Friday, June 23, 2017

Barriers To Entry, Again

Some businesses are easy to get into, but very competitive.  Others are very, very hard to get into, without a lot of capital, or an original idea.

Several articles recently appearing in the news illustrate why some of these start-up companies might not be such a great investments.  People are all agog about Uber as being the next big thing in ride-sharing and saying that it will take over the world.  However there are a number of competitors to that service including many in foreign countries that we don't hear about here in the USA.  In addition, many car makers are promising to build autonomous self-driving cars and offer them in a ride sharing type environment.  Nissan/Renault is the latest car maker to throw their hat in the ring.

What happens when there are five or more ride-sharing companies out there?  There are little or no barriers to entry in this business, and it is doubtful that Uber can protect their business model through patents or other means of monopolization.  Uber has aggressively tried to dominate market share, which is the model used by many companies, particularly the dot-com kind.  The theory is, if you go big quickly, you will take over so much of the market that other competitors will be pushed out or wil not even bother trying to move into your space.

And maybe for a company like Amazon, which has extensive physical infrastructure including warehouses and processing centers, as well as banks of servers and ordering software, going big makes sense.  It prevents others from trying to enter the space, as the amount of capital they would need to compete with Amazon would be staggering.  However, Amazon still has to deal with Walmart which is number two in online sales, and number one in brick and mortar.   And as it has turned out, going big in brick and mortar has prevented others from entering Walmart's space, and one by one they've taken out other brick-and-mortar retailers.

But ride-sharing?  That's more of just an app.  A teenager could come up with the software over a long weekend.  And car companies are probably more likely to be able to develop self-driving cars than the company that Uber is. Uber, for some strange reason, is trying to develop self-driving car technology even as a host of other companies are already doing this. Since they don't have automobile production capabilities, they will have to partner with an automaker to produce self-driving cars.  And since most automakers already have their self-driving technology divisions under way, it is remains to be seen whether any of them would want to partner with Uber.

First to Market is often last in the marketplace.  Uber made a big splash with ride sharing "technology." However the next level, perhaps with self-driving cars, might belong to a different competitor. The first company to make it big in any business usually ends up going by the wayside very quickly.  This is a long-standing and predictable pattern.  We don't fly on de Havilland aircraft anymore, we fly on Boeings.

Similarly, we are hearing more and more about other forms of crypto-currency these days.  I've counted at least five or six different crypto-currencies being hyped by the financial media.  Some are even claiming that Bitcoin is now a thing of the past, although I think that might be a bit premature. The question arises, if there are five or six or eight, or dozens of different crypto-currencies, which one do you use? And maybe when there are so many of these currencies - and problems with some of them - people will start to lose confidence in the entire concept. (UPDATE 2022:  Yea, this.)

Again, the barriers to entry for crypto-currency are not very high.  No one is even really sure who came up with the Bitcoin concept and developed the Bitcoin mining technique that is used for the crypto-currency.  This would suggest that almost anybody could come up with a similar currency without too much effort.

As more and more people try to get into this business, you can end up developing all of these currencies and also causing people to lose faith in them, as some of them no doubt will fail.   If there are 100 crypto-currencies out there, it will cause trouble for many or most.

Barriers to entry in the marketplace serve to keep out competitors, which can sometimes be a good thing or a bad thing.  For example a valid patent or other intellectual property portfolio can be used to prevent others from moving into your business space, at least for someone limited period of time. This at least allows you, in theory, to develop your business and achieve market share while forcing competitors to play catch-up.

In other industries, which require a large amount of technical expertise and capital equipment, these requirement provide steep barriers to entry for new competitors.  The car making business is very difficult to break into, as Elon Musk is finding out.  Building an automobile which will meet Federal safety standards, emission standards, and gas mileage regulations is very, very difficult.  Moreover, since automobiles are dangerous, it is inevitable you eventually be sued by someone who gets into an accident in one of your cars.  If your company is very thinly financed, you cannot survive such a suit, particularly if dozens, hundreds, or thousands are hurt due to a defect.  The car business is a classic case of go big or go home.  Small competitors just not going to make it in that business, or if they do it's a Herculean effort.

So what does this all mean?   Well, if someone tells you the "next big thing!" is some form of crypto-currency or some sort of "app" or website, ask yourself if low barriers to entry will fail to prevent others from moving into this space if the product or service starts becoming successful.  If something is wildly profitable, others will copy the idea, and unless they can keep competitors out, the first to market may be forced out - particularly if the competitors have deeper pockets and are better capitalized.

Similarly, when someone announces a new "investment" like the Elio 3-wheeled car or the Tesla electric car, you have to ask yourself whether the company in question has the capital to dive into the very capital-intensive automobile production business.  Tesla has done OK so far with limited production (by automotive standards) of its roadster, model-S and model-X (the latter having some teething problems as it is unnecessarily complex - the "gull wing" doors remind me too much of the Bricklin and the DeLorean).   But the mass-production of the model-3 is taking a lot of capital and is turning into a real struggle for them, and the market for such cars may be limited.   The first-adopter and hobbyists will all buy them - and then what?  Tesla sells a few hundred thousand cars a year - most automakers sell that in a month.

Then there is the fact that ever major car company on the planet, who are far better capitalized that Tesla, already has an electric car or one in the works.  Nissan just introduced Leaf 2, and GM has its Bolt. Oh, don't be confused by "market cap" articles which say Tesla is worth more than Ford. I've already debunked that notion.   "Market Cap" doesn't represent how much capital a car company has at its disposal, but rather how much the stock is worth, in theory.   For companies like Tesla, it represents how much the founders can cash out of the deal, if they had to.

I am not "anti-Tesla" or "anti-electric car" - only trying to be realistic, here. One massive recall and safety problem could bankrupt Tesla.  Ford and GM are able to digest things like exploding gas tanks and ignition keys that shut off while driving - and hundreds of similar issues.  Tesla may succeed - it may be the rare start-up car company that takes off and stands on its own.   But the track record for such companies is spotty.   I think down the road, some other car company that wants to jump into the electric car business may buy Tesla, if Tesla hits a rough spot.   How do you think GM was formed in the first place?   Consolidation is the name of the game in the car business.

As for Elio - well, they need a staggering amount of money to even start building an assembly line in their factory, and they are hundreds of millions in debt.  It won't be until the wreckage settles to the ground that we find out what crashed that Hindenburg.

Crypto-currency is all the rage (keep chanting:  Blockchain!  Blockchain!  Blockchain! - even if you have no clue what it means).  But I suspect that a stable crypto-currency may be a perpetual oxymoron.  And I more than think the articles for and against particular currencies, in the financial press, are just attempts to affect the markets for these currencies - for the personal profit of the author or someone out there.  Who knows?  Maybe this "Elysium" currency will replace Bitcoin - illustrating that first to market is often last in the marketplace.

We'll have to wait and see - on the sidelines.