Tag Archives: Strategy

7 Powers: The Foundations of Business Strategy by Hamilton Helmer

Summary

  1. 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.

Key Takeaways

  1. 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.
  2. 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
  3. 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.
  4. The Value Axiom. Strategy has one and only one objective: maximizing potential fundamental business value.
    1. 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.
  5. 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.
    1. 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.
    1. 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
    1. 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.
  6. 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.
  7. The 7 Powers
    1. Scale Economies
      1. Scale Economies—the First of the 7 Powers The quality of declining unit costs with increased business size is referred to as Scale Economies.
        1. Benefit: Reduced Cost
        1. Barrier: Prohibitive Costs of Share Gains
    1. Network Economies
      1. 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,
      1. Industries exhibiting Network Economies often exhibit these attributes: Winner take all.
    1. Counter-Positioning
      1. Counter-Positioning: A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.
      1. 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.
      1. 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.
      1.  
      1. 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:
        1. 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.
        1. 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.
      1. 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.
      1. 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)
      1. 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
      1. 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, collateral damage.
    1. Switching Costs
      1. 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.
      1. 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.
      1. 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.
      1. Switching Costs can be divided into three broad groups:
        1. Financial.
        1. Procedural.
        1. Relational.
      1. Switching Costs are a non-exclusive Power type: all players can enjoy their benefits.
    1. Branding
      1. Branding is an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product.
      1. Benefit. A business with Branding is able to charge a higher price for its offering due to one or both of these two reasons:
        1. Affective valence. The built-up associations with the brand elicit good feelings about the offering, distinct from the objective value of the good.
        1. Uncertainty reduction. A customer attains “peace of mind” knowing that the branded product will be as just as expected.
      1. Barrier. A strong brand can only be created over a lengthy period of reinforcing actions (hysteresis), which itself serves as the key Barrier.
      1. 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.
      1. Problem is, the qualities that make Branding a Power also make it hard to change; the considerable risk is dilution or brand destruction.
      1. Type of Good. Only certain types of goods have Branding potential as they must clear two conditions:
        1. 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.
        1. 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 behavior.
    1. Cornered Resource
      1. Cornered Resource definition: Preferential access at attractive terms to a coveted asset that can independently enhance value.
      1. 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.
      1. 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.
      1. 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.
      1. Another way to put this is that a Cornered Resource is a sufficient condition for potential for differential returns.
    1. Process Power
      1. I save it until last because it is rare. I will use the Toyota Motor Corporation as a case.
      1. 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.
      1. 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.
      1. 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:
        1. 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.
        1. 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.
  8. The Path to Power: “Me Too” Won’t Do
    1. 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 worthwhile destinations.
    1. 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.
    1. 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.
    1. 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] * [Power]
    1. Invention has a powerful one-two value punch: it both opens the door for Power and also propels market size.
  9. Other
    1. 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.
    1. 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.
    1. 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:
      1. Superior—improves free cash flow
      1. Significant—the cash flow improvement must be material
      1. 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.

A Treatise on Efficacy

This book ties together so many recent themes for me – Werner’s effortless mastery, strategy, philosophy, psychology, and more.

A book well worth reading and re-reading. One of my all time favorites

A Treatise on Efficacy

The Prince by Niccolo Machiavelli

 The Prince

 

Summary
  1. Machiavelli lays out what the prince of a territory should and should not do in order to rule successfully. His insight covers topics from how to rule your people, what to do with colonies, whether one should wish to be feared or loved (not hated turns out to be the answer), how to rule newly conquered people, etc. It is often very direct and harsh in its suggestions.
Key Takeaways
  1. It is far better to gain the confidence of the people than to rely on fortresses
  2. He who thinks that new favors will cause great personages to forget old injuries deceives himself
  3. Of fortune and women, it is the bold rather than the cautious that will win and hold them both
  4. Men are still the dupes of their simplicity and greed
  5. The cloak of religion still conceals the vices of mens’ ambitions
  6. Louis XII made the 5 errors – he destroyed the minor powers, he increased the strength of one of the greater powers in Italy, he brought in a foreign power, he did not settle in the country, he did not send colonies
  7. He who has not first laid his foundations may be able with great ability to lay them afterwards, but they will be laid with trouble to the architect and danger to the building
  8. Upon this a question arises: whether it be better to be loved than feared or feared than loved? It may be answered that one should wish to be both, but, because it is difficult to unite them in one person, it is much safer to be feared than loved, when, of the two, either must be dispensed with. Love is preserved by the link of obligation which, owing to the baseness of men, is broken at every opportunity for their advantage; but fear preserves you by a dread of punishment which never fails. Above being feared and loved, it is more important to avoid hatred
  9. A prince who is not wise himself will never take good advice, unless by chance he has yielded his affairs entirely to one person who happens to be a very prudent man.
  10. It is of the greatest important in this world that a man should know himself, and the measure of his own strength and means; and he who knows that he has not a genius for fighting must learn how to govern by the arts of peace. 
What I got out of it
  1. The term Machiavellian has been a bit distorted over the centuries to become synonymous with manipulation. While Machiavelli undoubtedly advises this in certain situation, that is not his main argument. Many valid points on how to deal with people or groups of people and while his examples are dated, his messages are as clear as ever.

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Art of War by Sun Tzu

Art of War

 

Summary
  1. Sun Tzu’s 2,000 year old principles are as relevant today as they were back then. Whether in business, sports, war, or any other field, taking care of the small decisions as well as deception, disguise and diversion are all required for success.
Key Takeaways
  1. Sun Tzu lived from 544 to 496 BC and was a very successful general even in his own time and was revered by all Chinese military leaders for centuries
  2. Art of War was origianlly written for King Helu
  3. “He who relies solely on warlike measures shall be exterminated; he who relies solely on peaceful measures shall perish.”
  4. Many think of China as the largest peace-loving nation on earth but forget about her turbulent, violent times thousands of years ago. They had built the Great Wall and had a huge standing army before Rome’s first legion even existed
What I got out of it
  1. Amazing how certain principles will always be relevant and Sun Tzu’s Art of War is no exception. Although his examples are all based on warfare, these can be translated into any field. Great read

Read The Art of War

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