7 Powers

Key Insights from 7 Powers by Hamilton Helmer

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While the below graph might seem like the first one, it's actually a different chart that shows the intensity of the seven powers.

Definition of Strategy

Strategy is understood as the route to achieving and sustaining power in significant markets. It involves making crucial choices under uncertainty, which if wrong, can lead to severe repercussions for the business.

Execution vs. Strategy

Superb execution is essential for success, yet it's not sufficient alone. Strategic decision-making is crucial to guide and leverage day-to-day operations to achieve long-term objectives.

Power and its Importance

Power is the ability to generate persistent differential returns. It is central to the concept of strategy and involves conditions that sustain competitive advantages.

Static and Dynamic Aspects of Strategy

Strategy can be divided into statics (the current state, such as Intel’s durable value in microprocessors) and dynamics (historical evolution of that state).

The Seven Powers Framework

Hamilton Helmer discusses seven distinct powers that businesses can harness to create a durable competitive advantage:

• Scale Economies: This power involves achieving lower costs through increased scale, which is difficult for smaller competitors to match due to prohibitive cost structures.

• Network Economies: The value of a product increases as more people use it. Dominant players can charge premium prices due to the added value from a larger user base.

• Counter-Positioning: New market entrants can adopt a business model that incumbents cannot mimic without damaging their existing revenue structures, creating a barrier to competition.

• Switching Costs: These arise when customers face costs to switch providers, allowing companies to charge higher prices and secure customer loyalty.

As I had learned over my years as a business person, strategy is an unusual beast. Most of my time and that of everyone else at Netflix must be spent achieving superb execution. Fail at this, and you will surely stumble. Sadly, though, such execution alone will not ensure success.

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The arc of any celebrated business is underpinned by decisive strategy choices that are few and typically made amidst the profound uncertainty of rapid change. Get these crux choices wrong and you face a future of persistent pain, or even outright failure. To get them right, you must constantly attune your strategy to unfolding circumstances—ponderous planning cycles or handoffs to outside experts won’t get you there.

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Strategy: the study of the fundamental determinants of potential business value

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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?

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Power: the set of conditions creating the potential for persistent differential returns

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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 (Part I: Statics) and how to attain them (Part II: Dynamics).

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strategy: a route to continuing Power in significant markets

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I refer to this as the Fundamental Equation of Strategy. Recall my definition of strategy: strategy: a route to continuing Power in significant markets

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Potential Value = [Market Scale] * [Power]

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Remember, we’ve reserved the term “Power” for those conditions that create durable differential returns. In other words, we are trying to discern long-term competitive equilibria, not just next year’s results.

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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.

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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

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reputation. On the other hand, always the domain of Economists, I am a strong believer in the importance of leadership in the creation of value.

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My many years of advising companies and making value-driven equity bets has made it crystal clear to me that the ascent of great companies is not linear but more a step function. There are critical moments when decisions are made that inexorably shape the company’s future trajectory.

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The quality of declining unit costs with increased business size is referred to as Scale Economies. It is the first of the 7 Powers I will examine, and its conceptual lineage begins with Adam Smith’s Wealth of Nations and indeed the beginnings of Economics itself.

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For Scale Economies, the Benefit is straightforward: lowered costs. In the case of Netflix, their lead in subscribers translated directly in lower content costs per subscriber for originals and exclusives.

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The Barrier, however, is subtler. What prevents other firms from competing this away? The answer lies in the likely interplay of well-managed competitors. Suppose a company has a significant scale advantage in a Scale Economies business. Smaller firms would spot this advantage, and their first impulse might be to pick up market share, thus improving their relative cost position and erasing some of this disadvantage while improving their bottom line. To get there, however, they would have to offer up better value to customers, such as lower prices.

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In an established market, such tactics are visible to the leader, who would realize the threat of reducing their relative scale advantage; they would retaliate by using their superior cost position as a defensive redoubt (matching price cuts for example). After several bouts of this, a follower will come to expect such retaliation and build it into their financial models for the impact of gain-share moves. For them, such moves would inevitably destroy value, rather than create it.

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Scale Economies: Benefit: Reduced Cost Barrier: Prohibitive Costs of Share Gains

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This situation creates a very difficult position for Netflix’s smaller-scale streaming competitors. If they offer the same deliverable as Netflix, similar amounts of content for the same price, their P&L will suffer. If they try to remediate this by offering less content or raising prices, customers will abandon their service and they will lose market share. Such a competitive cul-de-sac is the hallmark of Power.

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Network Economies occur when the value of a product to a customer is increased by the use of the product by others. Returning to our Benefit/Barrier characterization of Power:

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Benefit. A company in a leadership position with Network Economies can charge higher prices than its competitors, because of the higher value as a result of more users. For example, the value of LinkedIn’s HR Solutions Suite comes from the numbers of LinkedIn users, so LinkedIn can charge more than a competiting product with fewer participants.

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This equation also makes evident the tipping point outcome of Network Economies. As the installed base difference gets large, the pricing such that the follower has zero profits results in very large leader margins (100% at the limit). This means a leader can price at very attractive margins while still pricing well below the breakeven point for the follower. The result is that a follower would have to price at a significant loss to offer equivalent value. As pointed out earlier, in BranchOut’s case it would not surprise me if users would have had to be paid (a negative price) to switch from LinkedIn.

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Benefit. The new business model is superior to the incumbent’s model due to lower costs and/or the ability to charge higher prices. In Vanguard’s case, their business model resulted in substantially lower costs (the elimination of expensive portfolio managers, as well as the reduction of channel costs and unnecessary trading costs) which then translated into superior product deliverables (higher average net returns). Due to their business structure of returning profits to their fund-holders, they realized value from market share gains (s in the fundamental equation of strategy), rather than ramping up differential profit margins (m).

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Barrier. The barrier for Counter-Positioning seems a bit mysterious: how could a powerhouse (such as Fidelity Investments in this case) allow itself to be persistently humbled by an upstart over such an extended period? Couldn’t they foresee the potential success of Vanguard’s model? Freqently in such situations, naïve onlookers castigate the incumbent for lack of vision, or even just poor management. Often, too, they level this accusation at companies with prior plaudits for business acumen.

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In many cases, this view is unjust and misleading. 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.

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There is a dynamic to CP: Milk has practical importance, especially for the challenger. As the challenger cannibalizes the incumbent’s customer base, two parts of the incumbent’s negative attribution lessen: (a) the incumbent’s original business shrinks, and (b) the uncertainty surrounding the viability of the challenger’s approach diminishes. As this scenario plays out, the risk-adjusted size of expected collateral damage declines. At some point, a rational incumbent, our hypothetical CEO, will then find the collateral damage insufficiently off-setting—an investment is warranted. Such delayed entry happens frequently, and while some may characterize it as incumbent foot-dragging, it is often simply a rational response to the circumstances.

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As the finalized chart indicates, there are three varieties of Counter-Positioning, depending on the particulars of the collateral damage involved: Milk, History’s Slave and Job Security.

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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.

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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.

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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.

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As a market matures, the Benefit of Switching Costs becomes transparent to all players and they are able to calculate the value of an acquired customer.

More often than not this leads to enhanced competition to grab new customers, which arbitrages out the Benefit for new customer acquisitions.

So the major value contribution comes from capturing customers before such value-destroying pricing arbitrage transpires.

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Tiffany’s Power lies in Branding. Branding is an asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product.

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Affective valence. The built-up associations with the brand elicit good feelings about the offering, distinct from the objective value of the good.

For example, Safeway’s cola may be indistinguishable from Coke’s in a blind taste test, but even after revealing the result, the taste tester remains willing to pay more for Coke.

Uncertainty reduction. A customer attains “peace of mind” knowing that the branded product will be as just as expected.

Consider another example: Bayer aspirin. Search for aspirin on Amazon.com and you will see a 200 count of Bayer 325 mg. aspirin for $9.47 side-by-side with a 500 count of Kirkland 325 mg. aspirin for $10.93.

So Bayer has a price per tablet premium of 117%. Some customers still would prefer the Bayer because of diminished uncertainty: Bayer’s long history of consistency makes customers more confident that they are getting exactly what they want.

Note that the Benefit from Branding does not depend on prior ownership, as with Switching Costs.

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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.

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Cornered Resource: the Benefit and the Barrier

This Power type is given a name in Economics: Cornered Resource.

The services of this cohesive group of talented, battle-hardened veterans were available only to Pixar; they had it cornered.

To put this into our 7 Powers framework:

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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.

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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.

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To illustrate: in 1988, long before Disney began its association with Pixar, Lasseter won an Academy Award for his Pixar short Tin Toy, prompting Disney CEO Michael Eisner and Disney Chairman Jeffrey Katzenberg to try to recruit their former employee back into the Disney fold.

Lasseter demurred: “I can go to Disney and be a director, or I can stay here and make history.”

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positioned to acquire the needed knowledge.

Here’s the rub: the TPS is not what it seems.

On the surface, it consists of a fairly straightforward variety of interlocking procedures, such as just-in-time production, kaizen (continuous improvement), kanban (inventory control), andon cords (devices to allow workers to stop production and identify a problem so it can be fixed).

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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.

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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:

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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. Period.

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Unfortunately, it does not by itself assure differential margins (a positive m in the Fundamental Equation of Strategy) combined with a steady or growing market share (s in the FES).

Competitors can easily mimic the improvements yielded by operational excellence, eventually arbitraging out the value to the business.

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Network Economies. Here the needs are similar to Scale Economies, except that installed base, rather than sales share, is the goal.

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Cornered Resource. You must secure the rights to a valuable resource on attractive terms.

This often comes from having developed that resource in the first place and then gaining ownership of it, the most common avenue being a patent award for research developments.

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Branding. Over an extensive period of time, you make the consistent creative choices which foster in the customer’s mind an affinity that goes beyond the product’s objective attributes.

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We are covering a lot of ground here, but you will notice a common thread: 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.

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Invention: the One-Two Value Punch

So far, so good. By looking through the lens of the 7 Powers, we have come to a vital insight: Power arrives only on the heels of invention.

If you want your business to create value, then action and creativity must come foremost.

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A lot of times, people don’t know what they want until you show it to them.

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The answer to the “What?” question provides a vital insight into Dynamics: Power comes on the heels of invention, be it in products, processes, brands or business models.

However, most invention is merely a manifestation of operational excellence and thus not immune to the arbitraging actions of competition.

So in this formative period, as your invention takes shape, you must attune yourself to the exigencies of Power and stay constantly vigilant.

This is why I developed the 7 Powers—to give you a ready guide for this.

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As a strategist and value investor, I cringe every time a CEO or CFO says they are pleased by the entrance into their market of a well-heeled competitor, insisting it “validates the market.”

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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

Commentary. In this book I have focused on Benefit + Barrier which has a one-to-one mapping to the

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Commentary. To the best of my knowledge the seven Power types positioned on this chart are the only strategies available to a company.

If you do not have at least one of these for each competitor (current and potential, direct and functional), you cannot satisfy The Mantra and hence are lacking a viable strategy.

In the 200+ strategy cases I have led over my career, these seven were sufficient.

This is also true of all the cases studied by my students, probably another 200 or so.

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Small set. The key strategic questions for you are: (1) “What Power types do I now have?” and (2) “What Power types do I need to worry about establishing now?”

The 7 Powers informs you that there are only seven possibilities for (1) and usually you can quickly rule out several.

The Power Progression informs you that at any given growth stage the maximum number of new Powers that you might explore is 3.

This focusing is very valuable.

If you cannot see a route to one of these 7, your strategy problem is not yet solved.

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