When Cash Becomes a Moat

All cash spending doesn't create equal results.

Legendary executives are the ultimate capital allocators as illustrated in William Thorndike's The Outsiders.

But, for the better part of the last decade, capital has been a commodity in the private markets. Startups easily raised capital with even the faintest hint of traction, and some even without a product.

Net, private market executives haven't needed to be great allocators.

Today, cash is more difficult to raise and the current market feels more like 2001 than 2021. For the next 18-24 capital will be less of a commodity and more of a major source of competitive advantage for those who know where they can spend to create operating leverage.

With cash at a premium, it's vitally important to understand when investing in your moat is the right call.

There are 4 reasons to leverage cash as a competitive differentiator:  

1. Unit economics at scale - do unit economics improve with more investment? Examples include pricing power, negotiating power, and customer density.
   
   Key metrics: pricing discounts, how many organizations within one customer use the core product? (customer density)

2. Customer stickiness - Your product is embedded in the day-to-day workflow, grows or increases the velocity of revenue, and implementation is complex so that switching costs are high.
   
   Key metrics: MAU/DAU, number of projects on your platform, and customer churn.

3. Customer expansion - are customers expanding naturally with the product? Net revenue retention (see below) is a good indicator for customer expansion, but I like to pair it with product and seat expansions to get a sense of the key drivers of NRR outside of price increases.
   
   Key Metrics: NRR combined with seat expansions or products per customer.

Bonus: Mergers and acquisitions - buying a competitor, a new product feature, or a new customer segment can be an especially powerful tool in down markets. Companies have investors looking to create a return on investment or consolidate their capital into market leaders.

There are also 3 reasons to be cautious of leveraging cash to build a moat that may not be sustainable:

1. No platform advantage - It's often said products need to be 10x better than the current process to gain adoption. However, to keep the advantage you have to be more than just a more enjoyable UX (user experience)/UI (user interface).
   
   Most enterprise software aspires to be a system of record with a good UX + data collection being the first step - what I would call a system of intelligence. The next step is a system of record or a true platform advantage, few companies ever make that leap.

2. No distribution advantage - Microsoft is the ultimate example of the distribution advantage and they eventually used it to crush Slack. They can push products like Teams and Azure for lower costs than competitors due to their ongoing operations within companies, primarily Office and Outlook.
   
   Ask yourself am I acquiring customers because of my strategy or simply because there's a budget that needs a home?
   
   Long-term, if you invest a dollar into a distribution channel, you should know the expected return. That's operating leverage.

3. Limited upsell opportunities - revenue retention growing only due to an increase in price is often a sign that momentum will be short-lived. Instead, we look for products per customer, NDR post-price increases, and unit expansion.

Cash, like any strategic asset, is a double-edged sword. It can be used effectively when you understand where to invest it, and it can kill your business if you manage it ineffectively. The difference is knowing when your spending is creating a moat and not just filling the kiddie pool.