I recently re-read an excellent business strategy book, 7 Powers: The Foundations of Business Strategy, by Hamilton Helmer. I read it about two years ago, but it really didn’t stick with me back then. Part of this may be that I didn’t have a great system for absorbing what I read, but I *think* I have a better one now. Please note I intend to write about my evolution of reading, learning, and note taking in a future post.
I was a bit conflicted in writing this up in that there has been a lot of good coverage of this book. That said, I intend to keep it short and sweet. I will link to that coverage at the bottom, including a podcast interview with the author.
I will explain i) Why I liked the book, ii) Describe the 7 Powers, and iii) List Takeaways from the book.
Why I liked the Book
I really liked the book because up front provides a clear and consistent framework for terms that have always seemed “foggy” to me. These terms are Strategy, strategy, and Power. A lot of Strategy textbooks will define terms and give anecdotes, but when I finish the book I’ve never connected it to concepts I discover later. Going forward, I feel like I have a path now. Helmer states the framework is meant to be simple, but not simplistic and I think this is useful. Lets jump right into the terms:
Strategy: the study of the fundamental drivers of business value.
This was useful me in that it differentiates between the study of a discipline and what a company should be “doing”. We can say Strategy is studying what drives business value and this seems important. Next, lets define the concept of strategy.
strategy: a route to continuing Power in significant markets.
Note this is different from the above. Strategy is a study of strategy. Is that confusing? Perhaps, but it is meant to separate the study of a general discipline from what a company’s mission should be. And what should companies be doing? They should be looking for sources of Power they can wield to create and maintain a competitive advantage.
Power: a set of conditions that create and allow for persistent, differential returns.
For a business to have a true strategy it must have Power. This usually involves recognizing a source of Power and then seeking to exploit it. Helmer emphasizes Power must have a benefit and barrier component. The benefit serves to increase cash flow through some combination of higher prices, lower costs, or lower investment needs. We come to a key point: many companies can create benefits and increase value (to customers), but they need a way to capture some of the value they create. So, that means the barrier is the key; a company needs a way to not only capture value, but keep competitors at bay. Taking the benefit and barrier a step forward, the benefit determines the magnitude of free cash flow and the barrier determines the duration of the free cash flow. The combination of these two discounted to the present determines value.
Finally, I like how Helmer divides the book between the “statics” and “dynamics” of Strategy. Statics describe the “being there” of strategy after you’ve attained Power. It describes the end state of where you want to be and we will cover the types of Power in the next section. He then spends the last two chapters of the book explaining the dynamics of strategy, or the “getting there”. He does this because sometimes describing the statics may give you a mistaken conclusion about what you need to do. For example, based on statics, you may decide you “need to get big”. Scale may be important, but you want Power and merely getting big doesn’t guarantee it.
Description of the 7 Powers
Next, we will touch on the 7 Power Helmer identifies as statics of “being there”. The goal is to be both brief and informative. Again, if you want to dig in, reference some of the links at the bottom as they do an excellent job providing more depth.
Scale Economies is a decline in unit cost with increased volume. The benefit to the leader is a cost advantage that results in increased cash flow. The barrier to the competition is that it will be painful for the challenger to gain share while the leader has this cost advantage. A good example of this is Netflix’s Power with its cost per subscriber given its large subscriber base. Scale Economies is an exclusive source of Power in that only one can have it. A key consideration for this Power is how much of the industry cost structure is fixed. In other words, having a large variable cost structure won’t help you here. Asset-light logistics companies have very variable cost structures which they tout, but that implies this Power is hard to come by.
Network Economies is when the value of a product increases as the installed base increases. The benefit here comes from a price premium the leader can charge, increasing its cash flow. The leader charges for it directly or indirectly in its advertising rates (i.e. Facebook or Google). The barrier to the challenger comes in the form of losses to try and catch up. Like Scale Economies, Network Economies is an exclusive source of Power so there may be no challenger as its “winner take all”. Network effects can also exist, but without Power. Finally, attracting complements (i.e. application developers) can be an indirect network effect that’s important depending on the industry.
Counter-Positioning is when an entrant adopts a new business model that is superior and the incumbent is unwilling to respond because of collateral damage to its existing business model. The benefit to the challenger is that the new business model is superior and results in higher cash flow. The barrier actually comes from incumbent’s fear to abandon or shift its existing business model. This fear comes from some combination of sunk costs, opportunity costs, and high margins embedded in the existing business model. Again, Netflix is the example here as we discussed in this post in its fight with Blockbuster. Unlike the first two powers, Counter-Positioning is not exclusive source of Power as others can adopt the new business model. For Netflix, they had Counter-Positioning relative to Blockbuster, but they needed to Scale Economies to have a viable long-term strategy.
Switching Costs occur when a customer determines a greater loss than value gained by switching to a competitor. The benefit allows the company with Power to charge a higher price. The barrier is that the challenger must compensate customers for switching costs to induce them to switch and its usually uneconomic to do so. A firm can grow its switching costs by launching new products and making acquisitions. Like Counter-Positioning, Switching Costs is not an exclusive source of Power and can lead to other Powers such as Network Economies and Branding.
Branding is an asset that conveys information to consumers and invokes positive feelings, increasing their willingness to pay (WTP). The benefit is a price premium for the brand that stems from a combination of positive feelings, associations, or uncertainty reduction. The barrier to the entrant is the time, costs, sunk costs, and uncertainty it takes to build up a brand. This Power type is non-exclusive and is typically stronger in consumer markets than in business to business markets.
A Cornered Resource is access to an asset on attractive terms that enhances value. The benefit comes from having a superior deliverable that results in price or cost benefits. It comes in the form of a person, patent, or access to some resource. The barrier depends on the nature of the resource, but it could be personal choice (if a person), property rights (if access to a resource), or patent law (if a patent) depending on the nature of the asset. For example, Helmer considers the Pixar Animation “Brain Trust” of Steve Jobs, Ed Catmull, and John Lasseter a Cornered Resource. This access needs to come at a non-arbitraged price meaning the holder of Power does not pay “market value” for this asset.
Process Power is a compounding of company activities to improve product benefits or lower its costs. The benefit to the company is driven by improvements in quality and cost that persist even if employees leave. The barrier is the time it takes to build these improvements. Also, these activities may not be copied because the process is complex and opaque. A key point to make is operational excellence is not Process Power. Operational excellence is table stakes and not a strategy. Helmer gives the example of the Toyota Production System as an example of Process Power.
Any discussion of strategy must address a path to Power. If management tells you about a “strategic acquisition”, you should pause. Ask yourself: does this lead to Power? If so, how? I believe the definitions given above along with the Powers provide a good filter for industry analysis. Any time the word strategy is mentioned, I hope this book primes me to pause.
A Power’s exclusivity dictates the pace. With Scale Economies and Network Economies, the goal should be to build scale or the installed base quickly. Branding, Switching Costs, and Process Power all take time to build up so its about careful decision making.
Invention is powerful in that it not only opens the door for Power, but can also expand the market size to create more value. Value is when a customer gets more for less. Invention leads to the potential for Power, but you need a barrier to obtain Power. Industries in flux is a good place to search for Power.
Power comes from invention, adaptation, action, and risk taking. A strategy cannot be planned but only crafted over time. It usually end up being come combination of leadership, timing, execution, and luck.