During fundraising, investors always ask questions about differentiation. They want to know what makes your business defensible from competition. As an investor, you want to deploy capital where it has the best chance of success. Eventually, delivering a positive return on a risk-adjusted basis. If you’re not familiar with the concept of economic moats, then keep reading.

Castle moat as a metaphor for economic moats
Photo by Colin Watts on Unsplash

According to ThoughtCo., “a castle was a fortress built to protect strategic locations from enemy attack or to serve as a military base for invading armies.” Moats were constructed around castles as a highly effective defense mechanism. In fact, one of the only successful ways to overcome moats was using portable bridges. A tactic which is cumbersome and time-consuming.

Thank Warren Buffet for popularizing the term economic moats. An economic moat is a distinct advantage a company has over its competitors that allows it to protect its market share and profitability. There are several sources for moats including intangible assets, network effects, cost advantages and efficient scale. However, one of my favorites is switching costs.

Switching costs are the costs that a consumer incurs as a result of changing brands, suppliers or products. It’s important to note, these costs aren’t only monetary. There are also psychological, effort-based, and time-based switching costs. Therefore, there’s a lot of ways to approach this in your strategy.

There are several common switching costs. You’re probably familiar with most of them from daily life. First, there are convenience costs. Think about changing banks, especially before you could do everything online. Annoying, time-consuming, and often never worth the effort.

Another switching cost is emotional. When you hold an account or have a relationship with a financial advisor over several years, you’re likely to have built trust and rapport. It’s hard to end a relationship when there’s an emotional connection.

Many types and tactics of switching costs exist and I encourage you to dig deeper. In addition, other forms of economic moats may be more beneficial depending on your business model and industry. For now, here are some of my favorite switching cost examples in the real world:

Airline Loyalty Programs. While I have reward accounts at all the major airlines, I’m a Delta stan myself. Fun fact, loyalty programs often make more money than the airline’s flying operations. Loyalty programs are great for increasing switching costs, especially when the product or service is commoditized and in-demand. For airlines, they have the ability to sweeten the travel experience while also providing a cost-saving rebate. Ultimately, while you may collect points when flying any airline, it’s hard to build up loyalty status at more than one.

Status Brands. Undeniably, luxury and status signaling brands have higher switching costs due to intangibles like branding. Apple is a great example because it benefits from both emotional and product compatibility costs. Apple has created an enormous cultural bifurcation with its blue versus green iMessage tactic. It also built products that work best when they connect and perform within the same ecosystem. Once you’re in, it’s hard to switch out.

Economic moats exist everywhere. They are much harder to establish as a young business. Therefore, it’s smart to keep them in mind as you grow and scale. Choosing the right strategies and building them into your growth plan ensures a higher probability that your business can defend itself from competitors along the way.