Unprofitable business models make more money (feat. Robinhood)

Adopt a new, superior business model that incumbents cannot mimic as it would cannibalize their existing business.

Best for defeating an incumbent who appears unbeatable by conventional logic.

The stronger the incumbent, the better counter-positioning works.

But it's more nuanced than it sounds. These are essential:

• Unproven approach by the startup: gives the startup the protection of uncertainty.
• Radically different business model: you can’t simply undercut a big incumbent. Incumbents have economies of scale, brand and a lot of momentum. The business model has to be different enough that the incumbent can't copy it.
• Incumbent profitability: the more profitable the incumbent’s business the more painful it is to make a drastic pivot to defend market share.

And while effective as a moat to keep incumbents at bay, it's not a defensibility towards other startups (who have nothing to lose by copying a new business model).

Robinhood disrupted the legacy high fee trading platforms by offering $0 commission trades. At the time the cheapest trading platforms were doing $10 trades. Robinhood instead makes its profits by essentially charging a small fee to the market makers who want priority over their orders.

With a better business model you can charge lower fees - keeping users from switching to competitors.

But more importantly this type of business model is an exceptionally effective deterrent to defend off existing businesses. That's because the incumbent typically responds either not at all or too late.

Here's the magic - the incumbent’s failure to respond, more often than not, results from thoughtful calculation.

How could that be?

Most startups fail. So it's correct to underestimate startups. You can't accurately predict the threat of some unproven upstart. This leads to denial.

Having a successful business model reinforces the incumbent's worldview. An executive in this position can't help but experience some confirmation bias. Often they ridicule the startup's new business model.

As the threat of the startup grows, the incumbent may go through a period of fear and anger. Internally, it's a conflicting process. On one side is the pressure to do something, and on the other is the pressure to avoid damaging the legacy business model.

Inevitably, the executives don't see a justifiable payoff to warrant damaging the legacy business model. They may dabble in shallow solutions, but fail to commit in a way that meaningfully answers the challenge.