7-Powers book notes
This is a summary of Hamilton Helmer's book – one of my favorite product/strategy books. I've wrote this summary for myself and for easy reference when sharing the concepts with others.
I highly recommend reading the full book (not an easy read, but well worth it).
Summary
The main idea is that every single company that doesn't rely on cheating (corruption, government ties, etc.) to come to life and achieve long-term success (measured in profit/revenue) has to have at least one or more of these "powers":
Scale Economies
Network effect
Counter positioning
Branding
Switching costs
Cornered resources
Process
Power progression
The idea is that these powers aren't constant either, and especially in tech, things are much more dynamic than static. Just because you succeed with one of these powers doesn't mean it will sustain forever, and each power has different defensibility in the face of competition as well. He qualifies the impact and the moment you can rely on and try to chase each power based on the phases of the business:
Origination
Take-off phase
Stability phase
Each phase is self-explanatory, but his idea is that chasing specific barriers in the right phase of the business will build much higher competitive advantage and barriers for new players. Also, he is explicitly focused on business phases, not product life-cycle.
Powers applicable to Origination Phase
Phase where you are between the creation of the business, building everything and just launched and/or haven't achieved growth or market fit yet.
Counter positioning
Cornered resources
Applicable to Take-off Phase
Take-off phase is when the business starts to achieve fast growth.
Scale economies
Switching Costs
Network effect
Applicable to Stability phase
The break between take-off and stability is when unit growth falls below about 30%-40% year.
Branding
Process power
Now to the description and examples of each power (in order of business phases):
Counter positioning (origination)
Can be identified by:
An upstart who developed a superior business model.
That business model's ability to successfully challenge well-entrenched incumbents.
Steady accumulation of customers, all while incumbent remains paralyzed and unable to respond.
Ex: The new business model is superior to the incumbent's model due to lower costs and/or the ability to charge higher prices.
Barrier of entrance:
Incumbent(s) will eventually ask: "Am I better off staying the course, or adopting the new model?" If the answer is "stay off", then the barrier is high. A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.
Counter-Positioning versus Disruptive Technologies (Clayton Christensen)
Digital photography vs Kodak - this is a DT, but not CP.
In-N-Out vs. McDonald's - this is CP, but not DT
Netflix streaming vs. HBO via cable - this is both CP and DT
The case for playing humble: Cognitive Bias can play a role in deterring the incumbent. But the challenger, by its posture, may be able to influence such a move. How to attempt this? In its ascendancy, the challenger should avoid the temptation of trumpeting its superiority, instead suppressing that urge and adopting a tone of respect toward the incumbent.
Counter positioning is not exclusive. Different from other powers like Network Effect, strong counter positioning doesn't require (or create) a winner-takes-all situation.
Five stages of the incumbent when dealing with successful counter positioning from a new challenger:
Denial (aka, "we are not competitors")
Ridicule (aka, "we are better")
Fear
Anger
Capitulation (frequently too late)
Blockbuster execs showed all 5 stages in their public statements when facing Netflix. I personally dealt with founders on 1 and 2 many times (and always end up on 5 later).
Once market erosion becomes severe, a Counter-Positioned incumbent comes under tremendous pressure to do something; at the same time, they face great pressure to not upset the apple cart of the legacy business model. A frequent outcome of this duality? Let's call it dabbling: the incumbent puts a toe in the water, somehow, but refuses to commit in a way that meaningfully answers the challenge.
CP often underlies situations in which the following happens at the same time:
For the challenger:
Rapid share gains
Strong profitability (or promise of it)
For the incumbent:
Share loss
Inability to counter the entrant's moves
Eventually management shake-up(s)
Capitulation
Cornered resources (origination)
Benefit:
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.
Ex: In the Pixar case, the Brain Trust produced an uncommonly appealing product—"superior deliverables"—driving demand with very attractive price/volume combinations in the form of huge box office returns.
Barrier:
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. In the case of spin casting technology, it is patent law, and in the case of cement inputs, it is property rights.
The Five Tests to validate Cornered Resource:
Individual/Exclusive: If a firm repeatedly acquires coveted assets at attractive terms, then the proper strategy question is, "Why are they able to do this?" Ex: if Exxon was able to persistently gain the rights to desirable properties, then understanding their path to that is key. Do relative scale allows them to develop better discovery processes? If so, their discovery processes are the Cornered Resource.
Non-arbitraged: cost to keep the resource should be low enough to afford consistent differential returns (ex: a movie hiring Brad Pitt might move the box office but won't necessarily 10x the cost).
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.
Ongoing: In searching for Power, a strategist tries to isolate a causal factor that explains continued differential returns. Ex. Post-it notes patent lasted for 30 years
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. Ex. George Fisher joining Kodak wasn't enough.
Switching costs (take-off phase)
Ex: SAP - 43% of users are unhappy but 85% say they will continue to pay for the product, and the sales validate their statements.
Benefit:
A company that has embedded Switching Costs for its current customers can charge higher prices than competitors for equivalent products or services. Benefit only possible when you have additional offerings to sell.
Barrier:
To offer an equivalent product, 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.
Types of switching costs:
Financial: $ cost of investing and purchasing new solutions (ex: SAP)
Procedural: loss of familiarity or risk of adoption of a new product (ex: "nobody was ever fired for choosing IBM")
Relational: Affection with the provider (ex: sales team) or product/identity as a user.
Network Effect (take-off phase)
Benefit:
Network Economies occur when the value of a product to a customer is increased by the use of the product by others (Branch Out vs LinkedIn)
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.
Barrier:
For Network Economies, the barrier 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.
Example: The value of LinkedIn's HR Solutions Suite comes from the numbers of LinkedIn users, so LinkedIn can charge more than a competing product with fewer participants.
Characteristics:
Industries exhibiting Network Economies often exhibit these attributes:
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. For example, even a company as competent and with as deep pockets as Google could not unseat Facebook with Google+.
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.
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. Facebook's trumping of MySpace is a good example.
Scale Economies (take-off)
The quality of declining unit costs with increased business size is referred to as Scale Economies.
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.
Barrier:
Some obstacle which engenders in competitors an inability and/or unwillingness to engage in behaviors that might, over time, arbitrage out this benefit.
For Scale Economies, the Benefit is straightforward: lowered costs. In the case of Netflix, their lead in subscribers translated directly into lower content costs per subscriber for originals and exclusives.
Example:
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 situation creates a very difficult position for Netflix's smaller-scale streaming competitors. If they offer the same deliverable as Netflix, similar amounts of content for the same price, their P&L will suffer. If they try to remediate this by offering less content or raising prices, customers will abandon their service and they will lose market share. Such a competitive cul-de-sac is the hallmark of Power.
Branding (stability phase)
Branding as power to charge higher prices and sustain market share.
Ex: Purchased a Diamond ring at Tiffany for $16,600 and one of similar size and cut at Costco for $6,600, then asked a reputable gemologist and appraiser to assess the rings' values: Costco ring at $8,000 plus setting costs, more than $2,000 above the selling price. Assessed Tiffany ring at $10,500 plus setting costs at a non-brand-name retailer.
"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."
Benefit:
A business with Branding power is able to charge a higher price for its offering due to one or both of these two reasons:
Affective valence - The built-up associations with the brand elicit good feelings about the offering, distinct from the objective value of the good. (Ex Tiffany's)
Uncertainty reduction - A customer attains "peace of mind" knowing that the branded product will be 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.
Barrier:
A strong brand can only be created over a lengthy period of reinforcing actions (hysteresis), which itself serves as the key Barrier.
Process (stability phase)
Ex. Toyota Process (TPS)
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.
Barrier:
These process advances are difficult to replicate, and can only be achieved over a long time period of sustained evolutionary advance. This inherent speed limit in achieving the Benefit results from two factors:
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.
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.
Innovation is the key to achieving any of the powers
Innovation is achieved by creating compelling value. There are three distinct paths to creating compelling value.
Capabilities-Led Compelling Value: Adobe Acrobat. Here the key capability brought to bear was Adobe's existing fluency at the intersection of software and graphics.
Customer-Led Compelling Value: Corning Fiber Optics. Interaction at a distance. The uncertainty in this case is technical: "Can we invent it?"
Competitor-Led Compelling Value: the Sony PlayStation. Sony perceived the value in immersion of 3D graphics and the gap in the competitors' offerings (Sega/Nintendo) to double down on 3D and launch PS1.