That Apple holds patents for things like multi-touch doesn’t mean that HTC and other companies can’t make smart/app phones. It doesn’t mean that they can’t design a new category of personal communication device that’s even more compelling and desirable to consumers than the iPhone. In fact, it suggests the very opposite—that to compete with the iPhone, you’ll need to make something better. This is not a barrier to entry, it’s an invitation to innovate.

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