Use Switching Cost to Create Defensibility, Opportunities to Build Startups in AI - Tactician: #00100

As a consumer, I love low-switching costs.

The worst is when you try to cancel a subscription and the website takes you through a maze:

'To cancel, press 1.

To hear these options in Klingon, press 2.

To go back to the main menu, stay on the line and hope for a miracle.'

For the past 24 hours Tactician.Pro has been down after Substack (my publishing platform) disabled my account, without notice or reason.

Conveniently, it happened just before I hit the Publish button on my 100th issue (🥳), after a perfect 99-day streak of never missing a day.

This was also 48 hours before a Lecturer from Stanford’s business school reached out and planned to share a Linkedin Carousel I made with his >48,000 followers on Linkedin.

Time is ticking, man!

After two unanswered appeals, one unanswered email, and an experience with a AI chatbot that almost made me lose hope in the future of AI chatbots… I began looking for a new home for my publication.

Fortunately, Beehiiv makes it easy to migrate subscribers and previous posts. And after about two hours of set up… I’m back, baby!

I’ll continue to explore Beehiiv’s product and offering while I wait for Substack to get back to me.

This experience inspired my below post on the importance of switching cost as a defensive moat, and is an ode to Beehiiv for making it easy for me to make that switch.

In this 100th edition I’ve tried something new with Use Switching Cost to Create Defensibility (below):

I’ve combined the points from two articles to deliver what I think is an enhanced storyline and more specific tactics.

Enjoy!

(Tactician is not part of Beehiiv’s affiliate nor advertiser program)

Use Switching Cost to Create Defensibility

Why Read:

• Get insights on building defensibility through counter-positioning and creating high switching costs.

Featuring:

• Nandu Anilal, Vice President at Canaan

  • “Modern Software Moats“

• Nabila Amarsy, Product Manager at Google

  • “6 Strategies to Lock Customers in Your Ecosystem”

Key Concepts and Tactics:

1. Defensibility is important for businesses, even in large markets and for startups.

   • Point: Defensibility matters regardless of market size, as competition erodes pricing power and makes customer acquisition challenging.

     • "Defensibility has nothing to do with market size. Large and small markets alike become uninhabitable when there's fierce competition. It makes acquiring customers more challenging and it erodes any individual company's pricing power."

       -Nandu Anilal

   • Point: While finding product-market fit is most critical early on, defensibility matters for startups as they scale and is evaluated by investors.

     • "I'll concede that when you're pre-product-market fit, there's really nothing more important than finding a big problem that's worth solving. Things like defensibility really don't matter until you're ready to scale. That said, VC-backed startups are a long-term investment and are certainly evaluated by investors on their ability to generate defensibility eventually."

       -Nandu Anilal

2. Counter-positioning is often the first moat startups develop, buying time to build other moats.

   • Point: Counter-positioning means taking an opposing view from incumbents, making it hard for them to copy without risking their existing business model.

     • "Startups that take a fundamentally opposing view from incumbents are defensible because incumbents typically grow too attached to their existing business model to risk compromising it. For startups, it's important to buy time and space to build something truly defensible."

     • "I see a few different categories of counter-positioning in software: 

     • Unbundling by use case:

       • The "Zoom for X" companies have carved out a piece of Zoom's TAM, hoping to create and expand markets outside of Zoom's primary focus... 

     • Unbundling the stack:

       • The "Headless X" companies are focused on unbundling frontend and backend functionality

     • New end user:

       • The "X for developers" companies span many categories, but have similarly built software that is developer-first rather

     • New monetization:

       • The "as-a-Service" model itself is partly a pricing innovation (in addition to being a new distribution model). Salesforce took down a formidable opponent in Oracle with a per-user, pay-as-you-go pricing that served to expand the market."

         -Nandu Anilal

3. High switching costs are a common moat for software companies.

   • Point: Switching costs come from the friction of displacing a deeply embedded solution. 

     • “Let's take a look at 6 different 'traps' that companies have used to lock customers in through switching costs:

       1. Base product & consumable trap’: Nespresso, Gillette, HP, Kodak

          • For this trap, companies lure customers into their ecosystem with a base product and then milk profits from 'consumables' that customers are forced to buy. Nespresso coffee machines (base product) are sold at cost[...]. But the highly-profitable coffee pods are only sold through Nespresso’s owned sales channels, allowing them to absorb juicy margins.

       2. ‘Data trap’: Apple, Google Android, Spotify

          • The ‘Data trap’ consists encourages customers to create or purchase content and apps that are exclusively hosted on a platform. These platforms can be websites, software or devices. But, leaving one platform for another forces customers to let go of data or activity that can't be migrated to another app.

       3. ‘Learning curve trap’: Adobe, Salesforce, Box

          • Customers can be discouraged when they have to start over and learn how to use a new product. The ‘learning curve’ trap is centered around offering a great value proposition that’s only accessible to those willing to train to know how to use it. Salesforce and Adobe use the ‘learning curve trap’ to get customers hooked to their products--some users get so good at using their software that they become certified experts.

       4. ‘Industry standards trap’: Microsoft, Adobe

          • Sometimes, you are forced to do things because everyone else does it a certain way. That's another way companies lock customers in. They position themselves as leaders by public acceptance. Their product, or one of their product features, has become the standard in an industry, which makes it very difficult to use something else. Microsoft Office’s Word software is one of them… Switching costs are high because it is nearly impossible to work with a word processing software that doesn’t create or accept .doc files today.

       5. ‘Servitization trap’: Rolls Royce, Hilti

          • If your competitor uses the ‘servitization trap’, you’re not just competing against their product, but against an entire experience they offer. In this approach, a company can bundle their products with complementary services provided only to their customers.

       6. ‘Exit trap’: Verizon, AT&T

          • The ‘exit trap’ forces customers to use a product for a certain period of time specified in a contract. If the customer wants to exit the contract, he/she has to pay early termination fees. This strategy is commonly used to dissuade customers from switching to a competitor before their contract ends.

     -Nabila Amarsy

Opportunities to Build Startups in AI

• Why Read:

  • Valuable insights on identifying AI opportunities, including targeting underserved niches, getting timing right, building defensibility, and moving fast with the right team.

• Featuring:

  • Pete Flint , General Partner at NFX

• Link: 

  • “The Startup Advantage in AI with Pete Flint (Live from Stanford GSB)”

• Key Concepts and Tactics:

  1. Identify areas where AI can be a disruptive innovation, not just a sustaining innovation for incumbents.

     • "One of the core questions that we have as investors and you should have as as startup Founders is who is going to really benefit from AI is it going to be the incumbents or is it going to be the startups"

     • "Clearly AI is is going to be both a sustaining Innovation for a bunch of areas but also disruptive innovation as well so what I'm going to talk about next is really five paths that that we see for disruptive innovation in in AI startups"

  2. Move fast in traditional industries that are slow and lack a digital incumbent.

     • "... there's a bunch of these traditional industries here which often don't have a big digital incumbent and we really love these kind of edge cases. Within these industries you can start to turn a huge amount of these offline activities into online activities just by moving fast."

  3. Finding opportunities with unstructured data in high-value contexts.

     • "... there's this large amount of unstructured data in quite a valuable context. You can take this data and build out really novel user experiences and I think if start to look at where is this data, where are the opportunities for startups where it's being underutilized particularly in high value businesses then you can see a ton of opportunities"

  4. Start by serving underserved or seemingly frivolous niches.

     • "Disruptive innovation often serves the underserved niches n the market. You've got the incumbent which is likely focusing on the money and going after the big customers in the enterprise, the rich customers, whereas the disruptors often focus on these underserved niches which can be the unprofitable or unsexy or somewhat frivolous areas which the incumbents are ignoring because they just seem to be that profitable"

     • "Take a look at character AI. It enables you to essentially chat with anyone you'd like and they're able to essentially impersonate anyone and I'm sure a lot of the usage is really frivolous stuff. People having fun. But this is exactly the point. They're starting in this underserved niche in an area where the sort of tolerance for error is very high. People don't care whether it's 100% accurate but then the opportunities for that to test and learn and improve and move into a bunch of business context could be extremely valuable and something that people will be willing to pay a lot of money for"

  5. Get the timing right by aligning enabling technology, economic impetus, and cultural buying.

     • "Broadly there are three characteristics to think about with startup timing and in an optimal case you hit all three: 

       1. Enabling technology: the breakthrough technology of today that previously wasn't around (and that you know in today's world that's predominantly AI) that can open up a whole bunch of other opportunities 

       2. Economic impetus: Whether that is something that was really expensive becomes really cheap 

       3. Cultural buying:  what is the cultural acceptance of an idea"

  6. Build long-term defensibility through network effects and embedding in workflows.

     • "Within AI there's probably two areas that we look at one is network effects so how does it get better as more people use that product and service. The second is around embedding and that could be simple embedding because the workflow is much easier to use so you start to embed yourself in the experience or embed yourself in other ways across the organization"

  7. Move extremely fast with the right team.

     • "I think that's kind of obvious but I would I will double click on the fact that not only is being fast as a team critical in any startup but the pace of change today is astounding. It's absolutely astounding in terms of the things that are being built and the execution that's happening so that capacity to move quickly in the right direction with the right personalities is beyond is a superpower in its own right…"

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