A strategy framework "prepares the mind" so that you can correctly make the crux decisions. It
should be simple but not simplistic.
Statics: "being there." E.g. What makes Intel's microprocessor business so durably valuable?
Dynamics: "getting there." E.g. What developments yielded this attractive state of affairs at
Intel in the first place?
Power: the set of conditions creating the potential for persistent differential returns
"We can only assume microprocessors possessed some sort of rare characteristics which materially
improved cash flow, while simultaneously inhibiting competitive arbitrage."
Strategy: a route to continuing Power in significant markets.
Potential value = market scale * Power
Being a clever business person is not sufficient to achieve differential long-term value creation.
Power delivers to the firm both a Benefit and a Barrier
For the differential returns to be durable, there must be some barrier preventing the
competition from performing arbitrage.
"In Intel's case, the heart of its microprocessors strategy can be best understood not by sorting
through the multiplicity of Intel's value improvements, but by deducing why decades of capable and
committed competition failed to emulate or undermine those improvements."
Single business focus: each business within a company will have its own strategy landscape.
Scale economies (chap 1)
Netflix, on transitioning from mail DVDs to streaming:
"Given the uncertainty inherent in this emerging field, they took their time, demurring on
high-testosterone bet-the-company antics."
"But deploying smart tactics, though complex and demanding, is not itself a strategy, and indeed
any potential for Power remained opaque in those early days. For the time, Netflix could only stay
alert and hope that Pasteur's dictum [("Chance Favors the Prepared Mind")] would eventually bear
fruit and chance would favor their prepared minds."
Netflix was able to afford original content because the cost to produce it was amortized across
their large subscriber base. Less scaled competitors couldn't justify the investment on original
content.
"In the Netflix example we see a feature of Scale Economies that recurs in many technology
firms: a single fixed cost which declines per unit as it is prorated over higher and higher
volumes."
(Couldn't this be argued to be the case for all complex software, since it has zero marginal
cost to service new users?)
Benefit: reduced cost
Barrier: prohibitive costs of share gains
To gain scale, an entrant must offer lower prices or better quality. A market leader will observe
that, and price-match to prevent the erosion of their scale economies.
Other types of scale economies
Distribution network density
Learning economies: if learning leads to a product benefit, and it's positively correlated with
production levels, then a scale advantage accrues to the leader.
(Google Search R&D arguably has this.)
Purchasing economies: when a large buyer can command lower prices, e.g. Walmart, Costco.
Network Economies (chap 2)
Examples: MS Windows, Facebook, LinkedIn
"Network Economies occur when the value of a product to a customer is increased by the use of the
product by others."
Benefit: product is more valuable with each incremental user.
Cost: value deficit of a follower can be prohibitive.
Common characteristics of Network Economies:
Winner takes all
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 and not professional
interactions. The boundaries of the network effects determine the boundaries of the business."
Indirect network effects (AKA demand side network effects)
"If a business has important complements and these complements are somehow exclusive to each
offering, then a leader will attract more and/or better complements."
Examples: a mobile OS having a good app ecosystem, which a new entrant cannot replicate.
Counter positioning (chap 3)
Basically, the innovator's dilemma.
Benefit: new business model is superior to the incumbent's model due to lower costs or the ability
to charge higher prices.
Barrier: by adopting the new model, the incumbent will incur collateral damage because they would
have to give up an existing lucrative position.
Incumbents are not stupid. They are often constrained from adopting the challenger's strategy.
"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 asset
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."
Note that some tech revolutions just change the landscape, and the incumbent has no ability to
compete and obtain power in the new landscape. This is not a case of Counter-Positioning.
Example: Kodak and digital cameras. They were a film company and had no competency in digital.
Why don't incumbents suffer the collateral damage?
In retrospect, it may have made sense for the incumbent to suffer the collateral damage and
adopt the new approach, but new strategies are often high uncertainty, and so it's not
reasonable for the incumbent to act — action has a lower expected value than inaction.
There's also an agency problem: it's hard to align a CEO's compensation to allow for pivots.
"Addressing the threat of a Counter-Positioned competitor frequently requires upending the
incumbent's business in multiple ways, and such turmoil is rarely symmetric in its impact on
enterprise value and compensation, even with best practice Long-Term Incentive Plans in
place."
Counter-Positioning creates power against a larger incumbent, but creates no power against
competitors similar to the entrant. E.g. In-N-Out vs. Five Guys. Both of them are
counter-positioned against McDonald's, but they are not counter-positioned against each other.
Five Stages of Counter-Positioning (how new incumbents react to counter-positioning):
Denial; ridicule; fear; anger; capitulation.
Capitulation happens often too late, via "dabbling," because there's dual pressures to adopt the
new model but also preserve the existing business.
"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."
Switching costs (chap 4)
It's hard for a business to switch from S&P's ERP software, or MS Office, or for consumers to
switch away from iTunes.
"A company like SAP, profiting from the indenture of its clients, has all incentive to hike the
prices of such services."
"Switching Costs arise when a consumer values compatibility across multiple purchases from a
specific firm over time."
Or, if the customer had to customize the deployment of the solution.
Benefit: firm can charge higher prices.
Barrier: to offer an equivalent product, competitors must compensate customers for Switching
Costs. This makes share grains for the entrant expensive, and thus less attractive.
Note that Switching Costs do not offer power over new, potential customers. Entrants can compete
for those new customers without suffering from the barrier.
(E.g. Google Docs targeted new businesses, not existing businesses who were already using MS
Office.)
Types of switching costs
Financial: customer has to restart their investment and perform a migration.
Procedural: retraining, unfamiliarity with the new solution, new headcount, risk resulting from
the migration.
Relational: it's hard to abandon a community that the user likes and identifies with.
The firm can increase related sales to existing, captured customers, by introducing new product
lines, potentially by M&A.
When more product lines are adopted, they increases customer entanglement and thus switching
costs.
Switching Costs power can lead to Branding power
"If the product preference of users already tethered by Switching Costs spills over to a wider
pool of potential customers, you could find yourself enjoying the effects of Branding."
Branding (chap 5)
"Branding is an asset that communicates information and evokes positive emotions in the customer,
leading to an increased willingness to pay for the product."
The brand is built on historical information that buyers accumulate about the seller.
Benefit: the firm is able to charge higher prices due to affective valence or uncertainty
reduction.
Affective valence: built-up associations with the brand which elicit good feelings which are
distinct from the actual underlying value of the good.
Uncertainty reduction: the customer expects less risk in their usage experience, because of the
brand's reputation.
Barrier: "a strong brand can only be created over a lengthy period of reinforcing actions
(hysteresis), which itself serves as the key Barrier. Again, Tiffany has cultivated its brand name
for more than a century. What's more, copycats face daunting uncertainty in initiating Branding: a
long investment runway with no assurance of an eventual path to significant affective valence."
Brand dilution: taking actions which contradict historical actions. E.g. a luxury brand
introducing a "value" line of products.
Only certain types of goods have Branding potential:
For a brand to have branding power, the type of good being purchased must be bought based on
affective valence.
"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."
Uncertainty reduction is valuable in products where failure is highly undesirable.
"Such products tend to be those associated with bad tail events: safety, medicine, food,
transport, etc."
Cornered resource (chap 6)
Cornered resource: celebrity talent, patent or key invention, property rights on a key resource,
secret or non-replicable R&D process.
Pixar had celebrity talent: the only team that could produce animated films at that quality. They
didn't defect, because they were making history.
Benefit: the resource produces an uncommonly appealing product.
Barrier: fiat — the resource is cornered via decree, either general or personal ("personal"
meaning that the celebrity talent has chosen to exclusively work with the firm for some reason).
If the firm secures exclusive access to a coveted resource but has to pay such that all of the
value is arbitraged out, then it is not power. Example: a production studio signing an expensive
big-name actor.
Process power (chap 7)
Benefit: the firm is able to improve the product, or lower costs, as the result of process
improvements embedded in the firm. E.g. Toyota with TPS (Toyota Production System).
Barrier: hysteresis: the process advances are difficult to replicate and can only be achieved over
a long time period of sustained evolutionary advance.
The inherent "speed limit" in replicating a firm's process advancements is due to complexity and
opacity. Opacity meaning the process is not fully codified and thus not easily portable — it's
difficult to tease out what parts and dependencies are making it so successful.
This power is rare.
"The type of Benefit it cites — evolutionary bottom-up improvement — stands at the heart of
operational excellence; as such, it is quite common. The rarity of Process Power results from
the infrequency of the Barrier: an unyielding, long-time constant for the improvements in
question."
Operational excellence is not a strategy. It doesn't confer sustainable differentiation over
competent competitors.
Argues the quality / cost reduction gains over time — "traveling along the experience curve" —
are widely similar across firms.
Operational excellence is essential for establishing sources of power, but it is not itself power.
The path to power - "me too" won't do (chap 8)
(Helpful chapter on how firms actually transition from having no Power to having Power).
"Armed with one or more of these Power types, your business is ideally positioned to become a
durable cash-generator, despite the best efforts of competitors. If you possess none of these,
your business is at risk."
"Competitors can easily mimic the improvements yielded by operational excellence, eventually
arbitraging out the value to the business."
Netflix had counter-positioning power against Blockbuster when it was in the DVD business. But it
had no power in the streaming business, despite being a first mover, and competent. "Operational
excellence is not a strategy."
"here one might hypothesize some Scale Economies: as Netflix accumulates more data, the acuity of
their recommendations increases. True, but not linear: these advantages paid only diminishing
returns, meaning a smaller competitor of an attainable scale could realize most of the same
benefit."
(This sounds like a valid criticism that could be made against any personalization company
claiming their data sets provide durable Power.)
Netflix spent most of their time on operational excellence, and rightfully so — it was necessary,
but not sufficient, to guarantee ongoing differentiation.
Transitioning into originals unlocked Economies of Scale power, because the content became a fixed
rather than variable cost, and could be consumed by Netflix's existing large subscriber base —
larger than competitors'.
"The saga of Netflix's ascent exemplifies intelligent adaptation over an extended period in the
face of daunting uncertainty. The terrain of entrepreneurs, not planners."
"Prior to Netflix's success, the value potential was opaque to the investment community, not
because investors were thoughtless or ill-informed, but because the 'route to Power' was not just
unknown, but unknowable — even to Netflix management."
As soon as they established power and proved it, their share price increased 100x.
What route did Netflix take to creating Power? They took the competitive position of an attractive
new service. "Netflix's pioneering rollout excited customers, and their influx propelled Netflix
to an early relative scale advantage that the company has never relinquished."
The 7 powers maps "the only seven worthwhile destinations" for a company.
"Crafting": the author argues that Netflix crafted their course through experimentation and
testing the waters, rather than far-sighted strategic planning.
Crafting was the only feasible way to discover and develop all of the complements to their
streaming product.
The first cause of every power type is invention: some new thing to break in with.
"Flux" creates new footholds for invention to crack open the market and for firms to obtain power.
"The 7 Powers framework focuses your attention on the critical issues and increases the odds of a
favorable outcome." This is "the most that strategy can accomplish, as the company develops
inventions."
(If power only follows invention, then a firm without power should dedicate itself to having a
malleable development process and seek positions of high potential energy, to fuel the rate of
invention.)
Value capture: "Invention drives a favorable change in system economics — you get more for less.
The resulting gain in the end will be split somehow between your company and other segments of the
value chain. The 7 Powers is all about making sure that you get some of the increase. But it is
the gain customers experience that will shape the market size."
"Compelling value", that is sufficiently compelling such that customers rapidly adopt a product,
differs in magnitude by industry. For software, compelling may mean a 10x improvement. For battery
efficiency, it might be 2x. Jobs described this threshold as "insanely great" products.
How to create invention and compelling value? Several options:
Start from:
Your capabilities: customer need is unknown; takes awhile. E.g. Pixar.
Customer needs: well-known customer problem. Risk is technical: can you solve the problem?
Competitor-led: With a new technique or changing environment, can you offer 10x better
solution and then stay ahead?
The power progression (chap 9)
Intel as a case study: they had operational excellence and world class management in both their
memory and microprocessor business, but only one provided an enduring high-margin business,
because in microprocessors Intel had Power.
MS-DOS and Lotus 123 were written for the Intel processor. This meant that IBM PC clones had to
adopt Intel chips too. This network economy eventually disappeared as OSes and applications
abstracted away the chipset.
"The one-sentence story of Intel is a single design win, then a decade and a half of very high
Switching Costs, then Scale Economies."
(This chapter has a helpful, thorough analysis of each of Intel's sources of power)
All of Intel's sources of Power (scale economies, network economies, switching costs) were rooted
in their takeoff period.
Network economies: the takeoff stage is critical for this power, because Network Economies are
often characterized by a tipping point: "once the leader has achieved an edge in installed base,
most users will find it to their benefit to choose that leader."
(This was the case with Microsoft's languages, and later their operating systems. "We set the
standard.")
"Takeoff is the stage when differential customer acquisition can take place at favorable terms,
which is why it presents such ideal Power opportunities."
From the author's experience, the "takeoff period" for companies in a market lasts while the
business is growing 40% or more per year. Such high growth indicates ongoing flux and
opportunity to establish power, and for market leadership swaps.
"If a company has not established Power, competitive arbitrage will catch up as soon as growth
slows; fundamentals will assert themselves, and the favorable early returns will prove fleeting."
The company will transition to being a low-margin player running hard on a treadmill of
competition.
(See also Thiel: competition is for losers)
"The [Benefits of power] 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."
So, the question is, "when must Power be established"? It varies by the type of Power.
Power progression: Phase of business -> when a power can be established
"The Counter-Positioning and Cornered Resource are most likely to be established in the
origination stage. These are wonderful, durable types of Power specifically because your 'route to
Power' is locked in early, so long as you execute well."
Process Power is developed in the stability phase. "Only when a company has scaled sufficiently
and operated long enough can it have evolved processes which are sufficiently complex or opaque to
defy speedy emulation."
Branding: if one can invest enough time into branding, and remaining a market leader until the
stability phase, then you can qualify for this power, which is unavailable to new entrants.
"In the high flux shortened time frame of the takeoff Stage, sufficiently timely imitation becomes
less likely, and excellent execution can be highly strategic."
(Warren Buffet) "Good managers can rarely reverse the course of a bad business," i.e. one without
Power.
A business must have a route to Power over each one of its competitors for it to have sustainable
differentiation. The Power used may be different per competitor.
The prospect of monopoly profits is the incentive — the fuel — for invention.
"From a static viewpoint, the search for Power may seem like a zero sum game of preventing gains
flowing to consumers. But from a Dynamics viewpoint, it is the possibility of Power that is a
critical motivator of invention."