The Secret Business Model That Fuels Competition

There exist a certain class of industries which are inherently extremely competitive at their core. For a variety of reasons, this class of businesses have very little room to differentiate their product and are only able to survive by one-upping their competitors. One of the most jarring examples of this is the Asset Management industry — hedge funds thrive on proprietary data and secrecy because that is the only way they are able to outclass their competitors and rake in superior returns.

The level of competitiveness of these types of industries is extremely high, making it a difficult market to enter as a participant. However, as an entrepreneur, this type of industry poses a very lucrative market opportunity from the outside. On one level, this is because demand is usually price inelastic — this means that firms in this type of market structure are willing to pay inordinate amounts of money for any product that helps them gain a even a tiny amount of competitive edge over their competitors. More interestingly, an understanding of game theory exposes a completely different opportunity — an opportunity to pit firms in these markets against each other, forcing them to buy your products or die.

In the 1849 California Gold Rush, there was a complete frenzy to grab as much gold as one could. However, due to the sheer amount of competition, very few people got rich from this gold rush. The people who really created wealth during this period were people such as Levi Strauss and Samuel Brannan, who sold supplies to these miners such as pickaxes.

This story teaches an important business lesson — that it is sometimes worse to create consumer products (mining) than creating tools which enable consumer products (pickaxes). However, I believe that there is more nuance here in this story that, by putting on a Game Theory lens, becomes painfully obvious.

The reason that selling pickaxes was such a good idea was not just the fact that there was an increasing amount of miners coming into the market. It is because the utility value of pickaxes were increasing as more and more people possessed them. How can this make sense? How can the utility of a tool increase? The scenario below illustrates this idea:

At time t = 0 :
There are 100 miners.
All of them are using their hands to mine gold.
Each individual miner is keeping 1/100 of the gold supply.

At time t = 1 :
There are 100 miners.
20 of them decide to buy pickaxes.
The 20 pickaxe miners keep 3/100 of the gold supply each, whereas the 80 non-pickaxe miners keep 0.5/100 of the gold supply.

At time t = 2 :
There are 100 miners.
The 90 miners rush to buy pickaxes. It becomes an even playing field once again.
Each individual miner is keeping 1/100 of the gold supply.

This is a classic Prisoner's Dilemma situation. If all the miners co-operate with one another and agree to NOT purchase pickaxes, they would all be mining an equal amount of gold. However, if they do not co-operate, there will be a short-term inequality where the pickaxe miners will mine more than the non-pickaxe miners. This inequality will disappear quickly when the remaining miners realize that they need to buy a pickaxe to stay competitive — eventually each individual miner will be mining an equal amount of gold, except they would have spent some of their earnings on the pickaxe and other tools.

This seems ridiculous from an outside perspective. The miners should just agree to co-operate with each other from day 1. However, this co-operation will never work because there are incentives for an individual miner to break the pact and be the first one to have his hands on a pickaxe. For a short period of time, he will earn more, before falling back into equilibrium.

What does this mean from a business perspective?

By putting on our Game Theory lens of the world, we as a merchant, can spot this opportunity and be the first one to sell pickaxes. There will always be an incentive for someone to be an early adopter, and there will always be disincentives for people to stop buying pickaxes (they lose the mining game). This creates an extremely powerful business model which has both quick adoption and stickiness. For as long as you are able to produce the best pickaxe in town, you will be able to relish in your position as an unshakeable monopoly.

This mining example is interesting, but extends far beyond the gold mining industry of the 1800s — the Asset Management industry is a classic example. If you, as a business, are able to attain new and useful proprietary data, it becomes simple to sell your product. The first hedge fund will be inclined to buy your datasets because they provide him with a competitive advantage over his competitors. The second hedge fund will be inclined to buy your dataset to be on par with the first hedge fund. This will quickly permeate throughout the industry until the 100th hedge fund realizes that 99 of his competitors possess your dataset and he is shooting himself in the foot if he does not buy it as well. You can go from 0 to 100% market share extremely quickly, due to the extremely competitive nature of this industry.


When you spot an industry which is extremely competitive, think about what kind of products will be able to give a firm an advantage over their competitors. Once this advantage is clear, other firms are highly incentivized to purchase your product as well — leading to some sort of network effect fueled by competition and the Prisoner's Dilemma.