A beautiful read that is worth reading and re-reading. Joe was CEO of North America at Citi which was the best performing stock in the 1990s and now is a senior executive at KRR, having turned around Willis and First Data. In this 2019 talk he shares eight of his first principles of value creation
Plumeri’s 8 Principles
- Where’s grandma’s house? Where as we going
- We all need a vision. Without one, people will make up their out
- Do you passionately care about the client and vision?
- Make a big deal out of everything
- Delegate authority but never responsibility
- Write notes to everyone and recognize people as often as possible
- Gerald Ford helping to get friend buried at Arlington made me cry
- Create a no doors culture
- Go “play in traffic” – go make things happen
- Create a performance-based culture
- Citi had a program where if you didn’t exercise the stock, then you got double the amount. That’s how Sandy Weill was able to keep everyone
- Gave stock wherever he worked and he always put shareholders first. Would never even visit a tourist attraction if he was traveling because it was the shareholders who had paid to get him there
- Ownership, team building, everybody on the same page
- Widen the value gap
- The value gap is what people or companies can do for themselves compared to what you can do for them. You always want to be expanding this gap
- Never be in a commodity business
- Are you competent or compelling?
- Price is an issue in the absence of value
- Your reach should exceed your grasp
- Always ask, “What else?”
- Surround yourself with people who want to do great things
- Viking effect of burning boats, getting everyone all-in
- Patagonia exists to challenge conventional wisdom and present a new style of responsible business. We believe the accepted model of capitalism that necessitates endless growth and deserves the blame for the destruction of nature must be displaced. Patagonia and its two thousand employees have the means and the will to prove to the rest of the business world that doing the right thing makes a good and profitable business. Make the best product, cause no unnecessary harm, and use business to inspire and implement solutions to the environmental crisis.
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- Chouinard started off making pitons and replaced the European attitude of “conquering” mountains with the American view of leaving no trace
- We were our own best customers from the start. We made the tools, gear, clothes that we wanted.
- We didn’t have much competition – no one else was foolish enough to want to get into that market!
- Kris McDivitt when she became CEO of Patagonia – I had no business experience so I started asking people for free advice. I just called up presidents of banks and said, “I’ve been given these companies to run and I’ve no idea what I’m doing. I think someone should help me. And they did. If you just ask people for help – if you just admit that you don’t know something – they will fall all over themselves trying to help. So, from there I began building the company. I was really the translator for Yvon’s vision and aims for the company
- We had to surround ourselves with people we wanted to spend a lot of time with, who would be our product’s first customer. They had to come to work on the balls of their feet and go up steps two at a time, dress however they wanted, even barefoot, have all the flextime to surf the saves when they were good or be home with a sick child. We needed to blur that distinction between work and play and family
- I couldn’t find any American company we could use as a role model
- I’ve always thought of myself as an 80 percenter. I like to throw myself passionately into a sport or activity until I reach about an 80% proficiency level. To go beyond that requires an obsession and degree of specialization that doesn’t appeal to me. Once I reach that 80% level I like to go off and do something totally different; that probably explains the diversity of the Patagonia product line – and why our versatile, multifaceted clothes are the most successful.
- You can’t wait until you have all the answers to ask! I had faith the product was good, and I knew the market, so we forged ahead to shift our entire line of polypropylene underwear to the new Capilene polyester. Our loyal customers quickly realized the advantages of Capilene and Synchilla, and our sales soared. Other companies, just introduced rip-offs of our bunting and propylene clothes, had to scramble to keep up.
- I abide by the MBA – management by absence
- I was the outside guy, responsible for bringing back new ideas. A company needs someone to go out and get the temperature of the world, so for years I would come home excited about ideas for products, new markets, or new materials. I also began to see the environmental degradation happening. Some countries were in so much trouble that they were eating their seed corn
- Great term for being too short-sighted. Have to be planting your tree farm continuously, can’t be eating your seed corn
- Before he could help us, he said he wanted to know why we were in business. I told him the history of the company and how I considered myself a craftsman who had just happened to grow a successful business. I told him I’d always had a dream that when I had enough money, I’d just sail off to the South Seas looking for the perfect wave and the ultimate bonefish flat. We told him the reason we hadn’t sold out and retired was that we were pessimistic about the fate of the world and felt a responsibility to use our resources to do something about it. We told him about our tithing program, how we had given away a million dollars just in the past year to more than 200 organizations, and that our bottom-line reason for staying in the business was to make money we could give away.
- Never exceed your limits. You push the envelope, and you live for those moments when you’re right on the edge, but don’t go over. You have to be true to yourself; and you have to know your strengths and limitations and live within your means. The same is true from business. The sooner a company tries to be what it is not, the sooner it tries to “have it all,” the sooner it will die. It was time to apply a bit of Zen philosophy to our business
- The Iroquois have a 7-generation planning. As part of their decision process, the Iroquois had a person who represented the seventh generation in their future. If Patagonia could survive this crisis, we had to begin to make all our decisions as though we would be in business for 100 years. We would grow only at a rate we could sustain for that long.
- I’ve hard that smart investors and bankers don’t trust a growing company until it has proved itself by how it survives its first big crisis. If that’s true, then we’ve been there
- We have controlled our growth to what we call organic growth. We don’t force our growth by stepping out of the specialty outdoor market and trying to be who we aren’t. We let our customers tell us how much we should grow each year. Some years it could be 5% growth or 25%, which happened during the middle of the Great Recession. Customers become very conservative during recessions. They stop buying fashionable silly things. They will pay more for a product that is practical, multifunctional, and will last a long time. We thrive during recessions
- Some crises were created by management to keep the company in yarak, a falconry term meaning when your falcon is super alert, hungry, but not weak, and ready to hunt
- Product Design Philosophy
- Our philosophies aren’t rules, they’re guidelines. They’re the keystones of our approach to any project, and although they are “set in stone,” their application to a situation isn’t. in every long-lasting business, the methods of conducting business may constantly change, but the values, the culture, and the philosophies remain constant. At Patagonia, these philosophies must be communicated to everyone working in every part of the company, so that each of us becomes empowered with the knowledge of the right course to take, without having to follow a rigid plan or wait for orders from the boss. Living the values and knowing the philosophy of each part of the company aligns us all in a common direction, promotes efficiency, and avoids the chaos that comes from poor communication. We have made many mistakes during the past decade, but at no point have we lost our way for very long. We have the philosophies for a rough map, the only kind that’s useful in a business world whose contours, unlike those of the mountains, change constantly without much warning
- Having useful and high-quality products anchors our business in the real world and allows us to expand our mission. “Make the best,” period.
- Quality = degree of excellence
- Function of an object should determine its design and materials
- The more you know, the less you need
- Good design is as little design as possible
- We’ve found that each new line requires the hiring of 2.5 new people. The best-performing firms make a narrow range of products very well. The best firms’ products also use up to 50% fewer parts than those made by their less successful rivals. Fewer parts means a faster, simply (and usually cheaper) manufacturing process. Fewer parts means less to go wrong; quality comes built in. and although the best companies need fewer workers to look after quality control, they also have fewer defects and generate less waste
- I’d rather design and sell products so good and unique that they have no competition…The value of our products even seems to grow over time. In Tokyo there are stores that deal only in vintage Patagonia clothing
- When I’m working on a problem, I never think about beauty. I think only how to solve the problem. But when I have finished, if the solution is not beautiful, I know it is wrong – Buckminster Fuller
- Because of our commitment to quality, we run at such a slow pace that we’re the turtles in the fashion race. Our design and product development calendar are usually 18 months long, too long to be a contender in any new fads
- Use their slow cycles quality to their advantage by “missing” fads
- It’s almost as if every idea has its own time
- Production Philosophy
- Coming in second, even with a superior product at a better price, is often no substitute for just plain being first. This doesn’t mean we should be “chasing” trends or products. It applies more to “discovering” a new fabric or a new process. Again, the key word is discovering instead of inventing. There’s imply no time for inventing. Maintaining a sense of urgency throughout a company is one of the most difficult challenges in business. The problem is further compounded by having to depend on outside suppliers who may not have the same sense of expediency. I constantly hear people giving lame excuses of why something is impossible or why a job didn’t get done on time
- To stay ahead of competition, our ideas have to come from as close to the source as possible. With technical products, our “source” is the dirtbag core customer. He or she is the one using the products and finding out what works, what doesn’t, and what is needed. On the contrary, sales representatives, shop owners, salesclerks, and people in focus groups are usually not visionaries. They can tell you only what is happening now: what is in fashion, what the competition is doing, and what is selling. They are good sources of information, but the information is too old to have the leading-edge products. There are different ways to address a new or idea or project. If you take the conservative scientific route, you study the problem in your head or on paper until you are sure there is no chance of failure. However, you have taken so long that the competition has already beaten you to market. The entrepreneurial way is to immediately take a forward step and if that feels good, take another, if not, step back. Learn by doing, the process is faster
- The designer must work with the producer up front. this applies to every product. This team approach is concurrent rather than assembly-line manufacturing. A concurrent approach brings all participants together at the beginning of the design phase. Only about 10% of a product’s costs are incurred during the design phase, but 90% of the costs are irrevocably committed
- This level of quality requires a level of mutual commitment much deeper than the traditional business relationships. Mutual commitment requires nurture and trust, and those demand personal time and energy. Consequently, we do as much business a we can with as few suppliers and contractors as possible. The downside is the risk of becoming highly dependent on another company’s performance. But that’s exactly the position we want to be in because those companies are also dependent on us. Our potential success is linked. We become like friends, family, mutually selfish business partners; what’s good for them is good for us. The best often finds us attractive business partners because they know our reputation for quality, long-term relationships, that we’ll pay a fair price, commit to fabric purchases, and keep their sewing lines running at an even clip
- I think of Patagonia as an ecosystem, with its vendors and customers an integral part of that system. A problem anywhere in the system eventually affects the whole, and this gives everyone an overriding responsibility to the health of the whole organism. It also means that anyone, low on the totem pole or high, inside the company or out, can contribute significantly to the health of the company and to the integrity and value of our products…The whole supply chain has to be a functioning, interconnected system.
- You identify the goal and then forget about it and concentrate on the process
- Distribution Philosophy
- At Patagonia we sell our products at a wholesale level to dealers, sell through our own retail stores, through mail order, and through e-commerce, and do it all worldwide
- We fulfill orders at 93-95% throughout the selling season. This has been determined to be “ideal” because to fulfill at lower rates loses too many customers but to get to 98% is inefficient for inventory. You might have to double inventory to achieve a 98% fulfillment rate
- The customer should only have to make one phone call. Just as the Patagonia production philosophy requires on-time product delivery from its suppliers, so Patagonia must deliver its products on time to tis customers, and “on time” means when the customer wants it. Our model for customer service is the old-fashioned hardware store owner who knows his tools and what they’re made for. his idea of service is to wait on a customer until the customer finds the right widget for the job, no matter how long it takes.
- In owning our own retail stores, we’ve learned that it is far more profitable to turn that inventory more quickly than to have high margins or raise prices. This was especially true when we had to pay high interest rates on our loans. You want sharp customers who know the market and its customers. They place small orders from suppliers but more often. You don’t want to waste expensive retail space to carry extra inventory. You display the products as if it were a showroom but keep the backstock in the basement or nearby stockroom
- Key benefits of having a working partnership with a few good dealers
- We don’t have to expend the effort, time, and money to seek out new dealers
- We limit our credit risks
- We minimize the legal problems associated with cutting off a dealer whose bad service is a reflection on us
- We develop loyal buyers who make a commitment to the line and either carry a broad representation of the line, or in the case of a small specialty shop, in-depth inventory
- We maintain better control over our product and image
- We receive better information about the market and our products
- Our dealers win because they have a product line that sells year after year, protection from market saturation, a stable pricing structure, expertise from us in buying, merchandising, and displaying our products, being part of Patagonia’s synergistic marketing and distribution program.
- Marketing Philosophy
- Patagonia’s image arises directly from the values, outdoor pursuits, and passions of its founders and employees. While it has practical and nameable aspects, it can’t be made into a formula. In fact, because so much of the image relies on authenticity, a formula would destroy it. Ironically, part of Patagonia’s authenticity lies in not being concerned about having an image in the first place. Without a formula, the only way to sustain an image is to live up to it. Our image is a direct reflection of who we are and what we believe.
- Our guidelines for all promotional efforts
- Our charter is to inspire and educate rather than promote
- We would rather earn credibility than buy it. The best resources for us are the word of mouth recommendation from a friend or favorable comments in the press
- We advertise only as a last resort and usually in sport-specific magazines
- Financial Philosophy
- Who are businesses really responsible to their customers? Shareholders? We would argue that it’s none of the above. Fundamentally, businesses are responsible to their resource base. Without a healthy environment there are no shareholders, no employees, no customers, and no business
- At Patagonia, making a profit is not the goal, because the Zen master would say profits happen “when you do everything else right.” In our company, finance consists of much more than management of money. It is primarily the art of leadership thought he is balancing of traditional financing approaches in a business that is anything but traditional. In many companies, the tail (finance) wags the dog (corporate decisions). We strive to balance the funding of environmental activities with the desire to continue in business for the next hundred years…We avoid, at all costs, to go on a growth at any cost (suicide) track
- We recognize that we make the most profit by selling to our loyal customers. A loyal customer will buy new products with little sales effort and will tell all his friends. A sale to a loyal customer is worth 6-8x more to our bottom line than a sale to another customer
- Quality, not price, has the highest correlation with business success
- Whenever we are faced with a serious business decision, the answer almost always is to increase quality. When we make a decision because it’s the right thing to do for the planet, it ends up also being good for the business
- Returns and bad quality in manufacturing cost millions of dollars each year. But what is the cost of a dissatisfied customer?
- By growing at a “natural rate,” by growing by how much our customers tell us they want our products, we do not create artificial demand for our goods by advertising. We want customer who need our clothing, not just desire it.
- We never wanted to be a big company. We wanted it to be the best company, and it’s easier to be the best small company than the best big company. We have to practice self-control, growth in one part of the company may have to be sacrificed to allow growth in another. It’s also important that we have a clear idea of what the limits are to this “experiment” and live within those limits, knowing that the sooner we expand beyond them, the sooner the type of company we want will die
- We have little to no debt and this allows us to take advantage of opportunities as they come up or invest in a start-up without having to go further in debt or find outside investors. In any age when change happens so quickly, any strategic plan must be updated at least every year. An inflexible plan is centralized planning at its worst. It is oblivious to changes in reality
- We win with the government as well. We don’t play games, we aim to pay our fair share but not a penny more
- HR Philosophy
- A master in the art of living draws no sharp distinction between his work and his play; his labor and his leisure; his mind and his body; his education and his recreation. He hardly knows which is which. He simply pursues his vision of excellence through whatever he is doing, and leaves others to determine whether he is working or playing. To himself, he always appears to be doing both. – LP Jacks
- A business that thrives on being different requires different types of people
- We provide on-site childcare because we know parents are more productive if they’re not worrying about the safety and well-being of their children. Ours has an infant care room for children as young as 8 weeks and rooms progressively for toddlers to kindergarteners. The staff-to-child ratio in all parts of the center exceeds what is required by the state, and the caregivers are highly trained, and most speak more than one language to the kids. We encourage parents to interact with their child by breast-feeding, having lunch together, or visiting at any time. More than once we have had a father who fell asleep with this child at naptime. The first few years of a child’s life are recognized as being the most important learning period of their entire lives. When their brains are actively growing is the best time for them to learn cognitive skills, including problem solving and sensory processing, and language, social, and emotional skills. They are also learning physical skills, including gross and fine motor skills, as well as perceptual skills. Our child development facility is producing one of our best products, excellent kids. The babies are constantly being held and handled by lots of caregivers; they are being raised by a whole village, with lots of stimulation and learning experiences. As a result, when a stranger says hello to them, they don’t run and hide behind their mother’s skirts
- There are more than 500 employees in Ventura and more than 60 children in the center. We charge the parents rates that are comparable to local child-care centers, because we fund it with another $1m in subsidies. But what appears to be a financial burden is in fact a profit center. Studies have shown that it costs a company an average of 20% of an employee’s salary to replace an employee – from recruiting costs, training, and loss of productivity. 58% of our employees in Ventura are women, and many occupy high-level management positions. Our center helps us retained our skilled moms by making it easier for women to progress in their careers. Both moms and dads are motivated to be more productive, and the center attracts great employees.
- One cautionary tale we learned: if you’re going to have a child development center, you also need to give at least 8 weeks of paid maternity/paternity leave (we actually offer 16 weeks fully paid leave and 4 weeks’ unpaid for the mother, as well as 12 weeks fully paid paternity leave). Otherwise, many young parents still unclear on the concept of parenthood dump the baby in the nursery as soon as possible and go back to work and to pay for the new car or whatever. Those first few months are extremely important for children’s bonding with the parents instead of child-care workers.
- The child development center, with tax subsidies, pays for itself, ad the cafeteria requires only a small company subsidy. Patagonia is consistently included in a list of the 100 best companies to work for and for working mothers. Why on earth would anyone run a company that was hard to work for?
- Management Philosophy
- We never order employees around, so they have to be convinced that what they’re being asked to do is right, or they have to see for themselves it’s right. Some independent people, until the point arrives that they “get it” or it becomes “their idea,” will outright refuse to do a job.
- In a company as complex as ours, no one person has the answer to our problems, but each has a part of its solution. The best democracy exists when decisions are made through consensus, when everyone comes to an agreement that the decision made is the correct one. Decisions based on compromise, as in politics, often leave the problem not completely solved, with both sides feeling cheated or unimportant, or worse. The key to building a consensus for action is good communication. A chief in an American Indian tribe was not elected because he was the richest or had a strong political machine; he was often chosen as chief because of his bravery and willingness to take risks and for his oratory skills, which were invaluable for building consensus within the tribe. In this information age it’s tempting for managers to manage from their desks, staring at their computer screens and sending out instructions, instead of managing by walking and talking to people. The best managers are never at their desks yet can be easily found and approached by everyone reporting to them. No one has a private office at Patagonia, and everyone works in open rooms with no doors or separation. What we lose in “quiet thinking space” is more than made up for with better communication and an egalitarian atmosphere. Animals and humans that live in groups or flocks constantly learn from another. Our cafeteria, besides servicing healthy organic food, is convenient for everyone and is open all day as an informal meeting place.
- Systems in nature appear to be chaotic but in reality, are very structured, just not in a top-downs centralized way. Like in an ant colony, no one ant is in charge of a colony, there is no central control. Yet each ant knows what its job is, and ants communicate with one another by way of very simple interactions; altogether they produce a very effective social network. A top-down central system like a dictatorship takes an enormous amount of force and work to keep the hierarchy in power. Of course, all top-down systems eventually collapse, leaving the system in chaos
- A familial company like ours runs by trust rather than on authoritarian rule. I’ve found that whenever we’ve had a top manager or CEO leave the company, there is no chaos. In fact, the work continues as if they were still there. It’s not that they were doing nothing but that the system is pretty much self-regulating
- A study found that the most successful CEOs in America (not the celebrity CEOs) all enjoy working with their hands. They solved problems for themselves rather than looking for a repairman. The longevity of a CEO’s career is directly proportional to his or her problem-solving skills and ability to adapt and grow with the job
- If for whatever reason we have another downturn in our business like we had in 90-91, our policy is to first cut the fat, freeze hiring, reduce unnecessary travel, and generally trim expenses. if the crisis were more serious, we would eliminate bonuses and reduce salaries of all top-level managers and owners. Then shorten the workweek and reduce pay, and finally, as a last resort, lay people off
- How you climb a mountain is more important than reaching the top.
- You might think that a nomadic society packs up and moves when things get bad. However, a wise leader knows that you also move when everything is going too well; everyone Is laid-back, lazy, and happy. If you don’t move now, then you may not be able to move when the real crisis happens. Teddy Roosevelt said, “In pleasant peace and security, how quickly the soul in a man being to die.” Bob Dylan says, “He not busy being born is busy dying.” New employees coming into a company with a strong culture and values may think that they shouldn’t rock the boat and shouldn’t challenge the status quo. On the contrary, while values should never change, every organization, business, government, or religion must be adaptive and resilient and constantly embrace new ideas and methods of operation.
- Environmental Philosophy
- Anyone who thinks you can have infinite growth on a finite planet is either a madman or an economist. – Kenneth Boulding
- Elements of our environmental philosophy
- Lead an examined life
- Clean up our own act
- Do our penance
- Support civil democracy
- Do good
- Influence other companies
- Every time we’ve elected to do the right thing, it’s turned out to be more profitable
- I have a definition of evil different than most people. Evil doesn’t’ have to be an overt act; it can be merely the absence of good. If you have the ability, the resources, and the opportunity to do good and you do nothing, that can be evil
- When you get away from the idea that a company is a product to be sold to the highest bidder in the shortest amount of time, all future decisions in the company are affected. The owners and the officers see that since the company will outlive them, they have responsibilities beyond the bottom line. Perhaps they will even see themselves as stewards, protectors of the corporate culture, the assets, and of course the employees
- It seems to me if there is an answer, it lies in these words: restraint, quality, and simplicity. We have to get away from thinking that all growth is good. There’s a big difference between growing fatter and growing stronger
- The ship’s carpenter on Shackleton’s lifeboat the James Caird took only three simple hand tools with him on the passage from Antarctica to South Georgia Island, knowing that, if he needed to, he could build another boat with those tools. I believe the way toward mastery of any endeavor is to work toward simplicity; replace complex technology with knowledge. The more you know, the less you need. From my feeble attempts at simplifying my own life I’ve learned enough to know that we should have to, or choose to, live more simply, it won’t be an impoverished life but one richer in all the ways that really matter.
What I got out of it
- A really fun read on someone who never wanted to get into business but ended up founding a very successful and robust one. Grow appropriately, infinite growth is impossible, live simply, treat your people/suppliers/customers well, be the first customer for your products and know them intimately
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Some brilliant insights into human nature and organizational impact (annual car models, coordinated policy with decentralized authority, a policy of filling the gaps, how to incentivize employees with their bonus/compensation plans, the importance of sound dealer relations, and more). Too long of a book in many ways but worthwhile for anyone interested in business or GM’s history
- Helmer sets out to create a simple, but not simplistic,
strategy compass. His 7 powers include: scale economics, switching costs,
cornered resource, counter positioning, branding, network effects, and process.
- Strategy: the study of the
fundamental determinants of potential business value The objective here is both
positive—to reveal the foundations of business value—and normative—to guide
businesspeople in their own value-creation efforts. Following a line of
reasoning common in Economics, Strategy can be usefully separated into two
topics: Statics—i.e. “Being There”: what makes Intel’s microprocessor business
so durably valuable? Dynamics—i.e. “Getting There”: what developments yielded
this attractive state of affairs in the first place? These two form the core of
the discipline of Strategy, and though interwoven, they lead to quite
different, although highly complementary, lines of inquiry.
- Power: the set of conditions
creating the potential for persistent differential returns. Power is the core
concept of Strategy and of this book, too. It is the Holy Grail of
business—notoriously difficult to reach, but well worth your attention and
study. And so it is the task of this book to detail the specific conditions
that result in Power
- The Mantra: a route to continuing
Power in significant markets. I refer to this as The Mantra, since it provides
an exhaustive characterization of the requirements of a strategy.
- The Value Axiom. Strategy has one
and only one objective: maximizing potential fundamental business value.
- For the purposes of this book,
“value” refers to absolute fundamental shareholder value—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.
- 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.
- Benefit. The conditions created by
Power must materially augment cash flow, and this is the magnitude aspect of
our dual attributes. It can manifest as any combination of increased prices,
reduced costs and/or lessened investment needs.
- 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
- Benefits are common, and they often
bear little positive impact on company value, as they are generally subject to
full arbitrage. The true potential for value lies in those rare instances in
which you can prevent such arbitrage, and it is the Barrier which accomplishes
this. Thus, the decisive attainment of Power often syncs up with the
establishment of the Barrier.
- 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.
- The 7 Powers
- Scale Economies
- Scale Economies—the First of the 7
Powers The quality of declining unit costs with increased business size is referred
to as Scale Economies.
- Benefit: Reduced Cost
- Barrier: Prohibitive Costs of Share
- Network Economies
- Network Economies: the value of the
service to each customer is enhanced as new customers join the “network.” In
such a situation, having the most customers is everything,
- Industries exhibiting Network
Economies often exhibit these attributes: Winner take all.
- 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 chapter introduces
Counter-Positioning, the next Power type. I developed this concept to depict a
not well-understood competitive dynamic I often have observed both as a
strategy advisor and an equity investor. I must confess it is my favorite form
of Power, both because of my authorship and because it is so contrarian. As we
will see, it is an avenue for defeating an incumbent who appears unassailable
by conventional wisdom metrics of competitive strength.
- But nearly always, these featured
the same outcome: the incumbent responds either not at all or too late. 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. In the Vanguard case, Fidelity looked at their highly
attractive active management franchise and concluded that the new passive
funds’ more modest returns would likely fail to offset the damage done by a
migration from their flagship products.
- What are the potential causes of
such decrements? They could be numerous, but over several decades of client
strategy work, I have noted two that seem common. The first involves two characteristics
of challenges to incumbency:
- The challenger’s approach is novel
and, at first, unproven. As a consequence, it is shrouded in uncertainty,
especially to those looking in from the outside. The low signal-to-noise of the
situation only heightens that uncertainty.
- The incumbent has a successful
business model. This heritage is influential and deeply embedded, as suggested
by Nelson and Winter’s notion of “routines,” and with it comes a certain view
of how the world works. The CEO probably can’t help but view circumstances
through this lens, at least in part. Together these two characteristics
frequently lead incumbents to at first belittle the new approach, grossly
underestimating its potential.
- As noted in the Introduction, Power
must be considered relative to each competitor, actual and implicit. With
Counter-Positioning, this is particularly important, because this type of Power
only applies relative to the incumbent and says nothing regarding Power
relative to other firms utilizing the new business model.
- Though this isn’t always the case, I
have noticed a frequently repeated script for how an incumbent reacts to a CP
challenge. I whimsically refer to it as the Five Stages of Counter-Positioning:
Denial Ridicule Fear Anger Capitulation (frequently too late)
- 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. Counter-Positioning often underlies
situations in which the following developments are jointly observed: For the
challenger Rapid share gains Strong profitability (or at least the promise of
it) For the incumbent Share loss Inability to counter the entrant’s moves
Eventual management shake-up (s) Capitulation, often occurring too late
- Such reversals are rare in business,
because contests typically take place over extended periods and with great
thoughtfulness on all sides. Even a momentary lapse by an incumbent won’t
present a sufficient opening. The only bet worthwhile for a challenger is one
in which even if the incumbent plays its best game, it can be taken off the
board. A competent Counter-Positioned challenger must take advantage of the
strengths of the incumbent, as it is this strength which molds the Barrier,
- Switching Costs
- 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.
- Benefit. A company that has embedded
Switching Costs for its current customers can charge higher prices than
competitors for equivalent products or services. 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.
- 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. Thus, as with Scale Economies and Network
Economies, the Barrier arises from the unattractive cost/benefit of share gains
for the challenger.
- Switching Costs can be divided into
three broad groups:
- Switching Costs are a non-exclusive
Power type: all players can enjoy their benefits.
- Branding is an asset that
communicates information and evokes positive emotions in the customer, leading
to an increased willingness to pay for the product.
- Benefit. A business with Branding is
able to charge a higher price for its offering due to one or both of these two
- Affective valence. The built-up
associations with the brand elicit good feelings about the offering, distinct
from the objective value of the good.
- Uncertainty reduction. A customer
attains “peace of mind” knowing that the branded product will be as just as
- Barrier. A strong brand can only be
created over a lengthy period of reinforcing actions (hysteresis), which itself
serves as the key Barrier.
- Brand Dilution. Firms require focus
and diligence to guide Branding over time and ensure that the reputation
created remains consistent in the valences it generates. Hence, the biggest
pitfall lies in diminishing the brand by releasing products which deviate from,
or damage, the brand image. Seeking higher “down market” volumes can reduce
affective valence by damaging the aura of exclusivity, weakening positive
associations with the product.
- Problem is, the qualities that make
Branding a Power also make it hard to change; the considerable risk is dilution
or brand destruction.
- Type of Good. Only certain types of
goods have Branding potential as they must clear two conditions:
- Magnitude: the promise of eventually
justifying a significant price premium. Business-to-business goods typically
fail to exhibit meaningful affective valence price premia, since most
purchasers are only concerned with objective deliverables. Consumer goods, in
particular those associated with a sense of identity, tend to have the
purchasing decision more driven by affective valence. Here’s the reason: in
order to associate with an identity, there must be some way to signal the
exclusion of alternative identities.
- For Branding Power derived from
uncertainty reduction, the customer’s higher willingness to pay is driven by
high perceived costs of uncertainty relative to the cost of the good. Such
products tend to be those associated with bad tail events: safety, medicine,
food, transport, etc. Branded medicine formulations, for example, are identical
to those of generics, yet garner a significantly higher price. Duration: a long
enough amount of time to achieve such magnitude. If the requisite duration is
not present, the Benefit attained will fall prey to normal arbitraging
- Cornered Resource
- Cornered Resource definition:
Preferential access at attractive terms to a coveted asset that can
independently enhance value.
- 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.
- 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
- Our general term for this sort of
barrier is “fiat”; it is not based on ongoing interaction but rather comes by
decree, either general or personal.
- Another way to put this is that a
Cornered Resource is a sufficient condition for potential for differential
- Process Power
- I save it until last because it is
rare. I will use the Toyota Motor Corporation as a case.
- Perhaps the best way to think of it
is this: Process Power equals operational excellence, plus hysteresis. Having
said that, such hysteresis occurs so rarely that I am in strong agreement with
Professor Porter’s sentiments.
- 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
- 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.
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.
- The Path to Power: “Me Too” Won’t Do
- Here’s the first important takeaway
from our consideration of Dynamics: “getting there” (Dynamics) is completely
different from “being there” (Statics). In other words, to assess which
journeys are worth taking, you must first understand which destinations are
desirable. Fortunately the 7 Powers does exactly that: it maps the only seven
- The first cause of every Power type
is invention, be it the invention of a product, process, business model or
brand. The adage “‘Me too’ won’t do” guides the creation of Power.
- Planning rarely creates Power. It
may meaningfully boost Power once you have established it, but if Power does
not yet exist, you can’t rely on planning. Instead you must create something
new that produces substantial economic gain in the value chain. Not
surprisingly, we have worked our way back to Schumpeter.
- Power arrives only on the heels of
invention. If you want your business to create value, then action and
creativity must come foremost. But success requires more than Power alone; it
needs scale. Recall the Fundamental Equation of Strategy: Value = [Market Size]
- Invention has a powerful one-two
value punch: it both opens the door for Power and also propels market size.
- By far the most important “value
moment” for a business occurs when the bars of uncertainty are radically
diminished with regards to the Fundamental Equation of Strategy, market size
and Power. At that moment, the cash flow future makes a step-change in transparency.
- A primary driver of opacity is high
flux: if a business is in a fast-changing environment, then the information
facing investment pros tends to have much higher uncertainty bars regarding
future free cash flow. But high flux also attends the sort of conditions which
orbit the “value moment.” So if the 7 Powers can lead to alpha by identifying
Power in these situations ex ante, it also promises to be useful in doing the
same for those inventors on the ground trying to find a path to satisfy The Mantra.
- The 3 S’s. Power, the potential to
realize persistent differential returns, is the key to value creation. Power is
created if a business attribute is simultaneously:
- Superior—improves free cash flow
- Significant—the cash flow
improvement must be material
- Sustainable—the improvement must be
largely immune to competitive arbitrage
What I got out of it
Helmer provides a simple,
but not simplistic, strategy framework in which to analyze, build, invest in
companies. SSCCBNP – scale economies, switching costs, cornered resource,
counter positioning, branding, network effects, process. The book is well worth
reading and re-reading. The real world examples he gives relating to his
framework are helpful to better understand it all.