7 Powers - Hamilton Helmer  ## Metadata - Author: **Hamilton Helmer** - Full Title: 7 Powers - Category: #books - Tags: #business ## Highlights - *Counter-Positioning.* Throughout my business career I have often observed powerful incumbents, once lauded for their business acumen, failing to adjust to a new competitive reality. The result is always a stunning fall from grace. A superficial thinker might pin this on lack of vision and leadership. Not Hamilton. By inventing the concept of Counter-Positioning, he was able to peel back the layers to peer into the deeper reality of these situations. Rather than lacking vision, Hamilton established, these incumbents are in fact acting in an entirely predictable and economically rational way. Our earlier battle with Blockbuster bore out this notion. ([View Highlight](https://read.readwise.io/read/01gmcs1r912494qexsfyvregvq)) - • *Power Progression.* At Netflix, we aggressively prioritize our attention in order to focus on what is essential to accomplish now. This applies to strategy as well: what are the near-in strategic imperatives? Unfortunately, existing strategy frameworks offered little guidance. There was recognition that this was an important issue, but none of those other frameworks could address it in a systematic, reliable, sufficiently transparent way. How did Hamilton respond to this void? Over a span of decades, he developed and refined the Power Progression, illustrating the approximate time fuse for each of the competitive battles facing a business person. It’s an extraordinary advance in the usefulness of strategic thinking. ([View Highlight](https://read.readwise.io/read/01gmcs3p9z1sw2hpn81v3zzgym)) - ***Power:*** the set of conditions creating the potential for persistent differential returns ([View Highlight](https://read.readwise.io/read/01gmcthmqtzpkgc876a9p73fzm)) - ***strategy:*** a route to continuing Power in significant markets ([View Highlight](https://read.readwise.io/read/01gmctjndnnazs9ssm1hcsvqrs)) - A mathematically equivalent but more felicitous formula for the NPV of free cash flow is: **NPV = M0 ***g*** ***s*** ***m***** Where: M0 ≡  current market size *g* ≡  discounted market growth factor *s* ≡  long-term market share *m* ≡  long-term differential margin (net profit margin in excess of that needed to cover the cost of capital) ([View Highlight](https://read.readwise.io/read/01gmfdsxwaj1gdn12epg9tv0y6)) - *Dual Attributes*. Power is as hard to achieve as it is important. As stated above, its defining feature *ex post* is persistent differential returns. Accordingly, we must associate it with both *magnitude* and *duration*. ([View Highlight](https://read.readwise.io/read/01gmfe56q04t9a7zqfs2j00qny)) - *Barrier.* The Benefit must not only augment cash flow, but it must persist, too. There must be some aspect of the Power conditions which prevents existing and potential competitors, both direct and functional, from engaging in the sort of value-destroying arbitrage Intel experienced with its memory business. This is the duration aspect of Power ([View Highlight](https://read.readwise.io/read/01gmfe6ve1ycp29waxqfcmr11j)) - *Industry Economics and Competitive Position*. The conditions of Power involve the interaction between the underlying industry’s economics and the specific business’ competitive position ([View Highlight](https://read.readwise.io/read/01gmfeabmmzjv4avpqa2tdsdrq)) - *Complex Competition.* Power, unlike strength, is an explicitly relative concept: it is about your strength in relation to that of a *specific* competitor. Good strategy involves assessing Power with respect to each competitor, which includes potential as well as existing competitors, and functional as well as direct competitors. Any such players could be the source of the arbitrage you are trying to circumvent, and any one arbitrageur is enough to drive down differential margins ([View Highlight](https://read.readwise.io/read/01gmfeay4sf7j8fxvmn3c04gfz)) - *Single Business Focus.* The protagonist of Strategy and of a strategy is each strategically separate business by itself, even if they exist within the same corporation, a common occurrence. In the case of Intel, memories and microprocessors were essentially separate businesses, posing two unique orthogonal Strategy problems. The concept of Power also takes into account this separation. The special considerations arising from the interplay of multiple businesses under a single corporate roof is the subject matter of Corporate Strategy ([View Highlight](https://read.readwise.io/read/01gmfeea5h5hbcngxdw5203tz3)) - *Leadership*. The notion of Power (and the impact of its lack) is what underlies Warren Buffett’s view that if you combine a poor business with a good manager, it is not the business that loses its reputation. On the other hand, always the domain of Economists, I am a strong believer in the importance of leadership in the creation of value. Intel’s experience is again instructive. I have little doubt that the managerial acuity of Bob Noyce, Gordon Moore and Andy Grove would be remembered quite differently had they stuck with memories ([View Highlight](https://read.readwise.io/read/01gmfefmfd72nebrcqxjz4mrk5)) - If, say, Netflix paid $100M for *House of Cards* and their streaming business had 30M customers, then the cost per customer was three dollars and change. In this scenario, a competitor with only one million subscribers would have to ante up $100 per subscriber. This was a radical change in industry economics, and it put to rest the specter of a value-destroying commodity rat race. ([View Highlight](https://read.readwise.io/read/01gmj26wbdvcdsfwf09e27p5cy)) - Tags: #business-model - The quality of declining unit costs with increased business size is referred to as Scale Economies ([View Highlight](https://read.readwise.io/read/01gmj28fx531m30d60as9666mr)) - • A *Benefit*: some condition which yields material improvement in the cash flow of the Power wielder via reduced cost, enhanced pricing and/or decreased investment requirements. • A *Barrier*: some obstacle which engenders in competitors an inability and/or unwillingness to engage in behaviors that might, over time, arbitrage out this benefit. ([View Highlight](https://read.readwise.io/read/01gmj2d5gt1af2mjqbef74dsgh)) - Suppose a company has a significant scale advantage in a Scale Economies business. Smaller firms would spot this advantage, and their first impulse might be to pick up market share, thus improving their relative cost position and erasing some of this disadvantage while improving their bottom line. To get there, however, they would have to offer up better value to customers, such as lower prices. In an established market, such tactics are visible to the leader, who would realize the threat of reducing their relative scale advantage; they would retaliate by using their superior cost position as a defensive redoubt (matching price cuts for example). ([View Highlight](https://read.readwise.io/read/01gmj2n9epsqbe7hkeyvg5wk6w)) - 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/01gmj30rvcvww0hedsjwh1rek5)) - Surplus Leader Margin (SLM). This is the profit margin the business with Power can expect to achieve if pricing is such that its competitor’s profits are zero ([View Highlight](https://read.readwise.io/read/01gmmfkgvpgevh62v5wf1wa8ba)) - Surplus Leader Margin = [Scale Economy Intensity] ***** [Scale Advantage] ([View Highlight](https://read.readwise.io/read/01gmmfkxqzp0m1jkwrwfw1xcms)) - Network Economies occur when the value of a product to a customer is increased by the use of the product by others ([View Highlight](https://read.readwise.io/read/01gmmfvaqe7bdcs9f38hy7jy5q)) - *Benefit.* A company in a leadership position with Network Economies can charge higher prices than its competitors, because of the higher value as a result of more users ([View Highlight](https://read.readwise.io/read/01gmmfw05stsa125ab9cnqfwnp)) - *Barrier*. The barrier for Network Economies is the unattractive cost/benefit of gaining share, and this can be extremely high. In particular the value deficit of a follower can be so large that the price discount needed to offset this is unthinkable ([View Highlight](https://read.readwise.io/read/01gmmfw6ycdn5n77kdg1racazj)) - *Winner take all*. Businesses with strong Network Economies are frequently characterized by a tipping point: once a single firm achieves a certain degree of leadership, then the other firms just throw in the towel. Game over—the P&L of a challenge would just be too ugly ([View Highlight](https://read.readwise.io/read/01gmmfzwz0krnypb5ryyhhvck8)) - *Boundedness*. As powerful as this Barrier is, it is bounded by the character of the network, something well-demonstrated by the continued success of both Facebook and LinkedIn. Facebook has powerful Network Economies itself but these have to do with personal not professional interactions. The boundaries of the network effects determine the boundaries of the business ([View Highlight](https://read.readwise.io/read/01gmmg2jsth7j58mwy2hdastyp)) - *Decisive early product*. Due to tipping point dynamics, early relative scaling is critical in developing Power. Who scales the fastest is often determined by who gets the product most right early on. ([View Highlight](https://read.readwise.io/read/01gmmg33xwtepvg0qff62pcspa)) - *Benefit.* The new business model is superior to the incumbent’s model due to lower costs and/or the ability to charge higher prices ([View Highlight](https://read.readwise.io/read/01gmmgkssf8fmen49ww9r01h3g)) - *Barrier.* The barrier for Counter-Positioning seems a bit mysterious: how could a powerhouse (such as Fidelity Investments in this case) allow itself to be persistently humbled by an upstart over such an extended period? Couldn’t they foresee the potential success of Vanguard’s model? Freqently in such situations, naïve onlookers castigate the incumbent for lack of vision, or even just poor management. Often, too, they level this accusation at companies with prior plaudits for business acumen. In many cases, this view is unjust and misleading. The incumbent’s failure to respond, more often than not, results from thoughtful calculation. They observe the upstart’s new model, and ask, “Am I better off staying the course, or adopting the new model?” Counter-Positioning applies to the subset of cases in which the expected damage to the existing business elicits a “no” answer from the incumbent. The Barrier, simply put, is collateral damage. ([View Highlight](https://read.readwise.io/read/01gmmgjaxh2rjechmczen1vy2a)) - At the heart of Counter-Positioning lies the development of a new business model that, over time, has the potential to supplant the old. In the more general sense of the word, it is disruptive. However, when we consider the more specific meaning of Disruptive Technologies (DT) developed by Christensen, the waters muddy. Consider these examples: • Kodak vs. digital photography. This is a DT, but not CP. • In-N-Out vs. McDonald’s. This is CP, but not DT (no new technology involved). • Netflix streaming vs. HBO via cable. This is both CP and DT. ([View Highlight](https://read.readwise.io/read/01gmmgtr9xsx931kqc9dj1ks58)) - I whimsically refer to it as the Five Stages of Counter-Positioning: 1. Denial 2. Ridicule 3. Fear 4. Anger 5. Capitulation (frequently too late) ([View Highlight](https://read.readwise.io/read/01gmmgx530n7hw89cs6jhb3p1p)) - The explanation for this paradox lies in the Power type covered in this chapter: Switching Costs. A simple example is Apple’s hold on its iTunes customers. Apple downloads come in a proprietary format, so in switching to another program, Apple customers forfeit their prior purchases. This is an unattractive prospect, which accounts for why so many customers stay locked in. ([View Highlight](https://read.readwise.io/read/01gmmh08nzndxz3gm5256v2q66)) - Switching Costs arise when a consumer values compatibility across multiple purchases from a specific firm over time. These can include repeat purchases of the same product or purchases of complementary goods ([View Highlight](https://read.readwise.io/read/01gmmh3fb97dtzef0jb1ackg9f)) - *Benefit.* A company that has embedded Switching Costs for its current customers can charge higher prices than competitors for equivalent products or services.[40](#bb40) This benefit only accrues to the Power holder in selling follow-on products to their *current* customers; they hold no Benefit with potential customers and there is no Benefit if there are no follow-on products. ([View Highlight](https://read.readwise.io/read/01gmmh6ekzas5edpamt46vsc00)) - *Barrier.* To offer an equivalent product,[41](#bb41) competitors must compensate customers for Switching Costs. The firm that has previously roped in the customer, then, can set or adjust prices in a way that puts their potential rival at a cost disadvantage, rendering such a challenge distinctly unattractive. Thus, as with Scale Economies and Network Economies, the Barrier arises from the unattractive cost/benefit of share gains for the challenger. ([View Highlight](https://read.readwise.io/read/01gmmh6r41z7aznd215ydsp9dw)) - ***Financial****.* Financial Switching Costs include those which are transparently monetary from the outset. For ERP, these would include the purchase of both a new database and the sum total of its complementary applications. ([View Highlight](https://read.readwise.io/read/01gmmj6dpwrm93ypj4gs5b5rss)) - ***Relational***. Relational Switching Costs are those tolls which would result from the breaking of emotional bonds built up through use of the product and through interactions with other users and service providers. ([View Highlight](https://read.readwise.io/read/01gmq2a595egtf9f64fahmnq7g)) - As noted before, Switching Costs are a non-exclusive Power: their benefits are available to all players. So the intensity of Switching Costs derives from “Industry Economics,” those conditions faced equally by all players. The potential benefits accrue only if you have a customer, so the competitive position component of Switching Costs is binary: you either have the customer, or you do not. ([View Highlight](https://read.readwise.io/read/01gmq45hvv05wa81g8fdq6e1s9)) - Tags: #zero-sum-game - You got exactly what they said you were getting. Anything that is brand-name and has developed a reputation that Tiffany has developed, they’ve earned it over the years for quality control. You can go there [and] you don’t have to think twice about your purchase. And you pay for that. ([View Highlight](https://read.readwise.io/read/01gmq4gm3191kedgqgq129a14n)) - *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. ([View Highlight](https://read.readwise.io/read/01gmq4s7rvz33e8fjryd4sfqwg)) - *Uncertainty reduction.* A customer attains “peace of mind” knowing that the branded product will be as just as expected. ([View Highlight](https://read.readwise.io/read/01gmq4vc96mwvt46kxqa8y56y5)) - *Barrier.* A strong brand can only be created over a lengthy period of reinforcing actions (*hysteresis*), which itself serves as the key Barrier. ([View Highlight](https://read.readwise.io/read/01gmq4z06zpxns7ec38s8m556h)) - In February of 1986, George Lucas, financially stressed by his 1983 divorce settlement, spun out The Graphics Group of the Computer Division of Lucasfilm to Steve Jobs for $5M. ([View Highlight](https://read.readwise.io/read/01gmskrywzwd44wtd537nr896s)) - Here there was a clear definition of power: John on creative, Ed on technical, and Jobs on business and financial. There was an implicit trust of each other, as well as one guy with the final word (Steve). ([View Highlight](https://read.readwise.io/read/01gmskskgane2f7tkst529tacq)) - *Benefit.* In the Pixar case, this resource produced an uncommonly appealing product—“superior deliverables”—driving demand with very attractive price/volume combinations in the form of huge box office returns. No doubt—this was material (a large *m* in the Fundamental Equation of Strategy). In other instances, however, the Cornered Resource can emerge in varied forms, offering uniquely different benefits. It might, for example, be preferential access to a valuable patent, such as that for a blockbuster drug; a required input, such as a cement producer’s ownership of a nearby limestone source, or a cost-saving production manufacturing approach, such as Bausch and Lomb’s spin casting technology for soft contact lenses. ([View Highlight](https://read.readwise.io/read/01gmskwtn7k6k7q5t8cjt9af9q)) - *Barrier.* The Barrier in Cornered Resource is unlike anything we have encountered before. You might wonder: “Why does Pixar retain the Brain Trust?” Any one of this group would be highly sought after by other animated film companies, and yet over this period, and no doubt into the future, they have stayed with Pixar. Even during the company’s rocky beginning, there was a loyalty that went beyond simple financial calculation. ([View Highlight](https://read.readwise.io/read/01gmsm01yw9hhkd4g0c451mp01)) - *Non-arbitraged.* What if a firm gains preferential access to a coveted resource, but then pays a price that fully arbitrages out the rents attributable to this resource? In this case, it fails the differential return test of Power. ([View Highlight](https://read.readwise.io/read/01gmsm2x1n7wrkbjt2cvzh1nej)) - *Transferable.* If a resource creates value at a single company but would fail to do so at other companies, then isolating that resource as the source of Power would entail overlooking some other essential complement beyond operational excellence ([View Highlight](https://read.readwise.io/read/01gmsm2gkge3v400mvw0qk0zqv)) - *Ongoing.* In searching for Power, a strategist tries to isolate a causal factor that explains continued differential returns. There’s a contrapositive to this, too: one would then expect differential returns to suffer should the identified factor be taken away. Clearly this perspective has bearing on the identification of a Cornered Resource ([View Highlight](https://read.readwise.io/read/01gmsm3n5ga8tdw391gqvsaky5)) - *Sufficient.* The final Cornered Resource test concerns completeness: for a resource to qualify as Power, it must be sufficient for continued differential returns, assuming operational excellence ([View Highlight](https://read.readwise.io/read/01gmsm3wt67gbqr4xtv6bycw5t)) - What’s curious is that few manufacturers have managed to imitate Toyota successfully even though the company has been extraordinarily open about its practices. Hundreds of thousands of executives from thousands of businesses have toured Toyota’s plants in Japan and the United States. ([View Highlight](https://read.readwise.io/read/01gmsm6dnv0vgnkg4yfrx4hkta)) - Tags: #open-source - *Benefit.* A company with Process Power is able to improve product attributes and/or lower costs as a result of process improvements embedded within the organization. For example, Toyota has maintained the quality increases and cost reductions of the TPS over a span of decades; these assets do not disappear as new workers are brought in and older workers retire. ([View Highlight](https://read.readwise.io/read/01gmsmnkeqcpxkmfj8cjq28qv2)) - *Barrier.* The Barrier in Process Power is hysteresis: these process advances are difficult to replicate, and can only be achieved over a long time period of sustained evolutionary advance. ([View Highlight](https://read.readwise.io/read/01gmsmr8t5cgrxgnv1p9qbgttp)) - *Complexity*. Returning to our example: automobile production, combined with all the logistic chains which support it, entails enormous complexity. If process improvements touch many parts of these chains, as they did with Toyota, then achieving them quickly will prove challenging, if not impossible. ([View Highlight](https://read.readwise.io/read/01gmsmtn6xasvmkmsh0kr910tr)) - • *Opacity*. The development of TPS should tip us off to the long time constant inevitably faced by would-be imitators. The system was fashioned from the bottom up, over decades of trial and error. The fundamental tenets were never formally codified, and much of the organizational knowledge remained tacit, rather than explicit. It would not be an exaggeration to say that even Toyota did not have a full, top-down understanding of what they had created—it took fully fifteen years, for instance, before they were able to transfer TPS to their suppliers. GM’s experience with NUMMI also implies the tacit character of this knowledge: even when Toyota wanted to illuminate their work processes, they could not entirely do so. ([View Highlight](https://read.readwise.io/read/01gmsmwpptmm2j0kw92n97ytg1)) - Reed Hastings, their CEO and founder, wrote in 2005: > DVDs will continue to generate big profits in the near future. Netflix has at least another decade of dominance ahead of it. But movies over the Internet are coming, and at some point it will become big business…. That’s why the company is called Netflix, not DVD-By-Mail ([View Highlight](https://read.readwise.io/read/01gmw5ykbxx2hs45w3w411nxbc)) - *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/01gmw63vbt65aqhddx5vz2cmxk)) - *Resources.* You must start with the abilities you can bring to bear. Using the academic convention, I will call these “resources.” They might be as personal and idiosyncratic as Steve Jobs’ aesthetic sensibilities, or as corporate as Google’s vast stores of organized data. For Netflix, their original DVD-by-mail business endowed them with numerous resources relevant to streaming, including such directly transferable skills as their recommendation engine, their UI, their customer data and their relationships with content owners. Equally important was the platform of their existing business, which allowed them to easily offer streaming as a complement to DVD-by-mail, rather than a standalone service. This was far more important than you might think, as it silenced potential complaints about the initial small streaming catalogue that could have driven fatally negative word-of-mouth. Conversely, though, there were also many abilities Netflix had to develop, and as they moved aggressively into originals, this set of required competencies expanded considerably. ([View Highlight](https://read.readwise.io/read/01gmw6x21q14prhsfvtsez6rj0)) - *External conditions.* These resources then intersect an opportunity set driven by evolving external conditions: technological, competitive, legal and so on. For Netflix, an advancing technology frontier opened up the potential for streaming: Moore’s Law in semiconductors, plus similar exponential advances in optical communications and storage. The embodiments of these trends were high-speed Internet connections, acceptably costed digital storage and a broad dispersion of devices with adequate performance (displays, storage, graphics processing and connectivity). If Netflix had bet the company on streaming any earlier, they would have been dead in the water—external conditions were not yet ripe. ([View Highlight](https://read.readwise.io/read/01gmw6zp7v05tkgrz5j7g5j07k)) - *Invention.* For Netflix, the inventions were their new product directions: streaming and originals and all the associated complements. Crafted, not designed. The potential for invention may be there but someone must seize it. ([View Highlight](https://read.readwise.io/read/01gmw72y9wrdyqkwa1vd3tecwp)) - Tags: #invention - • *Power.* The final step was the thrust into exclusives and originals. By bringing to rein the cost of content, Netflix forged powerful Scale Economies and hence Power. Note also in Figure 8.4 that the connection from Invention to Power is also dotted. Most inventions don’t assure Power. As I have discussed, operational excellence—really a constant process of re-invention—does not result in Power. ([View Highlight](https://read.readwise.io/read/01gmw754pepytmf0b9ny4m50v5))