differentiation

[Note: I shared this mental model with my email subscribers on Oct 30, 2016. If you want to receive a new mental model every week, join the club.]

 

In Lewis Carroll’s Through the Looking Glass, the Red Queen tells Alice:

Here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast!

What it is:

The Red Queen mental model comes from biological evolution. Trees in a forest grow taller and taller, to better capture sunlight. Soon, all the trees have expended enormous energy to get much taller. Yet, they get the same amount of sunlight as before.

This evolutionary arms race happens among animals too. Prey evolve to better ward off predators (e.g., rabbits running faster). But predators, in turn, evolve to better capture prey (e.g., foxes run faster too).

Everyone runs much faster, to stay in the same place.

 

Examples in business:

• A business differentiated only on price will likely never make money. If what you’re selling is a commodity, then someone will always come along to offer it at a lower price. And good luck if someone = Amazon. Your margin is Jeff Bezos’ opportunity.

• Buffett also highlights the futility of price reduction efforts in textiles (a commodity). Once you install new tech to reduce costs, so will your competitors. Soon, everyone is making less money than before.

• Perfect competition is for losers. If you’re not differentiated at all, then you won’t make money. All your profits will get competed away.

• And just incremental differentiation won’t do. So your new cab service is the only one with wifi. Well, guess what? Uber will have it in 24 hours!

 

Rules to protect yourself:

1. Don’t assume your competitors are stupid. They’re as interested in survival and growth as you are. And yes, they are as smart as you.
2. If you’re launching a business in a crowded market, you can’t be differentiated only incrementally. Or worse, only on price. Remember: 10x, not 10% (and cheaper too). Like Uber.

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Further reading:

• The Red Queen Effect, on Farnam Street.
• Value Capture: The most important business idea you haven’t read enough about.

 

Linked to: Value Capture

Filed Under: Biology (Mathematics & the Sciences)