7 Powers - Hamilton Helmer  ## Metadata - Author: **Hamilton Helmer** - Full Title: 7 Powers - Category: #books ## Highlights -  ([View Highlight](https://read.readwise.io/read/01jcvq9arm50k90h45ahgd6xck)) - For now, though, let’s return to our case study of Intel. Their defining success came in microprocessors—the brains of today’s computers. But, perhaps surprisingly, Intel did not start out in that business. Their initial thrust was into computer memories, and indeed they styled themselves “The Memory Company.” The invention of microprocessors came about only as an offshoot of a development job for Busicom, a Japanese calculator company. Their motivation in taking this on was simply to generate much needed cash for their memories business. After a long gestation period, though, microprocessors gained traction, and the paths of their two businesses diverged, leading to wildly different value outcomes: $0 for memories and $150B for microprocessors. ([View Highlight](https://read.readwise.io/read/01jcsfxk0vffnx98czagapamq4)) - ***strategy:*** a route to continuing Power in significant markets ([View Highlight](https://read.readwise.io/read/01jcsg1yh278tr4pc8zv2ydqa5)) - For the purposes of this book, “value” refers to absolute fundamental shareholder value[5](private://read/01jcs9fppyfpa8n32fnjyc0tpm/#bb5)—the ongoing enterprise value shareholders attribute to the strategically separate business of an individual firm. The best proxy for this is the net present value (NPV) of expected future free cash flow (FCF) of that activity. ([View Highlight](https://read.readwise.io/read/01jcsg7b1db4ac1t258p1stf59)) - **Scale Economies:** *Benefit*: Reduced Cost *Barrier*: Prohibitive Costs of Share Gains ([View Highlight](https://read.readwise.io/read/01jcsha8wbhhd8pdtvnw2h5eht)) - Scale Economies: > *A business in which per unit cost declines as production volume increases.* ([View Highlight](https://read.readwise.io/read/01jcshghq7vy1bmjbw0z9g92hj)) - Beyond fixed costs, Scale Economies emerge from other sources as well. To name a few: • *Volume/area relationships.* These occur when production costs are closely tied to area, while their utility is tied to volume, resulting in lower per-volume costs with increasing scale. Bulk milk tanks and warehouses would serve as examples. • *Distribution network density.* As the density of a distribution network increases to accommodate more customers per area, delivery costs decline as more economical route structures can be accommodated. A new entrant competitor to UPS would face this difficulty. • *Learning economies.* If learning leads to a benefit (reduced cost or improved deliverables) and is positively correlated with production levels, then a scale advantage accrues to the leader. • *Purchasing economies.* A larger scale buyer can often elicit better pricing for inputs. For example, this has helped Wal-Mart. ([View Highlight](https://read.readwise.io/read/01jcshhw1vkzj5f3es13kq82k8)) - The ERP model offers a more complex and larger-scale illustration. The decision to replace any ERP carries high cost. Once ERP is integrated into a client’s business, employees have sunk the cost of learning to use this system, relationships have been established with the new service team to solve problems, and investments have been made in compatible software to customize the system to the client’s needs. Once done, changing that only comes at an extraordinarily high cost: the time and effort to research competitive offerings, the purchase cost of a replacement ERP system, all the complementary software, transferring the data, retraining employees, forming new relationships, and risking interruption of services and loss of data during the transition from one system to another. ([View Highlight](https://read.readwise.io/read/01jcsnkw2baps8wgx09z3ssp73)) - *Benefit.* A business with Branding is able to charge a higher price for its offering due to one or both of these two reasons: 1. *Affective valence.* The built-up associations with the brand elicit good feelings about the offering, distinct from the objective value of the good. For example, Safeway’s cola may be indistinguishable from Coke’s in a blind taste test, but even after revealing the result, the taste tester remains willing to pay more for Coke. 2. *Uncertainty reduction.* A customer attains “peace of mind” knowing that the branded product will be as just as expected. Consider another example: Bayer aspirin. Search for aspirin on Amazon.com and you will see a 200 count of Bayer 325 mg. aspirin for $9.47 side-by-side with a 500 count of Kirkland 325 mg. aspirin for $10.93. So Bayer has a price per tablet premium of 117%. Some customers still would prefer the Bayer because of diminished uncertainty: Bayer’s long history of consistency makes customers more confident that they are getting exactly what they want. Note that the Benefit from Branding does not depend on prior ownership, as with Switching Costs. ([View Highlight](https://read.readwise.io/read/01jctqmgcvkdjfddc4txa9d1pg)) - all Power starts with invention. ([View Highlight](https://read.readwise.io/read/01jcw63yrb0w2kcrqdtrdhjqh3)) - When I became an investor in Netflix in 2003, my investment hypothesis had two legs: 1. Netflix’s DVD-rental business had Power: Counter-Positioning to the brick-and-mortar incumbent, Blockbuster; Process Power, as well as modest spatial distribution Scale Economies relative to other DVD-by-mail wannabes. 2. This Power was not properly recognized by the investment community. ([View Highlight](https://read.readwise.io/read/01jcw6af1gj90hh254c9pfpgqr)) - *Recommendation engine.* Netflix was a world leader in recommendation engine development, even sponsoring the Netflix Prize, which yielded machine-learning insights still notable in that community. Here one might hypothesize some Scale Economies: as Netflix accumulates more data, the acuity of their recommendations increases. True, but not linear: these advantages paid only diminishing returns, meaning a smaller competitor of an attainable scale could realize most of the same benefit. ([View Highlight](https://read.readwise.io/read/01jcw6qpkrrg1yryzvr5m0gypd)) -  ([View Highlight](https://read.readwise.io/read/01jcxdw3ksajvh7dx98xagfp2p)) - operational excellence is not strategic—because it’s imitable, and therefore subject to competitive arbitrage. ([View Highlight](https://read.readwise.io/read/01jcxe3qhnbwd0r814p269bp5q)) - good managers can rarely reverse the course of a bad business ([View Highlight](https://read.readwise.io/read/01jcxe86bfwxe50e1cwwbd6zrx)) - **The Fundamental Equation of Strategy. Value = M**0 ***g*** ***s*** ***m*** *Commentary.* The interpretation of this is that Value = Market Size * Power. M0 is the current market size, *g* is a discounted growth factor for the market, s is long-term average market share and m is long-term average differential margins (the profit margin above that needed to return the cost of capital). ([View Highlight](https://read.readwise.io/read/01jcxef3wmc1gzqrh44a2q5d3y)) - from a static viewpoint, the search for Power may seem like a zero sum game of preventing gains flowing to consumers. But from a Dynamics viewpoint, it is the possibility of Power that is a critical motivator of invention. An invention only gains traction if customers flock to it. This take-up is of course a sure marker of increases in consumer welfare—they are voting with their feet. This Dynamics perspective is of course the one that should motivate policy makers. ([View Highlight](https://read.readwise.io/read/01jcxepcf1x9mrxw644madqra1)) - Strategy (with a Capital S) is the intellectual discipline sometimes called Strategic Management. I define it: the study of the fundamental determinants of potential business value. ([View Highlight](https://read.readwise.io/read/01jcys2y1ads1da2tb51tzpbq4)) - The set of conditions needed for persistent differential returns. Power requires both a Benefit, something that materially increases cash flow, and a Barrier, conditions such that all the value to the firm of the Benefit is not arbitraged out by competition. ([View Highlight](https://read.readwise.io/read/01jcys3r34b8ap9cghbdfkwwfy)) -  ([View Highlight](https://read.readwise.io/read/01jcxeqmxhp9qzzjzay11c565q)) - Strategy (with a lower case s) is the path to potential value for a strategically separate business. I define it: a route to continuing Power in significant markets. ([View Highlight](https://read.readwise.io/read/01jcys6rj53ynmmrpqqws6z1dr)) - The fundamental enterprise value of an activity. This is reflected *ex post* as generation of accessible returns to an owner (free cash flow). It is investors’ expectation of the stream of these returns discounted over time that determines value *ex ante*. ([View Highlight](https://read.readwise.io/read/01jcys8edgydrvqt98ecvvdaft))