It is impossible to discuss business models without considering moats. The word "moat" is used to describe a firm’s (actually, a firm’s business model's) competitive advantage. Both startups and incumbents need a defensible moat.
It is terribly au courant to discuss moats, specifically for startups (and even more for insurance startups), as if the essence of a moat is the technology or technology applications a startup insurance firm uses to get and keep customers.
But there are more attributes beyond technology or technology applications that can make up a moat. The 10 attributes, including technology applications. that I have listed below is only a partial set. (Please note that "Cost (Low or High)" means only one or the other for a specific product or business unit. I realize that the same firm can employ both low cost and high cost depending on the product, solution or market segment.)
It is entirely possible – and, I believe, desirable – for a firm to create a moat that is built on two or more attributes.
“Guests, like fish, begin to smell after three days.” Benjamin Franklin
Regardless of which attribute or combination of attributes a firm uses to create a moat, a key question arises: What is the quality of the moat? That is, how fleeting is the defensibility of the moat? What might cause the moat to dry up? Will a firm’s moat last more than three days?
Moats will dry up. The attributes of a moat will age, wither and die. The mortality of a moat depends on a host of factors, including:
- emerging technologies and their applications
- changing customer needs, expectations or demands
- staff reductions
- damage to the firm’s brand/reputation
- labor shortages
- changing economic policies (at local, state or federal levels)
- external shocks (natural, man-made) to supply chains
- ? (you can fill in the ? here).
Regarding the first mortality factor (emerging technologies and their applications), we had an Arthur D. Little Center for Research and Development focused on banks, capital markets and insurance when I worked there as an insurance management consultant in the financial services practice. The center’s objective was to provide clients with a temporary window of competitive advantage through the use of technology.
We stressed to our clients that we were providing only a temporary competitive advantage because technology applications can be easily copied, newer applications based on the same technology can emerge and new applications from new technologies will arise quickly. To restate our position in the terms of this post: The mortality of a moat depending entirely or almost entirely on the applications of technology is extremely high.
Simply put: Relying on technology (or a technology application) for a sustainable competitive advantage is a fool’s errand.
Expanded insurance business model with selected key forces
At this point, I’ll turn "home" to the insurance industry, where I have spent my entire 40-plus-year career (with the exceptions of serving in the U.S. Army, going to graduate school and working as a "guest visitor" at Bell Labs on the Star Wars initiative).
Below, I illustrate an expanded insurance business model including selected key forces acting on an insurance company and its business model. This expanded insurance business model applies to both incumbent and startup insurance firms.
One way to consider an insurance business model (or a business model for firms in other industries) is that it sits in the middle of a communications web sending out and receiving signals from one or more of the forces shown in the visual. These forces act not just on the expanded insurance business model but also on the insurance firm’s moat (whatever the depth of the moat is at any given time).
Insurance startups: a new species in the insurance ecosystem?
Insurance startups are not a new species in the insurance ecosystem.
Insurance startups encompass new: insurance carriers, broking firms, managing general agencies (MGAs) and claim firms (to list only a few). These types of firms already exist in the insurance ecosystem.
The reality is that the essence of the value proposition must be the same for startups as it is for incumbent insurers: mitigate or manage risk (for a specific set of exposures) in a profitable manner that complies with insurance regulations. Insurance startups, to be successful, have to find a way to offer their value proposition in a manner that incumbent insurers cannot copy or don’t want to copy, at least in the near term.
(Relying on investor funds to paper over a startup’s losses is a myopic – and dangerous – approach to bringing an insurance firm to market. Eventually, financial reality will drop as sharply as a guillotine’s blade. And, if incumbent insurers don’t want to copy what one or more startups are doing, could it be that the incumbent insurers’ actuaries realize that the startups' offering will result in unacceptable levels of profitability or even losses?)
Giving credit where credit is due
To give credit where credit is due, I realize that insurance startups do use new(er) technology applications such as advanced analytics (i.e. forms of AI including algorithms/models, big data, cognitive computing or machine learning). This use of technology applications does give the insurance startups a degree of time to capture customers. But let’s get real: The insurance startups have not reached into a parallel universe and pulled out technology applications that incumbent insurers can’t copy and bring to market. There is no sustainable competitive advantage here.
To repeat myself, using technology (or technology applications) for a sustainable competitive advantage is a fool’s errand (however much money investors have plowed into the startup or however much enthusiasm the startup’s owners/management shout out to the world.)
Insurance startups have entered the insurance ecosystem by brokering transportation network companies' (TNC) insurance coverage, or insurance for telematics/usage-based insurance or insurance for specific items in a person’s home for a specific period.
Niches … all niches. I’ll agree that insurance startups creating their initial book of business on one or more niches is clever. But niches do not a robust moat make. I can see the moat vaporizing now.
Important questions incumbent insurers should ask concerning insurance startups
Incumbent insurers fully realize there are many hundreds of startup insurance firms in play or emerging around the world. There are quite a few "pump-and-dump" conferences that are filled with enthusiastic investors and entrepreneurs bringing the startup insurance firms to the insurance marketplace. A seemingly never-ending waterfall of digital ink promoting the startups and simultaneously scolding the incumbents (for not partnering or acquiring the startups) continues to fill all variety of insurance media.
See also: Why Analysts Need Business Awareness
Nevertheless, incumbent insurers are partnering with (or acquiring) some of the startup insurance firms or wondering if they should. However, I recommend that, before actually completing a (partnership or acquisition) transaction with a startup insurance firm, there are several important questions that incumbent insurers should consider asking the startup:
- What is the startup insurance firm’s business model?
- What best describes each part of the expanded business model?
- What is the level of money invested in the startup (and from what sources and what from what rounds of investment)?
- What is the number of customers that are on their books (not planned, not in the pipeline, not hoped for)?
- What exactly is the startup firm’s profit formula?
- What are the startup firm’s resources?
- What are the startup firm’s processes, activities within each process, technology applications supporting each activity and technologies enabling each technology application?
- What parts of the insurance market, whether existing or niche or new (niche could equal new), is the startup striving to serve?
- What is the startup insurance firm’s moat?
- What one attribute, if there is only one, does the startup firm’s moat most depend on?
- What is the mortality of the startup firm’s moat?
- Which moat attributes will dry up quicker than the other attributes?
- How, if at all, will that be a problem for the incumbent insurer?
- What parts of the incumbent’s business model will the startup’s business model:
- strengthen (by bringing in new customers in the same markets the incumbent already is in, for example)
- expand (by reaching new markets the incumbent is not in or does not plan to be in for some time?
- offer new products/services the incumbent is currently not providing?
- offer new technology applications, new skills/talent, new distribution channels that the incumbent is intrigued or interested in but has not yet decided to obtain itself for whatever reasons?
- weaken, and for what reasons?
- Whether partnering with the startup or acquiring the startup, what are the issues with integrating procedures, technology applications, staff and culture between the incumbent and the startup?
- Is the investment (of money, people, skills, procedures, technology applications), whether in partnering with a startup or acquiring a startup, financially acceptable to the incumbent? If yes, at what time scale (immediately, short term or longer term, whatever these terms mean to the incumbent insurer) is the transaction acceptable to the incumbent?
I’ve never shied away from my opinion that 99.99%-plus of the insurance startups are born to be devoured. Obviously, new insurance companies emerge in the insurance ecosystem, but it takes a great deal of time. Insurance is not a commodity, and that is a hurdle to succeeding in the marketplace. Another hurdle is that insurance regulations exist for a very strong reason: Insurance is all about helping people (and businesses) manage the risks to their lives, health, property, actions/behaviors and income streams. Insurance is not a "game" in which corners can be cut.
For me, the startup insurance firms’ business models and moats cry out for extinction.