How to Own a Market

Characteristics of Great Tech Companies

For a company to own its market, it must have some combination of proprietary technology, economies of scale, network effects, branding, and durability.

Consider great tech companies; although there is no single formula, most have at least one decisive advantage which helps them own their market. The greatest tech company today, Apple, has all of them.

Of these characteristics, branding is probably the hardest to pin down. Proprietary technology, economies of scale, network effects, and durability are more easily understood. Let’s dig into each one.

Proprietary Technology

There are many different versions of proprietary technology, but the key theme is that your technology needs to give you a massive delta over the next best thing. A good rule of thumb is that you want to have an improvement that’s at least an order of magnitude better on a key dimension.

Take Apple, for example; their first iPhone was at least ten times more advanced than every other smartphone at the time. Or Google, whose initial page rank algorithm performed ten times better than any other search engine.

All these great tech companies had a proprietary technology that was a quantum improvement, differentiating them from everybody else. Of course, if you come up with something completely new, that’s an infinite improvement.

Economies of Scale

Economies of scale come into play when you have high fixed costs and low marginal costs. In other words, your company gets more efficient and profitable as it grows.

Apple has serious scale cost advantages by owning its entire value chain. Amazon also has economies of scale by taking advantage of its high volume to offer low prices and cheap shipping.

Software companies are especially good at economies of scale because the marginal cost of software is zero. So if you get something that works in software, you can scale very quickly.

Network Effects

The gist of network effects is that the value of your product increases as the number of users increases. Generally, the nature of your product locks people into your company.

Apple’s network effects locks in millions of repeat customers interacting with the Apple ecosystem and countless developers building on the Apple platform. Google’s network effects also make it highly unlikely for users and advertisers familiar with Google’s services to switch to alternatives.

However, the challenging thing about network effects is that they’re often incredibly hard to start. So you always have to consider the difficult question of: why is it valuable to the first person using your product?

Branding

One way to think about branding is as a classic code word for a great tech company, but getting more specific than that is tough. Whatever a brand is, it means that people do not see your product as interchangeable, and thus, they’re willing to pay more for it.

Apple’s brand is not only a combination of all of the characteristics above but also something extra that’s hard to define. If another company were to make an identical iPhone, it would have to be priced less than the Apple version, as Apple’s brand allows for greater monetization even beyond its other decisive advantages. Both Coca-Cola and Pepsi generate huge cash flows because consumers have a strong preference for one or the other and buy into one of the two brands.

Branding is a tricky concept to understand and identify in advance, so investors never bet on companies that are just about branding. But what’s understood is that branding is an actual phenomenon that creates real value – if you manage to build a brand, you have built a great tech company.

Durability

Now the critical thing about these great tech companies is that it’s not enough to be one for just a moment; you also have to be durable. And so, if we look at all of the other characteristics, they exist at a moment in time, but you also want to think about if they will last over time.

Proprietary technology that’s significantly better than the state of the art today is how you initially break through and get people’s attention, but then you need to keep innovating at a fast pace so that no one can ever catch up. Economies of scale, network effects, and branding have a great time element where they get stronger over time, which can help your company maintain and grow its market share.

One of the things investors always overvalue is growth rates, and one of the things investors always undervalue is durability. This is because growth is something you can measure precisely in the here and now, whereas the question of whether a company will be around a decade from now is more qualitative, but it’s actually what dominates the value equation.

Last Mover Advantage

People often talk about this idea of the first mover advantage, but focusing on that may be problematic. You might move first but then fade away.

I always think the better framing is that you want to be the last mover. You want to be one of the last companies in a market and enjoy years or even decades of profits. Apple is the last operating system. Google is the last search engine. Meta will be very valuable if it turns out to be the last social networking platform. The greatest tech companies are all last movers who own a market over time instead of being eroded away by competitive forces.

So more important than being the first mover is being the last mover. In this instance, business is like chess, where the first mover has about one-third of a pawn advantage, but you want to be the last mover who wins the game – Grandmaster José Raúl Capablanca put it well, “[to succeed], you must study the endgame before everything else.”