Books in a Pod: 7 Powers
Hello and welcome to “Books in a Pod”. There are so many great books out there, but too few hours in a day to read them all cover-to-cover. We’re here to bring you the key takeaways in a simple blog format. Think CliffsNotes, but for working professionals. We’ll be reading from a variety of topics, from business, social sciences and economics to meditation and mental health. Each episode covers the main takeaways, key concepts and interesting frameworks you might want to chew on, so that you can get the bulk of the value in a fraction of the time.
Today we’re talking about 7 Powers: The Foundations of Business Strategy, by Hamilton Helmer.
The author holds a PhD in Economics from Yale University, and draws on his decades of experience as a strategic consultant, advisor, investor and educator to lay out a seven-faceted framework for how companies build persistent competitive advantages. Organizations like LinkedIn, Spotify and Netflix harness these concepts to build durable moats and cement their leadership in their respective sectors.
Helmer defines a power as something that serves as both a unique “benefit” to the power wielder and a significant “barrier” to competitors.
So what are the 7 powers? They are
1. Scale economies
2. Network economies
3. Counter-positioning
4. Switching costs
5. Branding
6. Cornered resources
7. Process power.
We’ll go through them one by one.
The first power of the 7 powers is scale economies, which is defined as “the quality of declining unit costs with increased business size”. What is a good example of scale economies? In the early days of Netflix, they struggled to gain market share against Blockbuster. Until one day, the company decided to produce original series, starting with House of Cards. This bold move eventually tipped the scale over to their favorite. Because the cost of producing exclusive original content is fixed, for every additional subscriber Netflix gets, the cost per subscriber goes down. This declining unit cost is the key benefit to Netflix.
Not only that, because Netflix was first in market to do so and grabbed enough early subscribers, it became cost prohibitive for competitors to try to catch on, as they would not be able to produce shows at the same margin. And that’s what happened to Blockbuster. It’s value-destroying if they fronted the same amount of money only for much lower returns. Over time, Blockbuster became irrelevant, partly due to the industry trend of digital replacing analog, and partly due to the scale economies that Netflix enjoyed.
Helmer stipulates that for something to be a “power” it needs to entertain both attributes: a “benefit” to the power wielder and a “barrier” to competitors. Scale economies has both. The benefit here is reduced cost and the barrier is prohibitive cost/benefit. Can you think of another example of scale economies? What about Costco’s bulk goods? Or UPS’s distribution network. What about on a personal level? Can learning be a scale advantage as you accrue more knowledge and experience?
Moving on to the next power: network economies. What is it? Helmer's definition is "a business in which the value realized by a customer increases as the installed base increases." In other words, a company's product or service becomes more valuable as usage increases. It's important to note here that we're talking about increasing usage, not just the total number of users. And we'll see why shortly. Leveraging network effects is a powerful way to create defensibility as a company takes off.
In 2010, a company called BranchOut tried to take on LinkedIn which then already had 70M members. BranchOut tried to scale rapidly by building on Facebook's base and enabling users to download their info from LinkedIn. In a quarter, their users ballooned from 10k to 500k, but soon they realized that the user engagement was low and when Facebook banned BranchOut, people quickly churned off the platform. Meanwhile, given the large user base LinkedIn already has, they were able to fend off competition because customers would prefer to join a network where they're likely to find people they know vs a completely new recruitment tool. Moreover, each additional user who makes connections on LinkedIn is enabling the platform to be more relevant and useful for both job seekers and recruiters.
Helmer also observes that network economies often exhibit these three attributes. The first one is winner take all. He says that businesses with strong network economies are often characterized by a tipping point - once a sign firm achieves a certain degree of leadership, then the other firms just throw in the towel. The second characteristic is boundedness, which is that the power of network economies is bounded by the character of the network. I think the best example that demonstrates both attributes is the food delivery space. UberEats, DoorDash, GrubHub, Postmates each enjoy great network economies in different metropolitan regions, for example GrubHub in New York, DoorDash in the Bay Area, showing attributes of "winner takes all". But none has dominated the entire US market, so they're "bounded" by how each company resonates with the local regions.
The third attribute is decisive early product. Helmer says that "due to tipping point dynamics, early relative scaling is critical in developing power." Some might extrapolate this as growth at all costs. I don't think that's what Helmer intended to say as we'll read later in the book where he talks about the importance of unit economics. If you're losing money for each additional customer, the business just doesn't work and it wouldn't matter how fast you scaled compared to others. Does anyone still remember MoviePass?
The third power is called counter-positioning. It occurs when an upstart develops a superior business model, which has the ability to challenge well-entrenched incumbents, who are unable to respond effectively. Helmer points to the example of how Vanguard swam up against the riptides of powerful players such as Fidelity, and eventually popularized passive investing. In 1975, John Bogle had a radical idea of wealth management: an equity mutual fund that tracks the overall market, paying all returns back to shareholders, no sales commissions. This is drastically different from active investment. Vanguard is not just a new flavor of wealth management, it's working directly against the incumbents, the stock-picking asset managers who live by sales commissions. After an inauspicious start, Vanguard slowly picked up steam and is now one of the biggest funds in the US with $7 trillion of assets under management. In the years between 1975 and 2021, what happened to Fidelity & Wellington Management? Why didn't they react? How could they let this happen right in front of them?
Helmer argues that there are three types of collateral damage that prevent existing players from responding to disrupters. It wasn't because the folks at Fidelity were native, lacked vision, or couldn't execute, Helmer argues. On the contrary, it was a careful weighing of cost and benefit that led Fidelity to delay their response, and unfortunately, when they did react, it was too late.
The first type of collateral damage is called "milking": it's when the incumbents recognize that they have shared capabilities to enter the new market but are unwilling to cannibalize their existing business. Fidelity could pivot to passive funds, but after weighing the benefit of conceivable gains against the cost of cannibalization, they likely decided to stay put and wait it out. Helmer says that while some may characterize this as foot-dragging, it's simply a rational response to the circumstances.
Another type of collateral damage is "history's slave" or "cognitive bias": it happens when the incumbent views the challenger's approach as novel & unproven and dismisses the situation altogether. This is especially true for organizations that have enjoyed a successful run so far: they often view the future through a different lens. Quote from the book: "In the face of low-cost passive funds, Ned Johnson of Fidelity once famously inquired, 'Why would anyone settle for average returns?'." On top of that, due to the uncertainties surrounding the new approach, there simply isn't a clear ROI on adopting the new business model.
The third and last type of collateral damage is "job security" or "agency issues": it's the fact that CEOs are incentivized to be more near-term focused, which sometimes can hurt the long-term health of the organization. Helmer coined the "Five Stages of Counter-Positioning": denial - ridicule - fear - anger - capitulation (often too late). I think the lesson here is that if you're an incumbent, it's important to adopt some sort of horizons framework or innovation hub where the organization is not tied to short-term milking behaviors, and open up for self-disruption before others do it to you. Check out Bill Sharpe's three horizons framework on how to build sustainable business growth.
The fourth power is called switching cost. Have you wondered why so many people dislike SAP but still renew it year after year? Have you wondered why after we paid taxes once using TurboTax, it's more difficult for us to switch to another software? Have you decided not to switch from iPhone to other phones because you spent hours adding cover art to all your songs in Apple Music and the thought of losing them is unbearable?
A company that has embedded switching costs often has higher retention, higher customer lifetime value from up-sell and cross-sell. Competitors who want to offer feature parity must compensate customers for switching costs, which is a powerful inhibitor. For example, Gusto is offering free payroll transfers when a business switches over from another payroll provider. This white-glove service is still worthwhile because once the customer is onboarded, Gusto now benefits from high switching costs. Switching costs can also come in the forms of emotional cost, sunk cost, integration cost (do I lose access to the broader ecosystem?), etc. People are risk-averse and old habits die hard. For an organization hoping to leverage the power of switching cost, think about how you can increase the financial, procedural, relational cost of your product & service, making it unattractive for competitors.
The fifth power is "branding". Helmer is not talking about the broadly understood type of branding, which includes the character of the product, and sometimes the culture of the organization. He is talking about the brand that only comes with time, tried and true: this power is enjoyed by companies only after they've been tested by time. Consider diamond rings. We don't see a lot of new upstarts disrupting Cartier, or Harvey Winston.
In 2005, Good Morning America bought a ring at Tiffany for $16k and a similar size and cut at Costco for $6k. A famous appraiser assessed the ring from Tiffany at $10k and the Costco ring at $8k. The difference in the retail price comes from branding: from the blue box that makes your heart go faster, the flagship store on Fifth Avenue, the scenes from Breakfast at Tiffany's, the bragging rights, to the peace of mind, knowing that this ring is carefully crafted by a reputable jeweler for over a hundred years. The power of branding comes from customer trust that's hard-earned over time. Once you achieve the status, other brands become irrelevant. Helmer cautions that just because a company has high brand recognition doesn't mean it has branding power. Recognition is not enough, customer love and loyalty are the secret sauce to enduring success.
The sixth power is "cornered resource". Helmer defines it as "preferential access at attractive terms to a coveted asset that can independently enhance value". For example, a valuable patent such as Pfizer's vaccines, a required input such as lithium for Tesla's batteries, a cost-saving production manufacturing approach such as Warby Parker, or a brain trust such as the Pixar trio of Steve Jobs, Ed Catmull, and John Lasseter each complementing the other and collectively turned Pixar around in an unlikely feat. To bring this to life, organizations can think about how to acquire preferred access for something that's exclusive and that others can't emulate.
The seventh and last power is "process power". The poster child of process power is Toyota with the famous Toyota Production System (TPS) which includes just-in-time production, kaizen or continuous improvement, kanban or inventory control, andon cords (devices to allow workers to stop production and identify a problem so it can be fixed). GM has tried all of the above and yet still couldn't reproduce the same success as Toyota. They later realized that underneath all the explicit lessons of TPS, the implicit interlocking mechanisms are impossible for them to decipher. The true competitive advantage of Toyota comes from decades of practice. As Helmer observes, much of the organizational knowledge remained tacit. I think this power can also be understood as "company culture" in some ways. It's the tribal knowledge of how decisions are made, how work gets done, which is not easily put in words. When a company has a great culture with a strong mission and vision, it can be a durable moat because teams are often more aligned and motivated and move faster than the competition.
This concludes the first part of the book. The second part of the book discusses when companies can leverage the 7 powers at different stages. Helmer believes that as interesting as the dynamics of 7 powers, the mother of all power is invention. The first step is to build something new that brings value. Only then will it make sense to talk about how to sustain this business and defend against competition.
In the origination stage, companies may leverage cornered resource and counter-positioning to kick off the initial growth and secure their place as a contender in the market. In the takeoff stage, Helmer argues that companies can leverage network economies, scale economies and switching cost to gain market share, retain customers and grow customer lifetime value. In the stability stage, branding and process power become the key differentiator between a battle-tested veteran and a new entrant.
That's a wrap for the book, 7 powers by Hamilton Helmer.