Loch Ness, Unicorns & The First-Mover Advantage

When they are asked about the defensibility of their businesses, I regularly hear entrepreneurs cite “first-mover advantage” as the basis on which they will compete and defend their margins. It has come up several times recently, both in class discussions and at a recent MassChallenge panel I moderated on working with angels. Since everyone loves a good myth, I figured I would take a moment to examine this one.

Myth is actually a misnomer here because myths generally relate to the supernatural or nonexistent. First-mover advantage does occasionally happen in real life, just not very often. And not in the way entrepreneurs generally understand it.

Many entrepreneurs claim they will succeed because they have the “first movers advantage” in their market, and that they will secure an early lead because they don’t have any competition out there in front with them. Groan. Where do I start?

First of all, everyone who has a business has competition. Period. In fact, if you don’t have competition, you don’t have a market. You may be a first-mover, but you are moving into an empty space filled with the sound of crickets. Every product or service must solve a customer problem. Your competition might be in the form of substitute products that solve the problem in a different way, or accomplish something similar to your product. Or it may exist in the form of alternatives, such as a trip to the local movie theater as an alternative to a meal out in a restaurant, or the purchase of a blu-ray disc instead of an HBO subscription.

Regardless of its form, your competition is out there. So if I hear you say you are a first-mover and “don’t have any competition” I conclude you don’t truly understand the nature of you business and what a first mover’s advantage really is.

What does it take to be a first-mover and gain an advantage from it?

You obviously have to be the first, or at least very early into a market. It might be a brand new market, or it might be a disruption of an existing market causing a new niche. But needless to say, some “first-ness” is a prerequisite.

This is not as easy as it sounds because the cost of educating the market falls squarely on the first-mover, who has to spend an inordinate amount of time and money gaining mindshare, educating consumers, and manufacturing demand. And there is always the grave possibility that you are totally wrong and the market never materializes.

Secondly, you need to very quickly capture a huge percentage of that market. You need to grow at a breakneck pace while you are still hot and there is less organized and effective competition.

Third, you need to come up with some method to protect all that marketshare. Some form of the classic economic concept of high-switching costs. In the case of Facebook, the high switching costs would be all the friends, updates, photos and data you have collected on the system and cannot figure out how to move elsewhere. On a personal computer platform it might be all the software you have invested in which is only compatible with that platform. In cameras, it might be getting someone to invest in a lot of Nikon lenses over time so they will never switch camera brands. In smartphones it might be enticing them to download a lot of apps or music so they won’t change smartphone platforms.

In case it is not obvious, businesses with high switching costs are not that easy to build, especially in today’s internet-centric world where your competitors’ products are just a quick Google search away. More often than not, efforts to bake in switching costs just come across as product limitations which irritate consumers and slow adoption. Consumers are pretty savvy at avoiding lock-in and format wars when they can. As much as it hurts to admit it, sometimes the best lock-ins are an accident, or at least very subtle and sneaky in the beginning.

But even if you have done all that right and you have managed to find a market you can dominate, you are still a sitting duck for one important reason. You have spent a lot of money to get into your dominant position.  And you have been spending lavishly to maintain your market and the high switching costs. And you have gotten bit lazy as a result of all that marketshare. So your rate of innovation may have slowed down a bit.  And your prices have likely become a bit elevated to reflect your dominant market share and high costs.

At this point, along come the dreaded fast-followers. They have watched all your mistakes, waited for you to build awareness and educate consumers, and they have found weaknesses in your product and strategy. In they zoom to undercut you on price, and possibly outbid you on features and functionality. (Here’s a discussion of this phenomenon in the Facebook / Google+ context.)

As soon as you have demonstrated a great business in a great market, the fast-followers will be all over you like a pack of dogs.  And they will make your life much more difficult than you ever thought possible back when you first envisioned your utopian new market.

As if you and your poor enterprise were not already beaten down enough by cliched business buzzwords at this point, your punch-drunk response to fast-followers is almost always further hampered by an additional plague: the much-feared “innovators dilemma.”

All that switching cost lock-in you have built to protect your business also prevents you from reacting effectively to your competition. You don’t want to jeopardize your still-lucrative business by abandoning your installed base or failing to honor backwards compatibility with the de facto standard which has treated you so well.

So you underestimate the threat until denial is no longer possible, and then you spend too long trying to figure out what to do, based on a backwards-looking market perspective that only a myopic marketshare leader could muster.

But at that point it is already too late and all you can do is take your beating and yearn for the simpler days when you were still brash and nimble (cough, RIM Blackberry, cough, cough, Microsoft, cough).

Gaining a first mover’s advantage isn’t impossible, it’s just much more difficult, rare and expensive than most people realize. It does exist. And it can be a heck of wave to surf if you are lucky enough to catch it.  So don’t let me talk you out of it.  By all means, give it a shot.  And feel free to crow to me about it. Just please understand why it is I look a little skeptical as you are telling me all about it.

Comments, questions or reactions to this post? Leave a note below and I will respond to your questions.

If you enjoyed this, you might enjoy: What I Look For In An EntrepreneurWhy Angels Chase ElectronsAre Entrepreneurs Wild Risk-Takers?Pick Your Founder/Co-Investors Carefully & Reflections on the Nature of EntrepreneursTop 20 Dos & Don’ts with Angel Groups & Early Stage FinancingDelusional EconomicsThe OvertureThat Vision ThingThe Power of An Advisory BoardShould I Wait For A Technical Co-Founder.

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