Invest in Companies with Moats

How a glassblower made $2.1 billion dollars? I’ll bet my life you’ve never heard of the book “Art of Fire - Beginning Glassblowing”. It sells for $115 on Amazon…It’s about glassblowing 💨🍺(obviously) and has received 7 reviews since 2006. Despite its lackluster sales, the author is now worth $2.1 billion dollars💰and this book helped get him there.

I’ll bet my life you’ve never heard of the book “Art of Fire - Beginning Glassblowing”.

It sells for $115 on Amazon

It’s about glassblowing 💨🍺(obviously) and has received 7 reviews since 2006.

Despite its lackluster sales, the author is now worth $2.1 billion dollars 💰and this book helped get him there.

How?

In 2008, Jim McKelvey was selling the $2,000 art sculpture he’d made. He had a buyer on the hook 🎣 , and they wanted it…and wanted it bad. 

“Awesome” Jim thought. “Time to close the deal”

The customer pulled out his credit card to make the purchase, but there was a huge problem…

Jim’s small business didn’t accept credit cards.

He lost the sale…but it was the best $2,000 he never made. 

Frustrated by this issue, Jim reached out to a friend to develop a piece of technology that would allow him to accept credit cards straight from his mobile phone. 

That “friend” was Jack Dorsey, founder of Twitter, and the company they built was Square (Market Capitalization: $50B).

Square card reader


This is a story of how a founder came up with a snazzy idea to solve his own problem, developed a unique growth strategy to scale it to the moon 🚀, and then created a powerful moat to prevent competitors from taking all its customers. 

You see, building startups is about offense AND defense. 

Once competitors see a startup succeeding, they begin to copy them. For this reason, every startup needs a defensive strategy…a reason why its customer will stay with them over choosing a competitor.

Today, we’ll discuss a framework that every startup investor needs to commit to memory. Two systems, that when combined seamlessly, created billion-dollar outcomes. 

Let’s dig in!

Today we’ll explore:

  1. The power of network effects 💪: How Square achieved massive growth by converging its consumer and merchant networks.
  2. Defensibility & Competitive Moats 🧱: Durable competitive advantages that indicate strong future performance.

The power of network effects 💪: How Square achieved massive growth by converging its consumer and merchant networks.

Jim McKelvey has a net worth of $2.1B. He had a passion for glassblowing, and in a roundabout way, turned that passion into Square, a thriving $50B payments business. Square has an interesting path and it wasn’t always easy: 

Origins of Square

  • 2008: Jim McKelvey, a hobbyist glassblower in San Francisco, missed out on a $2,000 sale. Why? because he didn’t accept credit cards  💳. Frustrated…he turned to his friend Jack Dorsey, founder of Twitter (Twitter was founded in 2006 🐦​​), and they came up with a plan
  • 2009: Jack Dorsey and Jim McKelvey developed small physical magnetic strip reader readers that plug into mobile phones - turning any phone into a mobile payments system 📱….it worked..and grew quickly
  • 2012: Starbucks ☕ announced it would use Square to process transactions with customers who pay via debit or credit card. Whole Foods 🥕 joined shortly after…
  • 2013: Square launched Square Market, enabling its clients to launch websites and accept online payments 💻
  • 2013: Launched Cash app to support peer-to-peer payments 💵. Today, they have 36 million monthly active users (MAU) and over 100 million downloads 
  • 2014: Launched Square Capital, a lending arm, which has extended over $1 billion in working capital to over 100,000 small merchants
  • 2014 - 2015: Square reached a private valuation of $6B in October 2014. 1 year later they IPO’d…their valuation was cut in half to $2.9B…they struggled but persevered 💪
  • 2020: Reached $9.49 billion in revenue ​​💰
  • 2021: Secured a market capitalization of over $50 billion dollars 🚀

So what was the secret to Square’s growth? Square’s unequivocal business model - simple, low-cost pricing.

  • Upon tapping into a new market, Square’s growth accelerated.
  • Square provided merchants with cheap pricing (a ~3.5% transaction fee and a .15 transaction fee) and free registration.
  • This led to 10% growth each week for 2 years without any advertising.

Square made itself indispensable. It operated as a single integrated system incorporating software, hardware, and payment processing. Extra services, like invoicing and payroll, catapulted merchant growth and streamlined merchant operations.

In 2013, Cash App, formerly known as Square Cash, was launched as a peer-to-peer payment service. In 2021, Cash App reported 70 million annual users (36 million MAU). 

Much of Cash App’s growth is attributed to similar growth strategies of the merchant product. In other words, it was free, easy to use, and offered relevant services. 

Once again, Square had successfully tapped into a new market - the underbanked. Essentially, Cash App served as a proxy bank account with the core capabilities of a bank account, less the cost and hassle of opening one. 

In August 2021, Square acquired Afterpay for $29 billion. Afterpay, an Australian-based Buy Now, Pay Later company (BNPL), allows users to receive items immediately, while paying for the items in four interest-free installments. 

Network Effects created compounding growth 📈

The network effect is at play with Square. 

  • As more Square merchants offer Afterpay, awareness of BNPL grows.
  • As customers become accustomed to BNPL, they are more likely to make transactions.
  • Square’s merchant database will gain access to Afterpay and vice versa.
  • Thus, Afterpay cultivated a network effect between merchants and customers.

Moreover, Square sellers can receive payments through Cash App Pay, a contactless payment method for online and in-person purchases.

What’s Next for Square?

Square plans to incorporate Cash App into Afterpay’s network - quite a game-changer.

Customers who want to BNPL will increasingly use Cash App not only to BNPL, but also for other purchases. 


The synergies of Square’s two networks - the consumer network and merchant network - have merged. This is truly great news for Square. 

Moreover, Square’s Cash App intends to launch the Bitcoin lightning network with instant payments. The network can also support billions of transactions each second, increasing scalability.

Jack’s Revelation On Business Models

As Square’s story unfolds, it exemplifies the convergence of individuals and companies.

Jack Dorsey, a co-founder of Square, notes:

“the magic we’ve seen in our business is because we've blurred the line between those two dimensions. The more we resist the labels of B2C and B2B, the more optionality we have to build something that is used in unexpected ways.”

The key insight from Square’s story is the optimal combination of both utility and network. 

Startups are meant to be sustained over the long run. Strong companies create network effects to build defensibility and maintain a long-term competitive advantage.

Defensibility & Competitive Moats 🧱

There are 2 ways to help you evaluate the sustainability of a startup:

1. Defensibility: 

Why is defensibility important?

  • Defensibility shields the company from competitors;
  • And it sustains the competitive edge.

How is defensibility achieved?

  • Network effects are the strongest indicators of sound defensibility in the digital realm whereby the value of products for existing users depends on the number of new users who leverage it. This results in unparalleled efficiency in capital and labor.
Source: NFX 


Here are other, less powerful metrics that help assess a startup’s defensibility:

  • Economies of scale: Increased scale of operations is beneficial. With more users comes higher volumes. This leads to lower production costs. 
  • Brand: Strong branding cultivates loyalty. Consumers lean towards products they recognize and trust than ones they’ve never heard of.
  • Embedding: Embedding is implementing the software into an organization’s workflow, preventing the customer from replacing it with a competitor’s.

2. Moats: Protection Against New Competitors

Moats play a central role in evaluating companies. If you don’t believe me, believe one of the best investors of all time - Warren Buffet. He routinely looks out for “economic castles protected by unbreachable moats.” 

The most valuable startups have widening moats. 

  • Moats measure the durability of competitive advantages.
  • They help maintain growth, minimize churn, and provide impenetrable barriers.
  • This can look different for different companies. 
  • Examples of a growing moat can manifest in: sustainable business models, innovation, intellectual property, cost advantages, network effects, patents, and culture.
Source: Toptal 


The next time you’re evaluating a startup investment opportunity, remember that immense returns to investors — like 100X or 300x returns — arise from companies with long-term defensibility and continually growing moats

Hope this was helpful. See you next week! ✌️