Catch Them If You Can: The 7 Powers of Business Strategy
In the business arena, the ability to maintain competitive advantages over your competitors is sometimes called a moat. In his book — 7 Powers: The Foundations of Business Strategy — Hamilton Helmer sets out a framework for 7 true moats. 7 Powers.
The 7 Powers framework is remarkably easy to understand. It’s easy to apply. And easy to teach to others. It’s a fun little compass to keep in your pocket and whip out when you need some (business strategy) direction. So here they are: Scale Economies, Network Economies, Counter-Positioning, Switching Costs, Branding, Cornered Resource, Process Power.
1. Scale Economies
A business in which per unit cost declines as production volume increases.
Perhaps the only one you learnt about at school. Scale economies is the simple concept that producing a lot of things is cheaper, per-thing, than producing a few things.
I love Japanese cooking — but the first time you go to cook a meal, it’s expensive. You might need to buy any and all of soy, sake, miso, goma, yaki-nori and mirin. Your first meal might cost you $70. But once you have the staples, your cost per meal will come down over time. The more you cook, the cheaper your delicious Japanese meals become. That’s economies of (a tiny) scale.
In software, economies of scale are intensified. Because — and this is a generalisation — most fixed costs are incurred upfront (eg. product development, R&D). Once you have built the software, you can sell it rapidly without much further fixed cost, and every sale brings down your total cost per unit.
The magic of software is that you can build once, sell umpteen times.
Helmer uses Netflix as a prime example of Scale Economies. Netflix traditionally licensed content to stream on its platform. They would pay the owners on a per-play basis. The more a film was played, the more it would cost them. In 2012, Netflix made the radical move into producing original content. This meant huge capital investment upfront to produce blockbuster content. But once those costs were incurred, the content was theirs to show as many times as they want with no further cost.
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. — 7 Powers, Loc 384
2. Network Economies
The value of a service to each user increases as new users join the network.
I know you know this one. Network economies (also referred to as network effects) gets the most airtime of all the Powers in the real world. And rightly so, as it accounts for a huge amount of the value created in tech. Facebook. Twitter. Ebay. Any market leading 2-sided marketplace is experiencing Network Economies. Many social medium platforms too. You use these services because everyone else is using them. What is happening as Network Economies grow? Marginal cost is increasing linearly. While value is increasing exponentially.
Network Economies are notoriously hard to seed — because you have a chicken and egg problem (Why would I use Facebook if no one else was on it yet?). But once the flywheel is spinning and you hit a critical mass, they are incredibly powerful and hard to catch. If you are loving the sound of Network Economies, dig into nfx’s network effects bible.
3. Counter-Positioning
A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.
This is what we might refer to as disruption. A new market entrant offers a fundamentally different model which is superior to that of the incumbent. The new model might lower costs. It might deliver a 10x better product to the consumer. Think Uber v taxis. AirBnb v hotels. A topical example is Robinhood. It upended the retail stock trading industry with a new business model. Offering commission free trading to users by generating income from selling its order book.
To make the case for counter-positioning, Helmer points to the “poster child for low-cost passive index funds” Vanguard. Founded in 1975 in “a world in which active equity management ruled the day”.
Vanguard, by design, possessed a fundamental advantage in the iron law of active management: the average gross return of active funds has to equal the market return, and since their expenses are substantially higher than passive funds, their average net returns will always be less than those of passive funds — 7 Powers, Loc 657
A lot of ink has been spilled on how incumbents can ward off (or better yet, take advantage of) counter-positioning. Check out the seminal work by Clayton M. Christensen: The Innovator’s Dilemma. Christensen’s work focuses on disruptive technology. This is a subset of counter-positioning, as counter-positioning — like innovation generally — does not necessarily involve tech.
4. Switching Costs
The value loss expected by a customer that would be incurred from switching to an alternative supplier for additional purchases.
You know that feeling of dread you get when you flirt with the idea of buying an Android phone only to realise your fully integrated Apple experience will be disrupted? That’s switching costs. For mega-enterprise-software products like SAP, Salesforce and Oracle — switching costs are a powerful moat. So powerful in fact that it can outweigh having an inferior and disappointing product.
As Helmer puts it:
SAP’s paradoxical combination of high retention and low satisfaction reflects the economic reality of a software product of great value to a corporation but one that also comes with high Switching Costs. Once a customer has bought in, they are hopelessly hooked, enabling SAP to then reap the rewards of a future stream of revenues for annual maintenance charges, upgrades, add-on services, software and consulting — 7 Powers, Loc 972
5. Brand
The durable attribution of higher value to an objectively identical offering that arises from historic info about the seller.
Branding. Hard to quantify. Easy to recognise. Like Justice Potter Stewart’s famous description of pornography in a US Supreme Court judgement: “I know it when I see it”.
A strong brand will lead your customers to pay a higher price for your product than a competitor’s. Pretty simple. Helmer uses the example of a Tiffany engagement ring, which sells for about double the price of the same diamond from Costco.
Branding is an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product — 7 Powers, Loc 1099
6. Cornered Resource
Preferential access at attractive terms to a coveted asset that can independently enhance value.
Cornered resource is the possession of an attribute sufficiently potent to “drive high-potential, persistent differential margins, with operational excellence spanning the gap between potential and actual.” It’s not just having something valuable. The resource must meet a high bar. Passing Helmer’s five tests:
- Idiosyncratic — repeatedly creates returns.
- Non-arbitraged — cost of the resource does not exceed its profits.
- Transferable — can be transferred to another company.
- Ongoing — sustained returns.
- Sufficient — sufficient to create continued differential returns.
Helmer points to Pixar’s extraordinary leadership team as an example of cornered resource. John Lasseter (creative), Ed Catmull (technical) and Steve Jobs (financial). Together this team experienced stunning commercial and financial success. Consider their first ten movies: Toy Story, A Bug’s Life, Toy Story 2, Monsters, Inc., Finding Nemo, The Incredibles, Cars, Ratatouille, WALL-E and UP.
7. Process Power
Embedded company organisation and activity sets which enable lower costs and/or superior product.
The last power is the most elusive. As a reader I also find it to be the trickiest to grasp. Process power is operational excellence and hysteresis. This means a system of operational excellence habitual to the company over a long period of time. Helmer supports the view that operational excellence by itself is not a moat. But an advanced, systemic operational model which consistently generates returns over a long period of time. One that can’t be replicated even if a competitor can see it in plain sight. That’s a moat. An example of process power are Apple’s product journey — from first design to last mile. Another is Toyota’s manufacturing process — the creme of the crop in auto manufacturing.
That’s it. The 7 Powers. Hopefully you find the framework useful. If you’re anything like me the genie will be out of the bottle now. You’ll see the powers in strange places. You might notice switching costs enjoyed by mainstream religions. Or you’ll appreciate brand next time you see how cheap the generic brand of paracetamol is.
