Keeping secret the "secret sauce"

When talking about IP, normally tech startups and VCs emphasize the role of patents as a barrier to entry and imitation. This is understandable given that patents block independent invention, as opposed to copyright which failed miserably during the dot-bomb era as dozens of companies re-invented e-commerce and websites.

(Innovation scholars also tend to use patents as a proxy for “innovation” or “innovative output” — mainly because lots of data are available cheap.)

However, there’s more to innovation than just patents. (Tacit knowledge, for one thing.) The “secret sauce” for sustainable competitive advantage will vary based on the industry.

In mature industries, efficiency often comes from process innovations that may not be patentable, but could be trade secrets. It may not be protectable indefinitely if you have your entire strategy visible to your supply chain — as with Dell — but the less you reveal, the longer you can protect it.

On the way home from work tonight, I stopped at TJs, our family’s favorite grocery store. Then I read the interesting profile by Beth Kowitt published in Fortune over the weekend:

Trader Joe's is no ordinary grocery chain. It's an offbeat, fun discovery zone that elevates food shopping from a chore to a cultural experience.
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The privately held company's sales last year were roughly $8 billion, the same size as Whole Foods' (WFMI, Fortune 500) and bigger than those of Bed Bath & Beyond, No. 314 on the Fortune 500 list.
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You'd think Trader Joe's would be eager to trumpet its success, but management is obsessively secretive. There are no signs with the company's name or logo at headquarters in Monrovia, about 25 miles east of downtown Los Angeles. Few customers realize the chain is owned by Germany's ultra-private Albrecht family, the people behind the Aldi Nord supermarket empire. (A different branch of the family controls Aldi Süd, parent of the U.S. Aldi grocery chain.) Famous in Germany for not talking to the press, the Albrechts have passed their tightlipped ways on to their U.S. business: Trader Joe's and its CEO, Dan Bane, declined repeated requests to speak to Fortune, and the company has never participated in a major story about its business operations.

The article uses interviews with suppliers, ex-employees and others to summarize its sourcing, pricing and merchandising processes. It captures some of the reasons why our family has preferred TJs to its rivals for nearly 20 years.

Meanwhile, British grocery giant Tesco is failing badly in its efforts to dislodge Trade Joe’s with its Fresh & Easy chain.

Of course, much of this would be impossible if TJs were a publicly traded company. Even if you’re close-lipped like Apple or Google, being public requires a minimal amount of transparency and clarity that even Amazon will someday have to emulate.

For any long-term California resident, a discussion of a homegrown, secretive, privately-held, cult favorite store brings another chain to mind: the In & Out hamburger chain. Unlike TJs, they have a book about them. Also unlike TJs, I think their niche is sustainable indefinitely — in part because the fragmented fast-food restaurant supports niches better than groceries (or department stores), where economies of scope are a crucial factor.

The actual “secret sauce” at In & Out may not be all that secret or valuable, but its unique culture and processes may remain a competitive advantage for as long as it remains family owned, with branch locations directly controlled by the company rather than franchisees.