I hate competition.
—Marat Safin, tennis champion, Russian politician
When entrepreneurs approach me to invest in their companies, I naturally want to know who their competitors are. It’s a basic question that any investor would ask.
Some entrepreneurs answer the question thoroughly and confidently. They are not afraid to acknowledge what the competitive landscape looks like. Others equivocate, either because they don’t want the fact that competitors exist to diminish the appeal of their idea or they simply haven’t done their homework.
Of the two responses, I am more concerned about and hesitant toward entrepreneurs who seem delusional or unprepared. They often respond to my inquiry, proudly saying, “We do not have any competitors.”
I want to respond to them, “Yeah, right.”
The answer that they gave to make their venture appear more attractive actually made it more unattractive. Instead of telling them what I’d like to say, I keep quiet and focus on companies that are better suited for investment.
Theoretically, every company in a free market has competition, even if it is pioneering a completely new market category. A customer’s dollar can be spent in millions of ways, and with millions of businesses. The competition may not be obvious or simple to find, but it’s there. Your job as an entrepreneur is to find and to assess the most threatening competition. A more in-depth step includes identifying and analyzing companies that could easily leverage their resources—like distribution channels, investment capital, or intellectual capital—to enter your market and to compete with you.
A common mistake that mostly start-ups make when researching their competition is overlooking substitutes. What are substitutes? According to N. Gregory Mankiw, an economist from Harvard University, “Substitutes are often pairs of goods that are used in place of each other, such as hot dogs and hamburgers, sweaters and sweatshirts, and movie tickets and video rentals.” Substitutes can also be defined as “two goods for which an increase in the price of one leads to an increase in the demand for the other.” Substitutes can harm a company, especially in a price war.
Often entrepreneurs focus only on other companies that have very similar business models. To expand on the examples given in the definition, a hot dog company may only research other hot dog companies, a sweater company may only research other sweater companies, and so on. This myopic perspective ignores the competitive threat of dissimilar substitutes and can cause the downfall of a good company.
For example, it could be argued that Blockbuster’s demise occurred because it failed to adequately assess the threat of a substitute, Netflix, which was the first company to offer a DVD-by-mail service. As the price of Blockbuster’s video rental services increased, so did the demand of Netflix’s services, which were so much more convenient than walking into a brick-and-mortar store. Had Blockbuster correctly assessed the threat in the beginning, it would have had a better chance to survive by implementing its own DVD-by-mail service. Instead, it increased its video rental prices and didn’t introduce a DVD-by-mail service until 2004, years after Netflix had seized a large portion of the market.
Never tell a potential investor that you have absolutely no competition. Any seasoned investor interprets such a statement as, “These guys are full of themselves and naïve enough to think that they have no competition. This is a waste of my time.” Instead, introduce your competition, but describe the severity of the competitive threat. Moreover, no matter if you are in the initial stages of developing your start-up or if you are a developed company, don’t underestimate the competitive threat of substitutes. Committing either one of these mistakes will likely cause you to have a Blockbuster ending.