Value is great but competitive advantage is better. Go beyond ROI and look at your economic moats.
It’s generally understood that a good investment shows a positive return over time. That means to justify an investment we need to show the value of our proposition and how it benefits the business. For managers in charge of an enterprise technology like GIS, this can be a difficult and challenging fact of life.
When attempting to answer the question: "why am I spending money on this?", GIS managers typically turn to the trusty notion of Return on Investment (ROI). And why not, it’s a well-understood measure of value even if it is difficult to quantify. The task is straightforward in concept: sum up the benefits to the business, divide by the cost and presto – we have a nice, concise number to provide the decision-makers. If we’re really smart we’ll factor in the time-to-value to further prove the point. Assuming your ROI is better than available alternatives, you should be a go!
The problem with ROI, however, is that it doesn’t provide much competitive context. Sure we get a sense of the financial or non-financial benefits relative to the cost of the investment, but we don’t know whether the value created beats our competitor’s best efforts. In strategic terms, we don’t know if our investment contributes to our organization’s sustainable competitive advantage. This is also known as our organization’s “economic moats”.
An economic moat refers to a structural, durable competitive advantage that persists over time, irrespective of short-term trends and management maneuvering. Deep and wide economic moats protect market share by creating barriers to competitors. As stated by Warren Buffet, "In business, I look for economic castles protected by unbreachable moats."
Economic moats are extremely powerful and in a sense allow a business to thrive even when the lights are off. Generally, economic moats come in the following five varieties:
Intangibles Intellectual property that prevents competitors from duplicating services. Examples include brand, patents, agreements, company culture, social license, proprietary knowledge and skills.
Cost Advantage – Structural cost advantages that confer meaningful economies of scale relative to competitors. Examples include superior supply chain, proprietary processes, automation, strategic sourcing and optimized workforce.
Network Effects - The corresponding increase in the value of a service as more people use it. Examples include mobile phone networks (3G, LTE), benchmarking services, community-building platforms and shared data.
Switching Costs - The expense or inconvenience incurred when a customer switches to a competing provider. Examples include points programs, loyalty programs, partner tie-in programs, access to proprietary tools and data, and venture equity.
Efficient Scale - Monopolies that exist for the purpose of efficiency; services provided to a naturally limited market. Examples include airports, utilities and instrumentation networks.
Moats are a powerful, yet surprisingly overlooked way of thinking about value. The fact is that while many investments show a positive ROI, very few actually help to create or maintain a competitive advantage. This is because they don’t significantly contribute to an organization’s economic moats. They might reduce costs, improve employee productivity or reduce service delivery times, but they don’t necessarily advance the business ahead of the competition.
It’s not to suggest that ROI is not important. A business needs to run and grow and its vital to understand the viability of investments. ROI fits the bill here. But when considering investments in a strategic light, we need to look at the competitive environment. Specifically, we need to evaluate whether an investment advances our organization’s competitive position. For managers, this means understanding how your solutions contribute to your organization’s economic moats. Let's look at an example.
Building a Competitive Advantage
Imagine you’re the Director of GIS for a national fast-food restaurant chain. Senior leadership has recognized analytics as key to understanding customer behaviour and providing better service. Specifically, leadership feels that access to the real-time location of potential customers paired with high-quality demographic information will allow its marketing department to identify active hotspots of customers and predict their dining preferences on the fly. This would provide opportunities for immediate and focused promotion by restaurants in the vicinity. A recent pilot during a concert festival weekend showed that promotion conversion was several times greater than other weekends where promotions were delivered through untargeted mass advertising channels.
Leadership is excited and decides that it’s time to put this into action. You are asked to put together the business case. You start with an ROI analysis to confirm the viability of the investment. After some evaluation, you determine that opportunity would deliver a 22% total return based on increased revenue and reduction in current marketing costs. In addition, the personalized marketing will increase customer satisfaction by 15%. Slam dunk!
You take your analysis to the leadership team and everyone seems impressed. Why wouldn’t we do this? The numbers look great and we could get this into production by the summer – just in time for concert season! But being a forward thinker, you ask the leadership team to consider this opportunity through the lens of strategy. You then reveal the second part of your analysis.
You ask the group to consider the long-term benefit of the solution. Specifically, you ask the question: will this solution deliver a competitive advantage to the business? And if it does, how sustainable or defensible will it be? You use the concept of economic moats to walk them through the analysis.
Intangibles - Certainly the improvement in customer service helps the brand, but without strong IP (like patents or copyrights) what prevents a competitor from doing the same thing? Does the company excel at the brand building needed to stay ahead of the competition?
Cost Advantage - The main cost advantage comes from the reduction in marketing expenses by avoiding wasteful and expensive mass advertising campaigns. But comparatively, this is only true as long the company holds the competition at bay. Can this solution be extended to other parts of the value chain such as – giving customers the ability to connect directly with the nearest restaurant through a mobile device and place an order in advance?
Network Effects - Demand-side network efforts are one of the most powerful competitive advantages. A strong network effect creates a self-reinforcing loop whereby the more customers that use a platform, the more valuable it becomes to everyone else. The company's marketing solution doesn't inherently create a network effect so the question is – can the company configure it in a way so that it does? Could the company create a mechanism to allow other businesses in the vicinity to promote their own complementary products or services?
Switching Costs - While not as strong as network effects, this is definitely an area where our restaurant chain can build a moat...even a small one. Loyalty programs or tie-in programs for other promotions could help to create a switching cost.
Efficient Scale - As with most commercial businesses, natural monopolies are not realistic. Nothing to be gained or lost here.
By framing it this way, you give the management team pause. When presented with the ROI, the investment looked promising; but put into a strategic context the picture gets murkier. The CEO thanks you for your hard work and insight and instructs you to explore the true strategic potential of this solution in more detail. The concept of economic moats has resonated with him and he insists that in the future similar opportunities should be given the same strategic treatment. He states that in today’s digitally-intensive landscape, shoring up the company’s competitive defenses and protecting market share from incumbents and upstarts alike is paramount. Short-term thinking is a way of the past.
Economic moats are a powerful way of elevating the conversation about GIS and digital investments. Moats provide clarity about the strategic value of an opportunity beyond the immediate concern of costs and benefits. ROI might give you the inclination to break ground but sustainable competitive advantage is the reason to keep going. Don't stop digging!