[click on image to enlarge]

When I was in business school at Columbia I took a class taught by Bruce Greenwald. Bruce may be to strategy what Einstein was to Physics. Ever since Michael Porter unleashed his Five Forces on the world, that model has been the de-facto framework for thinking about a company’s strategic position. That is, until people hear or read Bruce Greenwald’s take on the world of competition.  Unfortunately, Greenwald and his framework are far less well known.

In his class and in his book, Competition Demystified: A Radically Simplified Approach to Business Strategy, Greenwald rationalizes Porter’s 5-part framework for strategic competition down to one consideration: barriers. Porter’s model included threat of substitutes, degree of competition, buying power and selling power. To give you the Cliff’s Notes version of Greenwald’s book:

1)  The threat of substitutes and competition are in no small part determined by the extent to which the company has barriers.

2)  Selling and buying power are largely driven by the company’s market share which is ultimately determined by barriers.

Greenwald goes on to argue that if a company’s barriers are limited, management becomes the only medium-term differentiator, a differentiator that fades in relevance as the period of evaluation is extended. Greenwald calls companies that don’t have barriers “efficiency plays,” as the determinant of the company’s success is the efficiency of the management team. In this model, the way to determine who is going to win in a marketplace is either by picking the business with the most viable barriers or, if no barriers exist, the best management team.

Few things in life can be described by just one framework. For example, in this case, VCs would not invest in a company that has great barriers but a product that nobody wants to buy - patenting something useless is not an equation for making money. While Greenwald’s framework doesn’t indicate the viability of a product or service, I have found it to provide a useful perspective for trying to assess the extent to which a company is poised to scale.

Using barriers as the means for determining a company’s ability to scale, I have created a simple framework for evaluating which information technology companies have the chops to become big players in their respective markets.

In the IT space there are two key categories of barriers – those related to information and those related to technology.

Key information technology barriers generally include:

1)  Data scale: building a repository of data that enhances the underlying service and is difficult to replicate (e.g., Yelps' user review data or LinkedIn's connection data).

2)  Network effects: aggregating nodes in a network to increase the value of the service (a la LinkedIn and Facebook).

Key technology barriers include:

1)  Cost-side economies of scale: Leveraging scale to reduce the average cost of delivering the service – typically an advantage when technologies are expensive to develop.  For example, while Tesla's technology and infrastructure may have been expensive to develop, the average cost per unit declines as they sell more cars making it difficult for new entrants with low volumes to compete with their prices).

2)  Intellectual property protection: Patents and trade secrets that can actually provide meaningful business protection (Imagine if Google's proprietary algorithm wasn't defended by a patent).

I dryly refer to companies that can exploit information barriers as information businesses and companies that can exploit technology barriers as technology businesses. While some companies are poised to exploit one category of barriers or the other, other companies are uniquely positioned to leverage both types of barriers. For example, Microsoft Office has both cost-side economies of scale (a technology barrier) and network effects (an information barrier) working in its favor; it's expensive to replicate and the files are useful when everyone is using the same software to create, view and edit.  I call these hybrid companies.

This framework should be useful for entrepreneurs who are trying to understand the scalability of a given opportunity. At the end of the day, whether we invest capital as VCs or time as entrepreneurs we’re all investors – and to investors scalability is an important consideration.