Customers as a moat

July 23, 2018

Following Warren Buffett’s first definition of the concept, most companies have sought to find their moat in systems and processes. Superior technology, access to intellectual property, efficiency, and cost control are commonly believed to be sources of the moat, but perhaps the most seductive lure of all is innovation, being able to innovate faster than our competitors.

The problem with all these views of the moat is that while they might be successful in the short term, over time they are doomed to failure. Efficiency and cost control tend to have a deadening effect, tying companies more tightly to their original business model and restricting risk and growth. Yes, they are necessary to business success; but they are not sufficient.

Relying too heavily on innovation is also a dangerous game. As Clayton Christensen pointed out in The Innovators’ Dilemma, companies that create successful innovations and bring them to market often become so dependent on that innovation that they cannot move forward. Innovation creates a kind of path dependency. We know logically that sooner or later, someone will come along with another innovation that will make our technology obsolete, but emotionally we are still tied to that original vision, and cannot cut the ties that bind us to it.

This is why Elon Musk is wrong to say that innovation will make moats obsolete. Innovation is only a good thing if enough people are willing to buy our products, as Tesla is beginning to learn at its cost. Targeting early adopters is risky; they may be attracted by our bright shiny technology today, but tomorrow they will move on to the next thing. The moment the first roadworthy hydrogen cars appear will be the moment that Tesla’s business model collapses. Its managers will be wishing then that they had that moat.

the moat is people

The only real sustainable source of competitor advantage is customers; or more specifically, the relationship we have with our customers. They are the ones who make or break our business, and it is to them that we must turn if we want to see our firms prosper and grow.

Despite more than a century of research by marketers, economists, and psychologists, the relationship between a business and its customers is still poorly understood. When considering this relationship, managers typically make one of two mistakes.

The first is to fail to understand exactly what it is that customers want. They see customers as consumers of goods or services, without understanding ‘why’ customers want those goods and services. What is the value of these things to the customer? What, in economic terms, is the perceived utility? What benefits do they gain? Unless we know the answers to these questions, we will never understand our customers and never really gain that vital source of competitive advantage.

Take, for example, the car industry. What value do buyers of cars look for? The answer can include many things. On a practical level, they may be looking for a reliable source of transport, a safe vehicle for transporting one’s family and children, good fuel economy, and cheap running costs. But cars also say a great deal about our own image and personal values. Customers may buy a car because they think it will enhance their status in the community, or because owning it will make them feel good about themselves. The car we drive says a great deal about who we are.

Rolls-Royce understands this very well. The Rolls-Royce brand has a very clearly understood story and image, and people know exactly what it stands for. Rolls-Royce’s relationship with its customers is clear and unambiguous. That is why the brand has endured for more than a century, and I suspect will continue to endure long after Tesla is no more than a footnote to marketing history. The lesson is clear; we need to understand not just ‘what’ people buy, but also ‘why’ they buy it.

The second mistake is to try and duck the issue and take refuge in systems and processes. “I don’t worry too much about customers,” a finance director recently told me. “Generating sales is difficult and you never make as much money as you think you will. If you want to make money, cut costs. That’s easy.”

Nearly sixty years ago, Professor Theodore Levitt castigated similar points of view in his classic Harvard Business Review article, Marketing Myopia (1960). Dealing with customers was difficult and messy. Customers were emotional and irrational, and did not conform to precise models. When dealing with them, it was too easy to get things wrong. Far better to fall back on the certainty of systems and processes. Levitt described how managers would be masters of efficiency, running their factories at full blast and counting themselves as successful, while all the while their business model was eroding beneath their feet as customers departed for rival firms.

Facing up to customers and understanding their needs and wants is vital. Those needs and wants must also be the thing that drives innovation. It is absolutely necessary, but beware, the lure of the big breakthrough that changes the market and introduces new categories. Some companies manage to pull these off and become successful. Most of them crash and burn.

A safer route to the moat is the small-scale incremental innovation described by Patrick Barwise and Seán Meehan in their book Beyond the Familiar. They talk about getting close to the customer and understanding his or her needs as a precursor to all other strategic and innovation decisions. Procter & Gamble, for example, expends vast effort on doing so. P&G researchers in America will spend an entire day with a customer family, observing them, listening to them, understanding how they live their lives and what their hopes and dreams are, what they need and what they want. That information is fed back into the innovation process and drives a constant stream of small, incremental innovations that keeps the company’s products aligned with what its customers demand.

That is the moat; that strong and enduring relationship that means customers know the company and trust it to deliver what they want, so they come back time and time again to buy its products and services. That is why P&G has dominated the FMCG market, especially for soap, in America for decades.

Commentators on the moat sometimes talk about barriers to switching as a form of moat. Locking customers in, making it harder for them to move to alternative products or services, can produce the illusion of customer loyalty, but not the reality. Customers do not like being locked in. They want the option to choose; and if they choose our products, they want to know they are doing so of their own free will. Erecting barriers will make them feel like they are being exploited. No, just offer the best, and concentrate on making sure it stays the best.

And finally, do not just measure customer satisfaction. Measure dissatisfaction too. What do customers not like about your products? What do they feel could be improved in the service experience? Find those points of weakness and eliminate them. That will strengthen the customer relationship still further.

role of the employee

The role played by employees in this process is very important. Front-line staff are the ones who create and build those customer relationships, and it is vital that staff are both motivated to build these relationships and empowered to do so.

There is an old saying: ‘look after your staff, and they will look after your customers for you.’ Employees too are part of the moat. The products they innovate and create, the service they deliver, form part of the customer experience, and that experience in turn determines how customers feel about the company and the strength of the brand.

To make sure your moat is strong and deep, focus on that relationship between employee and customer. Make sure employees know what customers want and need, and then help them deliver. If you can do that, day in and day out, week in and week out, year in and year out, then you do not need to fear your competitors. It will be they who fear you.