Momentum != Moat
Poisoning The Well
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Over the last few years I’ve written several times about competitive moats. From whether Elon Musk thinks they matter to whether cash can be a moat to whether moats can be manufactured rather than earned. This past week, Bryan Kim, a partner at a16z, tweeted a very specific claim:
“$2M ARR in three months used to be impressive. Now we expect it within ten days. Right now, momentum is the only moat.”
He goes on to clarify that the reason momentum is so important right now is because AI is evolving so rapidly, its critical to earn mindshare because that will provide you with the right going forward to build more traditional “moats” into your product, distribution, etc.
To some extent, that is in line with Elon Musk’s perspective that I wrote about previously:
“First of all, I think moats are lame. It’s nice, sort of quaint in a vestigial way. If your only defense against invading armies is a moat, you will not last long. What matters is the pace of innovation. That is the fundamental determinant of competitiveness.”
But there is a critical distinction that, if left unchecked, will poison the well for a generation of companies. Bryan’s emphasis on momentum revolves around ARR growth. He refers to run-rate as one signal of early traction. But the critical distinction is that a focus on how quickly something is growing ensures several key flaws with the current venture model will be solidified in a given cohort of companies.
To Anyone With A Billion-Dollar Fund, Every Company Looks Like a Decacorn
This is the classic “to someone with a hammer, every problem looks like a nail.” Whether it’s Bryan’s “unless you’re growing from $0 to $2M ARR in 10 days, I’m not interested,” to Hemant’s claim that “triple, triple, double, double, double is dead. You need to go from $1M to $20M to $100M to be interesting.” This is the mentality of someone managing a multi-billion dollar fund. They need the outcomes to be as big as possible so every company should build for the largest outcome as possible to be interesting.
I always strain to emphasize that there isn’t necessarily a good or bad way to build a company (sans fraud or other crimes). To each their own. But my concern with this particular hammer / nail mismatch is that it poisons the well for a generation of companies that are NOT going to be worth $10 or $50 billion. The “middle-class” outcomes. And you can say “aim for the moon, you hit the stars,” or whatever. But the way you build a company dictates the outcomes that are available to you.
To build a company that goes from $1M to $20M to $100M, you likely have to be MUCH more aggressive on pricing, marketing, hiring, R&D. Basically every facet of the business has to be supercharged. Outside of the small subset of outliers that can see massive scale with a couple of employees, the majority of companies have to build in unsustainable ways to achieve that kind of scale.
One recent example is Wealthfront. This is a company that has been around for 17 years and is generating $308M in revenue and $123M of net income. If I could tell you with 100% certainty as you set out to build a company that you would see that kind of outcome, that would be incredible! That’s a great business. But based on Bryan or Hemant’s mentality; that company is a failure. It shouldn’t exist. It’s not interesting. If it were left to them, those types of outcomes would be managed out of their investing aperture.
The problem is that, of all the companies that have ever gone public, less than 5% will be worth more than $10B. Less than 1% will be worth more than $100B. The outcomes that massive multi-stage venture firms need to see effectively invalidates 95% of all the outcomes of any companies that have been built before.
The louder these types of firms get, the more people keep listening to them. VCs only want to play that game, founders only want to play that game, LPs only want to play that game. Pretty soon, the ecosystem turns its focus to only wanting to participate in the creation of top 1% outcomes and you lose a generation of middle-class outcomes that generate great results for customers, good jobs for employees, and even make many of them millionaires in the process! Generational outcomes. But to the current class of “momentum VCs” those outcomes should be eradicated.
Competition Is For Suckers
The deeper irony about the “momentum is the only moat” is that momentum is actually an anti-moat. Packy McCormick made this point well:
This hearkens back to the wisdom of Zero to One where Peter Thiel says competition is for suckers.
“Tolstoy opens Anna Karenina by observing: “All happy families are alike; each unhappy family is unhappy in its own way.” Business is the opposite. All happy companies are different: each one earns a monopoly by solving a unique problem. All failed companies are the same: they failed to escape competition.”
Like every other investor, I hear pitches every week of companies that have gotten to a couple million of ARR in shorter and shorter time frames. For every story like this, it attracts a massive influx of copy cats. And people can point to enough examples where a company wasn’t the first to do something, so if so-and-so and can grow so big so quickly, what’s the stop me from fast following and getting there to?
Legal AI, AI code gen, copywriting, “AI rollups”, foundation model for X, AI orchestration for Y. So many of these categories have at least one if not several companies that are touting their “fastest to $100M ARR” charts. Now we have “fastest to $1B of ARR” charts. But all of that attention floods the market of new players, additional capital, everyone looking to have a bet in a particular space.
The reason that people like Packy and Peter Thiel point to competition as a negative externality of momentum is because competition exacerbates what was already likely an unsustainable model.
Take code gen for example. Where you have Cursor hitting $1B of ARR, you also have Lovable, Windsurf, Devin, etc. all hitting $100M+ of ARR. Already, most of those companies are burning insurmountable amounts on compute to Anthropic (most of the time). On top of that, you have to win and keep customers, so you’re also going to have to fight to spend on sales and marketing. So what was already going to be a difficult economic equation to pull off becomes exponentially more troublesome.
Paying Up For Hot Air
As one person pointed out to Bryan’s original “momentum is the only moat” post, anything that can go from $0 to $2M in 10 days can just as quickly go back down to zero. The same is true of a LOT of the revenue in hyped categories.
Take OpenSeas as an example. In 2021, at its peak, OpenSea was doing $122M of revenue per month! The company raised at a $13.3B valuation of that momentum. Then? The market cratered and OpenSea hasn’t recovered to peak hype levels.
Does that mean OpenSea is a bad business? Not necessarily. OpenSea is, supposedly, generating ~$365M in annualized revenue right now. But it may not live up to that valuation. And those investors at $13.3B have already seen massive markdowns.
Today likely has many of the same cases. Companies that are seeing massively inflated revenue. Annualizing revenue that, based on the quality, has no business being annualized. Counting free trials as not just revenue, but then annualizing that revenue. Pricing that revenue at such a point that it only explodes because the company is selling $2 for $1.
As an investor investing into that “momentum,” you’re paying up by putting a multiple on revenue that is very unlikely to materialize in the long-term. The burnout we’re likely to see among a number of investors who try and play this game will be because, as Yoni Rechtman at Slow Ventures puts it, “this is a marathon AND a sprint.” Momentum investors are, too often, only focused on the sprint.
Momentum != Speed of Innovation
While Elon Musk pointed out that moats may not matter and that, instead, what matters is the pace of innovation, people will often incorrectly correlate that to “traction.” Alex Immerman, another a16z partner, corrected Bryan and said that “momentum isn’t the moat; it’s the boat.”
“It is what gets you to the island where you can build a fortress. At the earliest stages (where BK invests), there are no moats. Momentum earns you the ability to build moats. The classics have not changed in the ChatGPT era. Switching costs, network effects, economies of scale, brand, and proprietary data were sources of defensibility before and they remain so now. Models are more available, product components are cheaper, and the pace is faster—but the physics of defensibility are the same.”
What Musk is describing as “pace of innovation” is less about the numbers you’re putting up and more about the cycle of innovation you’re enabling. There are people who are building sub-par engines on top of unsustainable models and are experiencing high-volume outputs from that (e.g. ARR growth). But that doesn’t automatically correlate to an engine capable of high speed innovation. Higher quality products, step-function improvements in capability, teams capable of routing out inefficiencies, etc.
And what’s worse still, the generation of highly capitalized momentum investors actually exacerbate the negative effects of failing to build an engine capable of high-speed innovation.
Poisoning The Well
When we pour so much capital into the equation, it hides a multitude of sins. Every big firm wants to prioritize companies that can be massive outcomes. They don’t want to miss anything that could be that top 1% winner, so they invest earlier and earlier. Any signs of potential breakout success, and they pour out the coffers.
That means a huge swath of companies with unproven models, unsustainable economics, sub-par growth engines, low quality product teams, etc. will all be fueled by massive amounts of capital. Armed with that capital and attention, they’re able to attract more talent, more funding, more press, and all the while it reinforces their way of doing things.
That extends itself into influencing the next generation of companies. Then everyone is building with the same playbooks of unproven models, unsustainable economics, sub-par growth engines, low quality product teams, etc.
Momentum is not bad. But it is also not a moat. The pursuit of building high-quality, long-term sustainable economic engines is the whole point of building businesses. But the replacement of high-quality engine building with high-speed “momentum spotting” and “heat seeking” will reinforce a style of company building that will still yield the top 1% outcomes because the very best founders can’t be stopped. They will build empires with or without us.
But who WILL get left on the dust heap of history is the middle ~50%. Not the bad companies, but not the best companies. The rest.
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Great read. Love the idea: momentum finds winners, moat keeps them winning.
Perfect timing. Was talking about Moats and Momentum with a founder this week. Strongly recommending this post for him to read.