In business, we talk about barriers to entry a lot. In practical terms, a business is worth more if it’s hard to replicate what the business does. We see modern examples in the news when we hear about Google’s monopoly and how the FTC wants to break it up.
But we don’t talk much about relative barriers to entry, and how it’s evolving. And I think there is a very interesting phenomenon happening in the relative attractiveness of different types of barriers to entry (specifically, in the context of technology).
Let’s talk about AI, and how it’s impacting barriers to entry. AI is breaking down a lot of barriers—access to information, technical skills in data analysis, software engineering, and doing all of these in scale and at relatively low cost. AI is disrupting businesses that some thought would be impossible. A prime example of that is Google search. There are now AI-based search startups (like Perplexity) that are producing more relevant, more contextualized, and more personal search results (and people are adopting). Suddenly, information / network-based business models have become less indestructible, and therefore less valuable to invest in.
On the other end of the spectrum of business models is physical / location-specific businesses. I am talking about landscaping businesses, cleaning businesses, etc. Historically, these business were viewed as very low barriers to entry and it was true—anyone can cut grass or clean places. And because these businesses had low barriers to entry, many immigrants would take them on to earn their living.
But more recently, there has been an interesting dynamic happening, whereby these traditionally low barriers to entry businesses are benefiting from what I consider “structurally synthetic” barriers to entry and are becoming more attractive to investors than before. Let me explain what I mean:
(i) There is a shortage of blue-collar workers. The U.S. population is more educated than ever; technical education is more accessible than ever (e.g., coding bootcamps); the teenagers have figured out how to make (more) money elsewhere through the digital world (e.g., social media / drop-shipping); and the government is not going to have immigration friendly policies. The shortage of labor caused by these structural drivers is why I am calling it “structurally synthetic”.
(ii) Demand for these services continues to hold strong, because of increasing opportunity cost of doing it yourself. Salaries for white collar jobs have gone up tremendously over the years. Some may say that so did general inflation. But if your white collar salary went up 20% and your base comp was $100,000 to begin with, you will likely still have someone else mow your lawn with the extra $20,000 even if your lawn care costs doubled from $100 to $200 a month (I will come back to this point).
(iii) Now it’s simple economics: there is lower supply than what the world is demanding. Money should naturally then move here to increase supply, or the prices must go up to the point where the demand equals the supply (i.e., people are going to mow their own lawn).
Suddenly, buying these lower barriers to entry businesses (which by the way, is also generally cheaper because they have been overlooked) is becoming relatively more attractive than buying higher barriers to entry (e.g., software, internet) businesses. And investors are onboard with this idea. Look around your neighborhood. You may not realize it but many of your local lawn care companies, your local cleaning services companies, your local gyms, and your local HVAC companies are all being bought out by private equity. And by the way, have you noticed that prices are going up? Private equity is masterful when it comes to achieving market efficiency— they know that there has been mis-pricing in the market because many of you are willing to pay more than what the less sophisticated previous owner was charging.
But the previous owner is out. The transfer of wealth already occurred and hopefully he’s achieved some sort of an American dream as a blue-collar family, an immigrant family, or both.
What does this mean for small business owners and immigrants? Hone in on your trade and get it to a place where you can sell it to private equity. Unfortunately, this “structurally synthetic” barrier is not going to exist forever, so you can’t be complacent. Time is running and you need to realize your wealth before robots come and make your business worthless. Mind you, robots are very real.