How Apple and Amazon built ‘moats’ to stave off the competition

  • NYU Stern Professor Scott Galloway has become a bit of a media star for his prediction that Amazon should buy Whole Foods.
  • His new book, "The Four: The Hidden DNA of Amazon, Apple, Facebook and Google," looks at how these tech titans have risen to the top and beaten back the competition.
  • In this excerpt, Galloway explains one technique that Amazon and Apple used old school "moats."

The following is an excerpt from "The Four: The Hidden DNA of Amazon, Apple, Facebook and Google" (Oct. 3, 2017, Portfolio) by Scott Galloway:

Firms try to build higher and higher walls to keep enemies (upstarts and competitors) from invasion. Business theorists call these structures "barriers to entry."

They are nice in theory, but increasingly traditional walls are showing cracks, even crumbling — especially in tech. The plummeting price of processing power (Moore's Law again), coupled with an increase in bandwidth and a new generation of leadership that has digital in their DNA, has produced bigger ladders than anyone ever expected. ESPN, J.Crew, and Jeb Bush . . . all unassailable, no? No. Digital ladders (over-the-top video, fast fashion, and @therealdonaldtrump) can vault almost any wall.

So, what's a ridiculously successful firm to do? Malcolm Gladwell, the Jesus of business books, highlights the parable of David & Goliath to make the key point: don't fight on other people's terms. In other words, once you've made the jump to light speed as a tech firm, you need to immunize yourself from the same conquering weapons your own army levied on the befuddled prey. There are several obvious examples: network effects (everyone is on Facebook because . . . everyone's on Facebook); IP protection (every firm in tech over $10 billion is suing, and being sued by, every other $10 billion tech firm), and developing an industry standard—monopoly—ecosystem (typing this on Word because I have no choice).

However, I'd argue that digging deeper moats is the real key to long-term success.

The iPhone will not be the best phone for long. Too many firms are struggling to catch up. However, there is a key asset of Apple Inc. that has a stronger immune system: its 492 retail stores in 19 countries. Wait, a marauder could just put up an online store, no? No. vs. the Apple Regent Street Store in London is like bringing a (butter) knife to a gunfight. And even if Samsung decides to allocate the capital, nine women can't have a baby in a month and the Korean giant would need a decade (at least) to present a similar offering.

Brick and mortar's troubles have been laid at the feet of digital disruption. There is some truth to that. However, digital sales are still only 10–12 percent of retail. It's not stores that are dying, but the middle class, and the stores serving them. Most that are located in, or serving, middle-class households are struggling. By comparison, stores in affluent neighborhoods are holding strong. The middle class used to be 61 percent of Americans, now they are the minority, representing less than half the population . . . the rest being lower or upper income.

So, Apple, recognizing that ladders will keep getting taller, opted for more analog (time/ capital expensive) moats. Google and Samsung are both coming for Apple. But they are more likely to produce a better phone than to replicate the romance, connection, and general awesomeness of Apple's stores. So, every successful firm in the digital age needs to ask: In addition to big, tall walls, where can I build deep moats? That is, old-economy barriers that are expensive and take a long time to dredge (and for competitors to cross). Apple has done this superbly, continually investing in the world's best brand, and in stores. Amazon, also is going for moats, erecting a hundred-plus expensive and slow‑to‑get-built warehouses. How old economy! A good bet is Amazon will open thousands before they are done.

Recently Amazon announced leases on twenty 767s and purchased thousands of Amazon-branded tractor-trailers. Google has server farms, and is launching early twentieth-century aviation technology (blimps) into the atmosphere that will beam broadband down to Earth. Facebook, among the Four Horsemen, has the fewest old-economy moats, making it the most vulnerable to an invading army with big-ass ladders. You can expect that to change as Facebook announced they, along with Microsoft, are laying cable across the floor of the Atlantic.

The success of single companies like Apple can hollow out entire markets, even regions. The iPhone debuted in 2007, and devastated Motorola and Nokia. Together they have shed 100,000 jobs. Nokia, at its peak, represented 30 percent of Finland's GDP and paid almost a quarter of all of that country's corporate taxes. Russia may have rolled tanks into Finland in 1939, but Apple's 2007 commercial invasion also levied substantial economic damage. Nokia's fall pummeled the entire economy of Finland. The firm's share of the stock market has shrunk from 70 to 13 percent.

Read Bob Pisani's review of "The Four: The Hidden DNA of Amazon, Apple, Facebook and Google."

Scott Galloway is a professor at New York University's Stern School of Business, where he teaches brand strategy and digital marketing to second-year MBA students. A serial entrepreneur, he has founded nine firms, including L2, Red Envelope, and Prophet. In 2012, he was named one of the "World's 50 Best Business School Professors" by Poets & Quants. His weekly YouTube series, "Winners and Losers," has generated tens of millions of views. "The Four: The Hidden DNA of Amazon, Apple, Facebook and Google" is his first book. Follow him on Twitter @profgalloway.

For more insight from CNBC contributors, follow @CNBCopinion on Twitter.