Newsletter #25: 7 powers
15 minutes reading time. Thoughts on startups, growth, and technology 🚀
Welcome to another edition of the Struggle.
The Struggle is a weekly newsletter where I share my thoughts and learnings from running a fast-growing startup in Southeast Asia.
Whenever I choose a book to read, I take my time to find the most relevant, highly rated and endorsed content that will help me to reach the next level in my career.
Recently, I stumbled on a book that checked all the boxes as it was recommended by Reed Hastings, CEO and Co-Founder of Netflix, Daniel Ek, CEO and Co-Founder of Spotify, Peter Thiel, entrepreneur and investor, Mike Moritz, Chairman of Sequoia Capital and many more remarkable people.
"7 powers" written by Hamilton Helmer
answers one simple, but not a simplistic question:
What are the secrets to making a company enduringly valuable?
Hamilton’s framework helps business leaders determine long-term success or failure, as Hamilton hits the nail on the head with the concept of "power."
In the context of the book, "power" is something that provides a competitive advantage to a company's customers while creating a barrier to its competitors.
The startup world is obsessed with the total available market size (TAM), but if there is nothing about your business that keeps it from becoming a commodity, all of your economic profit will get arbitraged away. “7 powers” helps you to design a moat protecting your business.
To illustrate the framework, I will describe each power and share a popular example of a company which is taking advantage of such a strategy:
Power 1: Scale Economies
Also known as economies of scale. If you have attended Business School, you would know that economies of scale refer to a process where the unit cost declines as production volume increases. The benefits are reduced cost, and as a company gains market share, it becomes harder for new entrants to compete.
Let's take the example of Netflix. When Netflix creates originals e.g., House of Cards, they have a very high fixed cost, but the more users sign up, the cheaper it gets for them to create originals. Consider the following example (I am making up numbers):
Netflix's costs for producing House of Cards $100M
Total number of subscribers 100M paying Netflix $100/year
That's 1% of Netflix's annual revenue.
Now imagine that an emerging competitor comes into the picture with 1M subscribers who pay $50/year. Guess who is going to win the market?
Power 2: Network Economies
Also known as network effects and my favorite "power."
As you may know, I have written posts about Network Effects and Marketplaces in the past. If you haven't read them, consider the following, a network effect occurs when a product or service becomes more valuable to its users as more people are using it.
Let's take a familiar case and look at Airbnb being the most common example in my previous few posts. What gives Airbnb a unique network effect is an interplay between supply and demand. Guests become hosts, and hosts also become guests; thus, the flywheel spins on and on.
As a result, Airbnb can charge higher prices because their network is becoming increasingly more valuable. It's tough to compete with companies exhibiting network effects.
Power 3: Counter Positioning
This power takes place when a newcomer adopts a new, superior business model that the incumbent does not mimic due to anticipated damage to their existing business.
There is excellent literature on the topic by Clayton Christensen on Disruptive Technologies. A few notable examples are:
Personal computers (Disruptor) VS Mainframe and minicomputers (Disruptee)
Cellular phones (Disruptor) VS Fixed-line telephony (Disruptee)
Netflix (Disruptor) VS Blockbuster (Disruptee)
Typically, the disrupted companies would go through the following stages when such power is exhibited:
Denial
Ridicule
Fear
Anger
Capitulation
Power 4: Switching Costs
Think about companies like SAP or Oracle. No matter how dissatisfied you may be with their product, you will stick around because you are afraid of the value loss that may take place from switching to an alternative supplier for additional purchases.
As a result, if you can embed Switching Costs as a strategy, you can charge higher prices than your competitors while selling many additional services.
If a competitor wants to enter your space and compete for your clients, they will need to compensate customers for the switching costs.
Types of Switching costs:
Financial
Procedural (learning how to use a new product)
Relational (product and personnel)
Power 5: Branding
The durable attribution of higher value to an objectively identical offering that arises from historic info about the seller.
I guess that's a power that everyone can relate to as we use products on a daily basis that have cheaper alternatives but we prefer the items with the better brand.
When a company is able to build and sustain a good brand they are able to charge a higher price, but building a brand takes a long time. Many of the most powerful brands such as Apple, Nike, Louis Vuitton, Tiffany & Co took many years to be built.
The example above reflects the brand Tiffany & Co has been able to develop in the jewelry industry while sustaining 2 to 3 times higher margin than their competition.
Power 6: Cornered Resource
As the name suggests, here we are referring to preferential access at attractive terms to a coveted asset that can independently enhance value. The most common cornered resource is a patent, but what surprised me here is that Hamilton used the example of Pixar, referring to the Pixar Brain Trust consisting of the three founders: John Lasseter, Ed Catmull, and Steve Jobs. Another famous example is the Sequoia partnership after the 1999 fund. Such groups of exceptional people can produce uncommonly appealing products that are hard to replicate i.e., Pixar movies.
Power 7: Process Power
The best example in this category is Toyota's production system. Their process required many years to be developed, and the company let competitors study it (so many books are written on their lean manufacturing). Yet, Toyota remains the second most valuable car automaker in the world (after Tesla). The embedded process improves over time, leading to low costs.
And here you go all powers and their competitive positions:
Before I wrap it up, I would like to give an example of a business that has managed to take advantage of 6, perhaps all 7 powers. And in the process becoming one of the world's most valuable companies - Apple.
Scale economies
“Apple’s economy of scale is so enormous that it, in effect, has the logistics companies over a barrel. Any company shipping millions and millions of parcels per month will be able to negotiate with FedEx, DHL, and all the other courier firms.” [TechCrunch]
Network economies - via the App Store, which benefits from the 2-sided network effects. A large number of users leads to more developers, which means a lot more and better apps. This creates a symbiotic relationship between app developers and Apple users.
Switching costs
“the switching cost per iOS user ranges between $122 and $301. That implies the average user would need a discount of 49 percent to switch to a competing platform.” [AppleInsider]
Branding
“Forbes recently published its annual study on one of the world’s most valuable brands. Coming as no surprise to most, the front-runner Apple topped the list of branding behemoths for the ninth year running, amassing an eye-watering brand value of $205.5 billion—up 12% over last year.” [Forbes]
Cornered resources - iOS, Steve Jobs and Steve Wozniak being the founders.
Process
“what is really interesting about Apple is not just that it can design great products, but that it can actually manufacture the things in huge volumes, and deliver them to market on time. In the last quarter of 2014, shifted 114,676kg of iPhones a day, on average. Just for comparison, the operating dry weight of a Boeing 787-8 Dreamliner is 117,707kg. Ponder those numbers for a moment. They would be remarkable if Apple were simply stamping out 846,590 metal bars a day. But the iPhone is not a metal slab; it’s an astonishingly complex product – as you can readily ascertain by voiding your warranty and taking a screwdriver to yours.” [The Guardian]
Counter positioning - This is the only power that I am not convinced Apple managed to take advantage of. Perhaps in their early days against IBM? Please share your views as a comment or reply to this email.
In conclusion, I would like to leave you with a quote from Reed Hastings CEO and Co-Founder of Netflix, that summarizes well all the hype around “7 powers:”
“7 Powers tightly integrates the numerous insights he has developed in his several decades of consulting, active equity investing and teaching. It is a uniquely clear and comprehensive distillation of strategy. It will change how you think about business, and pull into focus your critical strategy challenges, not to mention their solutions. It may not be the lightest of beach reads; you probably won’t tear through it in a night, but I am confident that your attention will be rewarded many times over”.
Resources worth checking out:
📝 Report on Southeast Asia Tech Investment in 2019 | Cento Ventures - Some changes have been seen in the landscape of technology investment in Southeast Asia in 2019. The total amount we have seen invested in tech companies in the region in 2019 totaled $7.7B. This is noticeably lower than the $12B we recorded in 2018, however, while there were fewer ‘mega-deals’, there was a significant increase in smaller VC deals. The total amount invested in smaller deals (less than $50M invested) set a new record of $2.4B, up from $1.5B in 2018. In contrast, the amount that was deployed in the largest deals (more than $50M invested) was $5.3B in 2019, compared with $10.5B in 2018.
📝 The Three Sides of Risk | Morgan Housel - At a conference a few months ago I was asked what skiing taught me about investing. This was on stage, where you can’t ponder your answer – you have to blurt out whatever you can think of.
I didn’t think skiing taught me anything about investing. But one incident came to mind.
“Well, let me take this to a dark and tragic place,” I said before telling a group of 500 strangers a story I hadn’t talked about much in almost 20 years.
A quote worth remembering:
💬 Author James Clear on the benefits of having a challenging life:
“You are only as mentally tough as your life demands you to be.
An easy life fashions a mind that can only handle ease. A challenging life builds a mind that can handle challenge. Like a muscle that atrophies without use, mental strength fades unless it is tested.
When life doesn't challenge you, challenge yourself.”
A book recommendation:
📖 7 Powers: The Foundations of Business Strategy by Hamilton Wright Helmer by Marty Cagan
If you need more testimonials check out this link.
Positive news worth sharing:
Battery scientists are cramming more energy into a smaller space. It has led to so many benefits. Powerful smartphones. Electric vehicles becoming economically viable. Reducing our dependence on fossil fuels. Slashing the cost of battery power by 85% in a decade.
Check out the source here.
The Road to 500
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Thanks for reading,
Viktor