Competition Determines Value

A framework explaining how market competition levels determine business quality, with a focus on software businesses and vertical markets.

Core Market Competition Principle

• In free markets, competition level defines business quality
• Less competition = better business potential
• Example: Single restaurant with city license would be phenomenal business
  • Could charge premium prices
  • Would have 40-60% margins
  • Quality becomes less important due to lack of alternatives

Software Business Evolution

• Vertical market software has been extremely profitable for 30 years

  • Focused on niche industries (funeral homes, golf courses, infrastructure)
  • Limited competition due to lack of developer interest
  • High pricing power due to being "only game in town"
  • Customers rarely switch once committed

• Horizontal software markets are challenging

  • Example: Productivity software faces constant VC-backed competition
  • New entrants regularly drive down margins
  • Harder to maintain market position

Current Market Dynamics

• Constellation Software example ($70B company)
  • Buys ~100 vertical software companies annually
  • Implements scheduled price increases
  • Minimal investment in improvements
  • Targets $3-10M revenue companies

Future Threats to Software Business Model

• AI and no-code tools (like Replit) threatening status quo
  • Basic software becoming easier to replicate
  • Vertical software particularly vulnerable
  • 2-year horizon for significant disruption
  • Commoditization of software development

Strategic Adaptations

• Focus shifting to businesses with:
  • Hardware components
  • Strong lock-in effects
  • Communities and social networks
  • Enterprise relationships
  • Security requirements
  • Complex algorithmic needs

Risk Mitigation Strategies

• Derisk through faster payback periods
• Seek unique competitive advantages
• Focus on businesses with natural moats
• Look for cost advantages
• Target businesses with established user habits