Hamilton Helmer

“It wasn't for lack of competition either. The competitive assault in microprocessors has, over the decades, been at least as intense as that in memories. IBM, Motorola, AMD, Zilog, National Semiconductor, ARM, NEC, TI, and countless others have poured billions into this business. We can only assume microprocessors possessed some sort of rare characteristics which materially improved cash flow, while simultaneously inhibiting competitive arbitrage. I refer to these as power. potential for persistent differential returns. 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 one statics, and how to attain them, part two dynamics. The mantra. For Intel, microprocessors had power, and memories did not. And this made all the difference. Intel's enduring triple-digit billion market cap, reflects this power applied across a large revenue stream. Such an outcome is the goal of any business, and this allows me to define strategy, a company's strategy, in the following way.”

“So, value equals the product of M0 and G and bar S and bar M. I refer to this as the fundamental equation of strategy.”

“Strategy, a route to continuing power in significant markets. The product of M sub 0 and G reflect market scale over time.”

“Strategy, a route to continuing power in significant markets. The product of M sub 0 and G reflect market scale over time. Hence, they capture the significant markets component of this definition. The impact of competitive arbitrage is expressed in margins and market share simultaneously. So the maintenance or increase of S market share, while maintaining a positive and material long-term differential margin, provides the numerical expression of power. In other words, put another way, potential value equals market scale times power. This is potential value, and operational excellence is required to achieve that potential. Examining Intel through this lens, we can identify a large-scale market, M sub zero times G, for both memories and microprocessors. So what accounted for the utterly different value outcome? Under Andy Grove, operational excellence was the norm. So it was power that made the difference. Over time, competitive arbitrage drove bar m in memories negative, whereas power enabled Intel to maintain a high and positive bar m in microprocessors. upcoming topics.”

“If a company were growing at 10% per year, the next three years would account for only about 15% of its value.”

“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,”

“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.”

“However, over the longer term, that is ignoring speculative perturbations, investors are aware of the 10%-15% calculation I mentioned above. And this is what drives analysts' value models. They are attuned to their expectation of free cash generation over the longer term. Of course, changes in current performance may result in significant recalibrations of their expectations, but this is not because they only care about the short term. Rather, it is because current performance is a significant indicator of future performance and hence shapes long-term expectations. For those long-term expectations to bear out, though, persistence remains key. 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. 1. 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. Two, barrier. The benefit must not only augment cash flow, 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.”

“As a strategist, then, my advice is, always look to the barrier first.”

“This is the duration aspect of power. As I delineate the seven types of power in the chapters to come, I will similarly describe their unique benefit-slash-barrier combination. The benefit conditions probably won't sound all too rare—they are met often in business. Indeed, every major cost-cutting initiative qualifies. The barrier conditions, on the other hand, prove far rarer—a reality that merely proves the ubiquity of competitive arbitrage. As a strategist, then, my advice is, always look to the barrier first. In Intel's case, the heart of its microprocessor 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 fail to emulate or undermine those improvements. Industry Economics and Competitive Position The conditions of power involve the interaction between the underlying industry's economics and the specific business' competitive position. In Part 1, I will parse these two drivers for each of the seven types of power analyzed. This adds an explicitness that is useful in understanding and applying the concepts developed, while also shedding light on the role of industry attractiveness in creating value potential.”

“They would retaliate by using their superior cost position as a defense of redoubt, matching price cuts, for example.”

“To get there, however, they would have to offer up better value to customers, such as lower prices. 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 defense of redoubt, matching price cuts, for example. After several bouts of this, a follower would 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. Intel's microprocessor business that I discussed in the introduction is a good example of how this plays out. Intel developed scale economies in the microprocessor business. Over a very long period, they were doggedly challenged by advanced micro-devices in this space. Big outcome, a continuingly great business for Intel, and a persistent pain for AMD. At every turn, Intel could fight off AMD, relying on the economics rooted in its scale economies. This unattractive cost-slash-benefit is itself the barrier for scale economies. Of course it goes without saying, the barrier must be thoughtfully maintained by the incumbent leader, but to bet on anything else would be foolish.”

“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.”

“1. They are unable to or 2. They can, but refrain from so doing because they expect the outcome to be economically unattractive. With this in hand, I can now populate the chart with our first power type, scale economies. See figure 1.4 in the supplementary PDF. Here, let's define scale economies, a business in which per unit cost declines as production volume increases. 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. Beyond fixed costs, scale economies emerge from other sources as well. To name a few, volume-slash-area relationships. These occur when production costs are closely tied to area, while their utility is tied to volume, resulting in lower per-volume costs with increasing scale. Bulk milk tanks and warehouses would serve as examples. Distribution network density. As the density of a distribution network increases to accommodate more customers per area, delivery costs decline, as more economical route structures can be accommodated. A new entrant competitor to UPS would face this difficulty. Learning economies If learning leads to a benefit, reduced cost or improved deliverables, and is positively correlated with production levels, then a scale advantage accrues to the leader. Purchasing economies. A larger scale buyer can often elicit better pricing for inputs.”

“For power to exist, both of these terms must be significantly positive.”

“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.”

“Their founders were fully aware of this business characteristic and aggressively and competently pushed tactics fully consistent with this understanding. Facebook and LinkedIn could coexist because their respective networks were walled off from one another. users wanted to keep their personal lives, Facebook, separate from their work lives, LinkedIn. BranchOut hoped to build a bridge between the two, but it just didn't fly. Users wanted this wall maintained, a lesson Facebook themselves learned in their failed rollout of Facebook at Work. intensity, and some great businesses are built on them. IBM mainframes, operating systems for Microsoft, Steinway pianos, and exchange-traded funds. The Benefit and the Barrier 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-slash-barrier characterization of power, 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 Solution Suite comes from the numbers of LinkedIn users. So LinkedIn can charge more than a competing product with fewer participants.”

“In particular, the value deficit of a follower can be so large that the price discount needed to offset this is unthinkable.”

“As powerful as this barrier is, it is bounded by the character of the network,”

“Barrier The barrier for network economies is the unattractive cost-slash-benefit of gaining share. And this can be extremely high. In particular, the value deficit of a follower can be so large that the price discount needed to offset this is unthinkable. For example, what would BranchOut have had to offer users for them to use BranchOut rather than LinkedIn? I think most observers would agree that every user would have required a non-trivial payment, so the total spend for BranchOut would have been colossal. Industries exhibiting network economies often exhibit these attributes. Winner-take-all Businesses with strong network economies are frequently characterized by a tipping point. Once a single firm achieves a certain degree of leadership, then the other firms just throw in the towel. Game over, the P&L of a challenge would just be too ugly. For example, even a company as competent and with as deep pockets as Google could not unseat Facebook with Google+.”

“Facebook has powerful network economies itself, but these have to do with personal, not The boundaries of the network effects determine the boundaries of the business. Decisive early product Due to tipping point dynamics, early relative scaling is critical in developing power. Who scales the fastest, is often determined by who gets the product most right early on. Facebook's trumping of MySpace is a good example. This benefit-slash-barrier combination allows me to place network economies on the seven powers chart. See figure 2.2 of the supplementary PDF. Network Economies Definition A business in which the value realized by a customer increases as the installed base increases. Network Economies Industry Economics and Competitive Position Power ensures the ability to earn outsized returns well into the future, driving up value. This is captured by the benefit-slash-barrier requirement. As before in chapter 1, I will use surplus leader margin to calibrate the intensity of power. What governs the leader's profitability when prices are such that the challenger makes no profit at all? In the case of network economies, I assume all costs are variable, see?”

“It turned out that there was very little spillover.”

“There can be positive network effects, but no potential for power.”

“This, for example, is plagued Twitter.”

“In situations like this, it falls to the strategist to carefully peel back the layers of complexity and eventually seize upon some irreducible kernel of insight amidst the competitive reality. To understand the ascendancy of Vanguard, I must first note these characteristics. 1. An upstart who developed a superior, heterodox business model. 2. That business model's ability to successfully challenge well-entrenched and formidable incumbents. 3. The steady accumulation of customers, all while the incumbent remains seemingly paralyzed and unable to respond. These elements were not unique to Vanguard. They were pieces of an oft-repeated story. Think of Dell vs. Compaq, Nokia vs. Apple, Amazon vs. Borders, In-N-Out vs. McDonald's, Charles Schwab vs. Merrill Lynch, Netflix vs. Blockbuster, and so on. But nearly always, these feature the same outcome. The incumbent responds either not at all or too late. These victories aren't born of happenstance, of course. They are strategic, and the upstarts usually succeed in creating a lot of value for themselves, while severely diminishing that of the incumbents. Returning to our benefit-slash-barrier characterization of power. Benefit.”

“they realized value from market share gains, bar S in the fundamental equation of strategy, rather than ramping up”

“The incumbent's failure to respond, more often than not, results from thoughtful calculation.”

“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, bar S in the fundamental equation of strategy, rather than ramping up bar M. 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? Frequently in such situations, naive onlookers castigate the incumbent for lack of vision, or even just poor management. Often too, they level this accusation at companies with prior plots for business acumen. 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?”

“Counterpositioning 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 fund's more modest returns would likely fail to offset the damage done by a migration from their flagship products. With this preliminary understanding, I can now place counter-positioning on the 7 powers chart, which can be found in the supplementary PDF, figure 3.4. This allows me to define counter-positioning. A newcomer adopts a new, superior business model, which the incumbent does not mimic due to anticipated damage to their existing business. The Varieties of Collateral Damage There can be several possible reasons for the incumbent's failure to mimic the upstart. In this section, I will detail those differences, as knowing them will clarify the correct strategic posture. Here's a useful way to visualize this.”

“Standalone unattractive is not counter-positioning. in its first step the business development team would hive off those situations in which a standalone assessment of the new approach forecasts an unattractive return as these are not counter-positioning to this end the team would pose this question stand alone attractive no yes if no is the answer then collateral damage does not account for the incumbent's rejection of the challenger's approach to the business the new approach is simply a poor bet all by itself here the example of the digital camera challenge to kodak is instructive Kodak's business model was legendary, built on the customer's continuing need to purchase film, a product in which Kodak was wildly profitable, due to both scale economies and a proprietary edge. This power type is cornered resources, to be covered in Chapter 6. Kodak offered the first of its path-breaking Brownie cameras in 1900. By 1930, it was one of the firms in the Dow Jones Industrial Index, and it stayed in that group for more than 40 years, one of the great business empires. Until digital photography came along, that is. Anyone could extrapolate from Moore's law that analog chemical film was eventually doomed. Pundits have looked back and chided Kodak for poor management, lack of vision, and organizational inertia. And a reasonable person might well ask, How could a company high on the lists of the best companies in the world succumb to such a defeat?”

“A reasonable question. And the answer is much simpler than many suggest. In fact, Kodak was fully aware of its eventual fate and spent lavishly to explore survival options. But digital photography simply was not an attractive business opportunity for the company. Kodak's business model was built on its power in film. It was not a camera company. The digital substitute for film was semiconductor storage, and Kodak brought nothing to this arena. As a company, Kodak had excellent management. Thus, the observed wheel spinning, their fruitless explorations in the digital world, simply reflected the strategic cul-de-sac they faced. The technological frontier had moved. Consumers were better off, but Kodak was not. More generally, this situation can be characterized by three conditions. One, a new superior approach is developed.”

“Kodak's failure to respond had nothing to do with collateral damage within their film business.”

“Kodak's formidable strengths had little relevance to semiconductor memory, and those new products were on an inevitable path to commoditization. Such reinvention is quite common, as are the associated and often unfair castigations of the incumbent's management failures. The gales of destruction was Schumpeter's famous turn of phrase for such occurrences. But this is not counter-positioning. Kodak's failure to respond had nothing to do with collateral damage within their film business. Rather, it indicated only that digital photography as a standalone business failed to offer even the faintest promise of power for Kodak. Facing such a situation, our hypothetical CEO would nix any commitment of investment, branching in the following way. Standalone attractive? No. Don't invest. Not counter-positioning. Before turning to those cases in which collateral damage serves as the decisive inhibitor, I would like to comment on another frequently discussed issue.”

“Kodak could have easily taken the view that their business was image storage, not film, thus avoiding marketing myopia. Unfortunately this broader view of the business would have been to no avail, as the lack of semiconductor capabilities would have remained and been decisive in determining a negative outcome. 1. Milking. Negative Combined NPV. Suppose the new approach was unlike digital storage for Kodak, and instead looked promising on a standalone basis. In this case, our hypothetical CEO would face another set of issues. Standalone attractive? Yes. Joint NPV of entering? Positive? Negative? This was the situation faced by Ned Johnson, the CEO of Fidelity, when passive mutual funds started to appear. Unlike the Kodak case, Fidelity possessed all the capabilities to develop and distribute passive funds. They were a mutual fund powerhouse, and one could even reasonably argue that their capabilities in this space were superior to those of Challenger Vanguard. However, the impact of entry into passive funds on their remaining base business of active funds would have been subtractive.”

“For the assets they would have cannibalized, the revenue decline would have been dramatic. Further, many at Fidelity felt they were facing an existential threat and the introduction of passive funds would have taken them off message in the rearguard advocacy of active funds. They assumed, reasonably, that any conceivable gains made with these new funds would have been more than offset by losses in their base business of active funds. In similar hypotheticals then, a rational incumbent CEO would decide to eschew the new approach. This type of don't invest determination represents one type of counter positioning, CP. The term I use is milk because the CEO is essentially choosing to milk a declining original business even though the new model is attractive. To be explicit, while the decision to invest may have offset damage to the incumbent's original business, collateral damage, there remain some advantages to the decision to kill that investment. This is the barrier. Standalone attractive? Yes. Joint NPV of entering? Negative. 1. Don't invest. CP. Milk. especially for the challenger. As the challenger cannibalizes the incumbent's customer base, two parts of the incumbent's negative attribution lesson. A. The incumbent's original business shrinks. And B. The uncertainty surrounding the viability of the challenger's approach diminishes.”

“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 offsetting, 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. 2. History's Slave, Cognitive Bias Suppose an outside objective analyst examined the incumbent's potential entry into the challenger's new business model, and found that the incremental NPV of doing so was positive. Certainly this would warrant an investment, yes? Not so fast. There's more to our collateral damage story. Thoughtful CEOs still might forego entry investment if their opinions differed from this objective view and they perceived deeper decrements. Our next effort, then, is to explore reasons for such a difference. Standalone attractive, yes. Joint NPV of entering, positive. further decrement? What are the potential causes of such decrements? They could be numerous, but over several decades of client strategy work, I have noted two that seem common. The first involves two characteristics of challenges to incumbency. One, the challenger's approach is novel and, at first, unproven.”

“Together, these two characteristics frequently lead incumbents to at first belittle the new approach, grossly underestimating its potential. In the face of low-cost passive funds, Ned Johnson of Fidelity once famously inquired, why would anyone settle for average returns? This negative cognitive bias can lead to a don't invest decision, even if an objective observer might judge such an investment favorably. Here we arrive to the second type of counter-positioning. Stand-alone attractive? Yes. Joint NPV of entering? Positive. Further decrement? Cognitive bias. 2. Don't invest. CP. History slave. 3. Job Security – Agency Issues There's a second source of decrement that can lead our CEO to reject an objectively attractive investment decision. The difference is between the objective of the firm, maximum value, and that of the CEO, or other investment decision-makers.”

“Economists refer to these situations as agency problems, because the agent's actions are at odds with the organization she represents. Usually it's about incentives. For example, it is devilishly difficult to design a CEO's compensation so that it closely mimics long-term enterprise value. 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, This completes our parsing of the collateral damage barrier in counter-positioning. Standalone attractive? No. Don't invest. Not counter-positioning. Yes? Joint NPV of entering? Negative. Cognitive bias? 2. Don't invest. CP. History slave. Agency. 3. Don't invest. CP. Jobs. security. None. Invest. As the finalized chart indicates, there are three varieties of counter-positioning, depending on the particulars of the collateral damage involved. Milk, history slave, and job security. I should note that agency and cognitive bias issues are not mutually exclusive. Frequently they appear in concert, as they are connected with the to and fro that company is the upending of a well-established business.”

“When I started teaching at Stanford in 2008, Nokia was the leader in smartphones. By 2014, they had disappeared from this market.”

“SAP's paradoxical combination of high retention”

“This benefit only accrues to the powerholder 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.”

“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”

“Once a customer has bought in, they are hopelessly hooked, enabling SAP to then reap the rewards of a future stream of revenues for annual maintenance charges, upgrades, add-on services, software, and consulting. More, a company like SAP, profiting from the indenture of its clients, has all incentive to hike the prices of such services. The continued climb of SAP's stock price, shown in Figure 4.1 in the supplementary PDF, testifies to the vitality and endurance afforded by the business model born of such reliance. Switching Costs on the Seven Powers 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. Benefit 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 powerholder 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.”

“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-slash-benefit of share gains for the challenger. With this understanding, I can now place switching costs on the seven powers chart. Please see Figure 4.2 in the supplementary PDF. Switching Costs Definition The value loss expected by a customer that would be incurred from switching to an alternate supplier for additional purchases. Types of switching costs Switching costs can be divided into three broad groups financial Financial switching costs include those which are transparently monetary from the outset For ERP, these would include the purchase of both a new database and the sum total of its complementary applications. Procedural Procedural switching costs are somewhat murkier but no less persuasive. They stem from the loss of familiarity with the product or from the risk and uncertainty associated with the adoption of a new product. When employees have invested time and effort to learn the particulars of how to use a certain product, there can be a significant cost to retraining them in a different system.”

“All players can enjoy their benefits. IBM and Oracle are competitors to SAP and they also benefit from high customer retention rates and switching costs. 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. Switching costs offer no benefit if no additional related sales are made to the customer. To assure that such additional sales take place, one tactic might be to develop more and more add-on products. This has been SAP's hack, as seen from the Wikipedia list of the company's offerings, located in the supplementary PDF, figure 4.3. Acquisitions significantly accelerate product line extensions too, serving as a sort of outsourced development. This too has been part of SAP's playbook, as proven by their ambitious acquisition program. The building of such product portfolios can serve to boost all three categories of switching costs.”

“such advantages can be swept away by tectonic shifts in technology.”

“A high level of integration into customer operations and the extensive training that demands can also further disincentivize such disentanglement. This sort of training also has the potential of building emotional bonds to the current supplier, relational. Switching Costs Industry Economics and Competitive Position As noted before, switching costs are a non-exclusive power. Their benefits are available to all players. So the intensity of switching costs derives from industry economics. Those conditions face equally by all players. The potential benefits accrue only if you have a customer. of switching costs is binary. You either have the customer or you do not. I should note that such advantages can be swept away by tectonic shifts in technology. ERP firms know well this lesson. That's why SAP and Oracle are presently doing their best to make certain they're not leapfrogged by cloud-based applications. Importantly too, switching costs can pave the path for other powers as well. Connecting users and building a large supply of complementary goods may generate network effects. Or 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. Figure 4.5 Power Intensity Determinants Also found in the supplementary PDF.”

“A business with branding is able to charge a higher price for its offering due to one or both of these two reasons.”

“A strong brand can only be created over a lengthy period of reinforcing actions, hysteresis, which itself serves as the key barrier.”

“1. Effective 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. 2. Uncertainty Reduction A customer attains peace of mind knowing that the branded product will be 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-milligram 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. 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.”

“A long investment runway with no assurance of an eventual path to significant effective valence. Efforts to mimic another brand run the risk of trademark infringement actions as well with their attendant costs and unclear outcomes. With this understanding, I can now place branding on the 7 powers chart, which can be found in the supplementary PDF, figure 5.4. Branding Definition The durable attribution of higher value to an objectively identical offering that arises from historical information about the seller. Branding Challenges and Characteristics Brandolution Firms require focus and diligence to guide branding over time and ensure that the reputation created remains consistent in the valences it generates. Hence, the biggest pitfall lies in diminishing the brand by releasing products which deviate from or damage the brand image. Seeking higher down-market volumes can reduce effective valence by damaging the aura of exclusivity, weakening positive associations with the product. For example, Halston rose to fame in the 1970s as a high-end design standard for women's clothing. However, when Halston accepted $1 billion from lower-end retailer JCPenney to expand into affordable fashion lines for the mass consumer, Bergdorf Goodman dropped the label in order to protect their brand. The JCPenney line was a failure, and the Halston name never recaptured its previously enviable branding.”

“Dilution threatens branding power because it can reset the hysteresis clock”

“even if brand recognition is very high, there may not be branding power.”

“a strategist would gravely err in classifying this as branding”

“the cornered resource can emerge in varied forms, offering uniquely different benefits.”

“There were false starts, conflicts, do-or-die deadlines, politics and epiphanies, and many, many late nights. Like a Marine squad that has gone to war and back, the filmmaking team forged deep, resilient bonds of trust, respect and understanding. The next two films extended and strengthened them. This band of brothers later came to form the core of the group known as the Brain Trust, a creative cadre instrumental to the studio's sustained success. This core group is the Factor X that lies at the heart of Pixar's power. 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 Seven Powers framework, benefit. In the Pixar case, this resource produced an uncommonly appealing product. Superior deliverables, driving demand with very attractive price-slash-volume combinations in the form of huge box office returns.”

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

“No doubt, this was material, a large bar 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 & Lomb's spin-casting technology for soft-contact lenses. Barrier The barrier in cornered resource is unlike anything we've 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. Even during the company's rocky beginning, there was a loyalty that went beyond simple financial calculation.”

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

“Our general term for this sort of barrier is fiat.”

“Lasseter demurred. I can go to Disney and be a director, or I can stay here and make history. So in Pixar's case, the barrier was personal choice. In the case of spin casting technology, it is patent law, and in the case of cement inputs is property rights. Our general term for this sort of barrier is fiat. It is not based on ongoing interaction, but rather comes by decree, either general or personal. In the case of the cart driving the donkey, it was Lasseter's commitment to Pixar that helped convince Katzenberg to do the three-picture deal with Pixar in 1991. Likewise, Disney's later CEO, Bob Iger, would decide to acquire Pixar only after realizing such an acquisition would be the sole means of bringing Pixar's talent to Disney's flagging animation group. The subsequent revival of Disney Animation affirmed his wisdom. This now allows me to place Cornered Resource on our Seven Powers display. See figure 6.4 in the supplementary PDF. Cornered resource definition. Preferential access at attractive terms to a coveted asset. They can independently enhance value.”

“Further, Pixar's record shows that simple inclusion into the group will not preternaturally endow newbie directors with the brain trust process. Such directors frequently fail, as evidenced by the replacement of Ash and Colin Brady on Toy Story 2, Jan Pinkava on Ratatouille, and Brenda Chapin on Brave. I believe the brain trust is more than a combination of individual talents. Rather it is the foundational members' shared experience in the early trial years that has yielded one success after another. If indeed we observed new directors being brought into the fold, and achieving Pixar-level commercial and artistic success, then we could conclude that power came not from the brain trust, but instead from some deeper current. From this assessment, I've come to believe that the most important strategic challenge for Pixar is renewal of its director pool. An informed observer might ask about Brad Bird, who masterminded several of Pixar's biggest successes, coming into the studio and directing The Incredibles, based on a screenplay he had previously developed outside the purview of the brain trust, and later stepping in to rescue Ratatouille. Wouldn't he exemplify the sort of untested outsider Director mentioned above?”

“In fact, not really. On closer inspection, Brad Bird fits the assessment of the restricted nature of the brain trust. A classmate and friend of Lasseter from CalArts, Bird already shared a creative shorthand with many of the central figures of the brain trust. More, he was an accomplished and established animated film director upon his arrival at Pixar, as demonstrated by his fine film, The Iron Giant. 2. Non-Arbitraged What if a firm gains preferential access to a coveted resource, but then pays a price that fully arbitrages out the rents attributable to this resource? In this case, it fails the differential return test of power. Consider movie stars. A turn by Brad Pitt would probably advance box office prospects, therefore proving coveted. But his compensation captures much or all of this additional value, and so fails the power test. Likewise, although the Pixar brain trust is highly compensated, the amounts do not come close to matching their value. I was an investor in Pixar when it was public, and I realized a very nice return over the life of my investment, until the Disney acquisition. Three, transferable. If a resource creates value at a single company, but would fail to do so at other companies, then isolating that resource as the source of power would entail overlooking some other essential complement beyond operational excellence.”

“In the lead-up to his acquisition of Pixar, Bob Iger had an epiphany. The legacy of Disney's animated characters formed the core of the corporation, and only the Pixar team could revive that legacy. This motivated his purchase of Pixar, as well as his decision to place Catmull and Lasseter at the helm of Disney Animation, which resulted in the meteoric revival of that story division. Such a comeback would never have been possible without Catmull and Lasseter in key decision-making roles, and the brain trust on call, and it ultimately vindicated the steep price paid by Disney. This resource was transferable. 4. Ongoing In searching for power, a strategist tries to isolate a causal factor that explains continued differential returns. There's a contrapositive to this too. One would then expect differential returns to suffer should the identified factor be taken away. Clearly this perspective has bearing on the identification of a cornered resource.”

“Frequently, as I have observed, many will mistake specific leadership for a cornered resource.”

“For example, post-it notes emerged as a highly profitable business for 3M, only because as Dr. Spencer Silver tirelessly sought commercial application for his not-so-sticky glue. Once the Post-It application was established, the business's differential returns were not predicated on him and his unique glue, but rather a different, in part at least cornered resource. U.S. Patent $3,691,140 U.S. Patent $5,194,299 and the Post-it Trademark At Pixar, Steve Jobs offered a similar case in point. He was essential to Pixar's ascendancy, viewing him simply as patient money utterly understates his contribution. But his importance diminished as Pixar developed, and eventually his value became embedded in the company to the point where his continued presence was no longer needed to drive differential returns. The brain trust, on the other hand, endures as the sustaining force behind their success. 5. Sufficient The final cornered resource test concerns completeness. For a resource to qualify as power, it must be sufficient for continued differential returns, assuming operational excellence. Frequently, as I have observed, many will mistake specific leadership for a cornered resource. In fact, it fails this sufficiency test. For example, I am a fan of the abilities of George Fisher. He did a fine job leading Motorola.”

“Fisher was not a cornered resource.”

“When he took the helmet Kodak, there were high hopes that his presence would lead to a revival of the company. That is, that he was a cornered resource. The rough patch that followed was, in my view, not his fault. It was merely an indication of the hopeless cul-de-sac created by the company's focus on chemical film in a solid-state age. These difficulties, however, yield an insight. Fisher was not a cornered resource. and the Motorola success involved other compliments to his talent that were not later present at Kodak. Another way to put this is that a cornered resource is a sufficient condition for potential for differential returns. In my view, current evidence best supports the assertion that the Pixar Braintrust as a unit is the company's cornered resource, as opposed to individual members, such as Catmull or Lasseter. One might view Lasseter plus Catmull together as the real cornered resource, and then suggest that the other brain trust hires serve merely as a reflection of their selection skills. You could even view the revival of Disney animation under Lasseter's and Catmull's leadership as evidentiary to this view. The failure of newbie Pixar directors, however, tends to belie this.”

“Although Toyota offered full transparency regarding NUMI practices, GM just couldn't replicate the replicate the NUMI results in its own facilities.”

“This was not merely incompetence.”

“These assets do not disappear as new workers are brought in, and older workers retire.”

“This inherent speed limit in achieving the benefit results from two factors.”

“Process power. The TPS exemplifies a rare power type, process power. Let me characterize process power more formally using the usual benefits and barriers dimensions of the seven powers framework. 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. 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. 1. Complexity Returning to our example, automobile production, combined with all the logistic chains which support it, entails enormous complexity. If process improvements touch many parts of these chains, as they did with Toyota, then achieving them quickly will prove challenging, if not impossible. 2. Opacity. The development of TPS should tip us off to the long-time constant inevitably faced by would-be imitators.”

“It took fully 15 years for instance, before they were able to transfer TPS to their suppliers.”

“It took fully 15 years for instance, before they were able to transfer TPS to their suppliers. GM's experience with Numi also implies the tacit character of this knowledge. Even when Toyota wanted to eliminate their work processes, they could not entirely do so. This benefit-slash-barrier combination allows us to place process power on the 7 powers chart located in the supplementary PDF. Which brings us to our definition of process power. Embedded company organization and activity sets, which enable lower costs and or superior and which can be matched only by an extended commitment. Process Power and the Discipline of Strategy Process power has important intersections with the evolution of the discipline of strategy. By characterizing these, we can better understand the nature of process power and why it is so rare. Strategy vs. Operational Excellence Professor Michael Porter of Harvard created quite a stir with his long-ago insistence that operational excellence is not strategy.”

“Perhaps the best way to think of it is this. Process power equals operational excellence, plus hysteresis.”

“I am in strong agreement with Professor Porter's sentiments. If one were to adopt a different definition of strategy, something like, everything that is important, then operational excellence would be strategic. As is though operational excellence, while important, hard to achieve and worthy of management mindshare, is not sufficient to gain competitive advantage. Professor Porter would not dispute this. The Experience Curve A concept known as the Experience Curve loomed large in the formative years of the Boston Consulting Group and Bain & Company's strategy practices. The Experience Curve was based on the empirical observation that many company costs seemed to follow a downward trajectory that falls within a specified envelope. For each doubling of units produced, what's meant formally by experience, the deflated cost per unit would be between 70% and 85% of what it had previously been prior to the doubling, referred to as slope. This view is not naive, as indicated by the histogram derived from data in a 1990 science article.”

“You might be tempted to read these data as disproving my assertion that process power is uncommon. Rather you might say, it is a usual business condition driven by experience. Unfortunately these data simply underline the frequency of the benefits attending operational excellence. The improvements mapped above refer only to gains made over time. They tell us nothing about the relative position of multiple firms at a single point in time. For example, based on the experience curve, there would be no cost differences at any point in time between firms of different sizes, but all firms realizing similar year-to-year gains. Let's use a simple thought experiment to clarify my assertion that the gains over time indicated by the experience curve are widely shared amongst firms. If the relationship between experience held across all firms at a single point in time, then one would commonly expect a firm with a two times size advantage over its largest competitor to sustain operating margin gains of 15% to 30%. The rarity of such huge differences underscores an irony. The experience curve does not suggest power, but rather it indirectly testifies to Professor Porter's point, the ubiquity of competitive arbitrage. Routine. As mentioned before, while in graduate school I had the privilege of studying under Professor Richard R. Nelson.”

“usually such routines represent a benefit with no barrier, hence they do not result than power.”

“Competitors can easily mimic the improvements yielded by operational excellence, eventually arbitraging”

“These advantages paid only diminishing returns, meaning a smaller competitor of an attainable”

“Scale Economies With this first power type, you must simultaneously pursue a business model that promises scale economies, industry economics, while at the same time offering up a product differentially attractive enough to pull in customers and gain relative share. Competitive Position Network Economies Here the needs are similar to scale economies, except that installed base rather than sales share is the goal. 4. 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. 5. 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. Counter-positioning You pioneer a new, superior business model that promises collateral damage for incumbents if mimicked.”

“Process Power You evolve a new complex process, which renders itself inimitable within a reasonable period, and yet offers significant advantages over a longer period of time. 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. For any business person, me too won't do, feels right intuitively. Action, creation, risk, these lie at the root of invention. Business value does not start with bloodless analytics. Passion, monomania, and domain mastery fuel invention, and so are central. The compelling continuing contribution of founders demonstrates this. Planning rarely creates power. It may meaningfully boost power once you have established it. But if power does not yet exist, you can't rely on planning. Instead, you must creates something new that produces substantial economic gain in the value chain. Not surprisingly, we have worked our way back to Schumpeter. The Topology of Invention and Power So what are the elements of this dance of power and invention?”

“The script usually plays like this. 1. Flux in external conditions creates new threats and opportunities. In the case of Netflix, it was both. The eventual decline of their DVD-by-mail business was the threat, and streaming the opportunity. 2. The nature of flux demands that it unfolds in fits and starts. So any company wishing to capitalize on these new conditions must invent, again, by crafting not design. For a single company, these tectonic shifts do not occur frequently, but you can be certain they are coming. The relentless forward march of technology assures this Three amidst this cacophony. You must find a route to power It wasn't a fine-tuning of their DVD by mail business which increased Netflix's market cap by a factor of 100. It was streaming, with its insurmountable scale economies. Building on that, I can now chart the dynamics of power. See Figure 8.4 in the Supplementary PDF. Figure 8.4 The Dynamics of Power Getting there. What? Resources and external conditions both point with dotted arrows to invention, which also includes product, business model, brand, and process. Invention points with a dotted arrow to power. Now let's apply this framework to Netflix streaming.”

“You must start with the abilities you can bring to bear. Using the academic convention, I will call these resources. They might be as personal and idiosyncratic as Steve Jobs' aesthetic sensibilities, or as corporate as Google's vast stores of organized data. For Netflix, their original DVD-by-mail business endowed them with numerous resources relevant to streaming. including such directly transferable skills as their recommendation engine, their UI, their customer data, and their relationships with content owners. Equally important was the platform of their existing business, which allowed them to easily offer streaming as a complement to DVD-by-mail, rather than a standalone service. This was far more important than you might think, as it silenced potential complaints about the initial small streaming catalog that could have driven fatally negative word of mouth. Conversely, though, there were also many abilities Netflix had to develop, and as they moved aggressively into originals, this set of required competencies expanded considerably.”

“But assessing power prospects ex ante in high-flux situations, is also what drives the business person's need for a strategy compass. Let me give you some details. First, to summarize the strategy compass thesis, I have made the foundational assumption that strategy and strategies are about only one thing, potential fundamental business value. I refer to this as the value axiom, and it is the bedrock of power dynamics and the seven powers. This assertion represents an intentional narrowing on my part. The last several decades have proven to me that much acuity and usefulness results from adopting the value axiom. By far the most important value moment for a business occurs when the bars of uncertainty are radically diminished with regards to the fundamental equation of strategy, market size, and power. At that moment, the cash flow future makes a step change in transparency.”

“High uncertainty persists during this interval because these transitions are typically not difficult to forecast accurately. Strategy, the discipline, can only contribute in this period if it serves as a strategy compass to guide on-the-ground inventors, increasing their likelihood of finding a path to satisfy the mantra. To serve as such a cognitive guide, a strategy framework must be simple but not simplistic. That is the objective of the seven powers. So what relevance does this bear to active equity investing? To the best of my knowledge, the seven powers applies to all businesses everywhere. Furthermore, it is founded on fundamental business value, which also concerns a large class of investors. Does this mean that utilizing the seven powers can result in alpha for investment in any company? Of course not. In nearly all cases, both the potential for power and the size of the market are sufficiently evident to astute investment professionals.”

“Alpha depends on exceptions to the semi-strong form of the efficient market hypothesis. You need material informational advantage. In these cases, the seven powers offers no such advantage. The only places one might expect alpha from applying the seven powers are those situations in which such transparency is not the case, opacity in other words, and that such opacity is penetrable by the seven powers. A primary driver of opacity is high flux. If a business is in a fast-changing environment, then the information-facing investment pros tends to have much higher uncertainty bars regarding future free cash flow. But high flux also attends the sort of conditions which orbit the value moment. So if the seven powers can lead to alpha by identifying power in these situations, ex ante, it also promises to be useful in doing the same for those inventors on the ground, trying to find a path to satisfy the mantra. So how have I done following this approach? Have I been able to deliver alpha? My active investing records go back 22 years, But I will be brief in answering those questions. I have daily portfolio returns data for all the 4,664 trading days I was in the market. Dating from the beginning of 1994 through 2015, my year-by-year annual gross returns are shown in figure 8.10 in the supplementary PDF.”

“For the 20 invested years, 17 full years and 3 partial years, my gross returns exceeded those of the market for 14 years, and underperformed the market for 6. Over these trading days in which I actively invested, I achieved an average annual rate return of 41.5% per year versus 14.9% per year for the S&P 500 TR. So on average I outperformed the S&P 500 TR by 26.6% each year. However, my highly concentrated approach results in a different risk profile than that of the market overall. So we should also look at a risk-adjusted return. One way to do so is to take out the effects of the market overall, beta. This yields an average annual alpha of 24.3%, 9.1 basis points of alpha per trading day on average. Because of the high concentration, my approach has higher volatility, 31.6%, versus 15.8% for S&P 500 TR when annualized. An informative way to assess the risk-reward associated with this is to calculate an investor's prospects of beating the market. To do this for all 4,664 trading days, I calculated the risk-return profile. 1. Risk What was the probability of underperforming the market if an investor had stayed with my approach for 1, 2, 3, and 4 years. 2. Return. What would have been the average annual rate of return over those 1, 2, 3, and 4-year periods?”

“Figure 8.11 in the supplemental PDF displays those calculations. indicate that, historically, if you had invested based on this approach and continued with that investment for four years, you would have had about a 3% probability of not outperforming the market. This was your risk, and the average return for a four-year hold outperformed the market by about 30% per year. This was your return. So based on both these measures, utilizing the seven powers has historically delivered unusually attractive returns over an extended period. I know of no other strategy framework with this outcome. Thus, the seven powers seems to have been differentially acute as a tool for identifying the potential for power X and P in high-flux situations. This provides additional assurance in its utility as a cognitive framework for business leaders and ## Chapter 9: The Power Progression their crucial value moments, which are also inevitably high-flux. Chapter 9 The Power Progression Turn, turn, turn. Intel starts from scratch.”

“the importance of the takeoff stage is even more pronounced with network economies”

“Even for switching costs, takeoff is the critical stage.”

“Scale economies. To establish this advantage, Intel sees the required market share lead by the end of the explosive growth stage of the PC market. Once growth settles down, the stakes are well known and the volume leader can and will use their cost advantage to fend off competitors network economies the importance of the takeoff stage is even more pronounced with network economies network economies are often characterized by tipping point once the leader has achieved an edge in installed base most users will find it to their benefit to choose that leader for application software developers the choice of attractive microcomputer platforms was winnowed to only two choices with sufficient scale, Apple and PCs. Lacking in competitive applications, other platforms were doomed. Even for switching costs, takeoff is the critical stage. First off, switching costs are a source of power for those who get to the customer first, and a wealth of customer relationships are established in the takeoff. Secondly, in the takeoff period, customers are often struggling to find any supplier, so the price competition that will eventually arbitrage out the value of switching costs for new customers has yet to occur. The Power Progression, Takeoff So there we have it. All of Intel's sources of power were rooted in the takeoff period.”

“There is such a high degree of flux that the normal lags in the arbitraging process are material to the outcome, resolving uncertainty, transparency, product tuning, building capacity, establishing channels, effective marketing, and so on. For Intel, Operation Crush made a crucial difference to power. In a mature business, it would have simply been part of the to-and-fro of arbitrage. What cutoff point in the growth rate marks the end of this takeoff period? It depends on the degree of flux and uncertainty, but based on my experience, 30-40% per year seems a workable choice. By this measure for the PC market, take-off probably started in 1975 with the 8080 and continued through 1983. Armed with this understanding, you can see that Intel made it in just under the wire. They made a decisive break from the peloton of competitors at a crucial time. If the PC market had forged ahead for another year or two without them, the window of opportunity would surely have closed. No breakaway would have been possible. Intel would have captured some sales, but their prospects for power would have dimmed as the opportunity for scale economies quickly receded. Put into context, if another company had won the IBM contract, Intel as we know it today would not exist. This sort of situation breeds a common form of false positive.”

“Unfortunately, if a company has not established power, competitive arbitrage will catch up as soon as growth slows.”

“Stage 1. Before Origination This occurs before a company clears the Compelling Value Threshold, at which time sales rapidly pick up pace. For microprocessors, the entire BUSICOM period, including Intel's efforts up until the release of the 8080, constituted the origination stage. Stage 2, during, takeoff. This is the period of explosive growth. Stage 3, after, stability. The business may still be growing considerably, but growth has slowed from explosive levels, with 30-40% per year unit growth as a workable choice for the cutoff. Above this rate, the market doubles in two years, sufficiently fluid for market leadership swaps without value-destroying countermoves. A word of caution, parsing by growth should not create the impression that the phases above are congruent with the well-known product lifecycle stages of introduction, growth, maturity, and decline. They do not align, and the differences are critical. First of all, the three stages described above are defined by the metric of business growth, not industry growth. See definitions in Appendix 9.3 in the supplemental PDF. Business growth best reflects the degree of flux a company faces in that business. Secondly, the breakpoints are entirely different.”

“My parsing utilizes takeoff to delineate stages. When trying to discern the availability of power, this grouping proves essential. The product lifecycle grouping will not serve this purpose.”

“Stability, on the other hand, features considerable growth, and so it overlaps all of the last three stages of the lifecycle model. My parsing utilizes takeoff to delineate stages. When trying to discern the availability of power, this grouping proves essential. The product lifecycle grouping will not serve this purpose. Bearing this in mind, I can now tackle the challenge laid down at the beginning of this chapter. Can one meaningfully generalize about when power is established? I will use the same methodology as Chapter 8, parsing the question by power type. For each of the seven powers, must they be established in origination, takeoff, or stability? Distilling it further, what I am really asking is this. When must one establish the barrier? Power results from the simultaneous presence of a benefit and a barrier. Both of these play a pivotal role in dynamics. Chapter 8 demonstrated the vital role of invention in implanting benefits and forging the potential for power.”

“Thus, the decisive attainment of power often syncs up with the establishment of the barrier. The power progression maps this barrier timing.”

“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. The power progression maps this barrier timing. For the Intel example previously discussed, see figure 9.3 in the supplementary PDF. The power progression maps when power must be established by power type. It indicates at what point the window is open. Intel's three power types continued on into the stability phase, of course. That's why the company's value has endured. However, if Intel had not established scale economies, network economies, or switching costs, by the time they reached stability, the possibility of power would have vanished forever. They would have likely become a low-margin electronic components company, a relentless treadmill fate that awaited many other semiconductor firms, including the Japanese juggernauts that trumped Intel in the memory business only years before. The Power Progression, Origination Now let's turn our attention to the origination stage that occurs before takeoff. There are two types of power that typically become first available during this earlier period. Cornered resource. The crucial step in Intel's microprocessor victory came when they reacquired the rights to their invention from Busycom, which they accomplished three years prior to takeoff.”

“The crucial step in Intel's microprocessor victory came when they reacquired the rights to their invention from Busycom, which they accomplished three years prior to takeoff.”

“drug patents form the foundation of a branded pharmaceutical business”

“The promise of this type of power, secure from the start, is what underlies the industry's willingness to pour billions into high-risk research efforts.”

“The promise of this type of power, secure from the start, is what underlies the industry's willingness to pour billions into high-risk research efforts. Counterpositioning Counterpositioning requires the invention of an attractive business model that presents a vexing damned if you do, damned if you don't cul-de-sac for incumbents. It is this business model's whole product that creates the takeoff or the challenger, so it must proceed that phase and occur during origination. Thus, 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. I have mapped these two onto the The power progression, stability. Finally, there are two types of power that are likely to be established in the stability stage. Processed power. Process power occurs if a company over time develops a significantly superior internal process, which competitors cannot emulate easily. Process power typically avails itself only in the stability stage. Why then? Because 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.”

“Consider such failures as Hermes cognac or Porsche sunglasses.”

“Branding With branding in the mix, there is only one barrier of consequence. The long time and uncertainty a challenger would face in emulation. Think of the steep slope a new entrant would face against Hermes, with their many decades of carefully cultivated quality and exclusivity. Because this long path serves as a defining characteristic, the opportunity for branding must be squarely placed in the stability stage. Prior to that, there just hasn't been enough time to thoughtfully cultivate the necessary associations. You might lull yourself into thinking that there are opportunities for branding in the origination phase. Perhaps your existing brand is considering some transforming initiative, a thrust into an entirely new arena of business. You reasonably assume the brand's reputation can provide significant pricing power from the start. Use caution. This is possible, rare. Consider such failures as Hermes cognac or Porsche sunglasses. Perhaps the most notable exception would be Disney's move into theme parks, but again, such cases are rare. This then fully populates the power progression, which answers the question, for each of the seven powers, when does power first become available?”

“It makes sense then, that all powers relying on hysteresis, would only become available in the stability stage.”

“But the initiation of this business model is what gets the challenger off the ground, so it must occur in origination.”

“The power progression provides another solid instantiation of Professor Porter's insight to understand statics before tackling dynamics. This crucial question of the timing of strategy windows can only be meaningfully answered by asking it for individual power types. And these types are revealed by statics. The time character of the four barriers. Let's now delineate by time the seven powers chart developed earlier. See figure 9.6 in the supplementary PDF. This pulls into focus another dynamics insight. Each of the four generic barriers is specific to stage. This results from the nature of those barriers. Historesis. The barrier here? A structural time constant facing all players. It makes sense then, that all powers relying on hysteresis, would only become available in the stability stage. As the take-off stage is relatively short-lived, and does not usually provide sufficient time to build up the benefit, constrained as it is by the time constant. Collateral Damage Here it is the economics of the challenger's business model which threatens collateral damage to the incumbent. But the initiation of this business model is what gets the challenger off the ground, so it must occur in origination. Fiat The critical issue here concerns whether the right protected by fiat is fully priced.”

“Hence, generally speaking, only in the takeoff stage can a player gain share on attractive terms.”

“As the business proposition involving the cornered resource develops during takeoff, the resource's value becomes more widely known, substantially reducing the probability that it will be materially underpriced, and it must be underpriced to qualify as a cornered resource. Cost of Gaining Share Of course, the whole notion of gaining share carries no meaning in the origination stage, as sales have not yet materialized. When the business takes off, there are many factors which determine which company can scale most rapidly. Channel position, product features, communication approaches, location, production constraints and so on. As a consequence, the price of share usually does not reflect its intrinsic Upon reaching the stability stage, the most effective modalities become better known and accessible to many players. There the customer's focus turns from, can I get it, to, what is the best deal. In this situation, each player grasps the value of share, and will game accordingly, usually arbitraging out its value. Hence, generally speaking, only in the takeoff stage can a player gain share on attractive terms. Otherwise it is too costly to be worthwhile. The power progression. The data. Frequency histogram of power type. So far I've relied upon theory, supported by anecdote, to develop the power progression.”

“I had a team review the instances of power in all the research papers of my students, to determine at what stage at which power first occurred. The frequency histogram in figure 9.7 of the supplementary PDF displays the results of this distillation. The histogram lends strong support to the stage timing of power developed earlier. There are exceptions, but by and large the power progression is borne out. Origination, contrapositioning and cornered resource. Takeoff, scale economies, network economies and switching costs. stability, process power and branding. The Dynamics Difference In moving from statics to dynamics, scope is broadened considerably. At a high level, we see that in the fundamental equation of strategy, value equals the product of M sub-zero and G and bar S and bar M. Statics concerned itself only with power, and hence just the last two terms, R-S market share, and R-M differential margins. Primarily it focused on just one, R-M. In contrast, in a dynamics context, a company can profoundly influence both the two market size M sub 0, the current market size, and G, the discounted growth factor. The creation of compelling value, for example, is joined at the hip to the creation of a market. In the lingo of economists, in statics, M sub 0 and G are taken as exogenous, whereas in dynamics they are endogenous.”

“This broadening of scope also applies to many particulars as well. Here's one of great import, operational excellence. In my statics discussion, I explained why operational excellence is not strategic, because it's immutable, and therefore subject to competitive arbitrage. In the high-flux shortened time frame of the takeoff stage, sufficiently timely imitation becomes less likely, and excellent execution can be highly strategic. Consider for example Apple's trajectory. The Apple II was released in 1977, and paired with VisiCalc software, it rocketed ahead, seemingly poised to own its space. The follow-on Apple III was released on May 19, 1980, 15 months before the IBM PC. Unfortunately the product was a dog, and it couldn't even roll over, although it did a pretty good play dead. The Apple III had been manufactured utilizing an immature circuit board technology, so short circuits plagued the product from the start. At one point Apple even released a technical bulletin instructing customers to drop their computers from a height of 3 inches to try to reseat dislodged chips. To make matters worse, it was a pricey box, starting at over $4,000 and going up to almost $8,000 fully loaded. Only a year later, the IBM PC was offered at $1,600. The Apple III bombed, but at the very moment when a killer product would have propelled Apple to a near insurmountable preeminence.”

“Not only that, since Apple controlled the OS, their microcomputer business could have become a high-power one. Instead, that business never recovered. Apple had flubbed the take-off period. For a while they maintained a respectable business and continued to be the innovation leader, but these setbacks put them on the road to an ever-declining share in personal computers and an eventual near-death experience that could only have been reversed by the genius of a resurgent Steve Jobs. Operational excellence was crucial, and its lack caused Apple to fumble. For Intel and their microprocessor business, it was very much the converse. Without Operation Crush, it seems likely to me that Intel would have missed the IBM PC opportunity, and with it the chance to achieve an utterly dominant relative scale advantage. Operation Crush reveals another telling difference between a statics view and a dynamics view. The role of leadership. As a value investor, I consider Warren Buffett one of my heroes. I previously mentioned his insight that good managers can rarely reverse the course of a bad business. That is, one without power. Over and over, I've witnessed Buffett's axiom play out in the press. The business leaders castigated for poor management ability in the face of seemingly impossible circumstances. Yahoo, Twitter, and Zynga come to mind here.”

“Operation Crush would never have happened were it not for Andy Grove's implacable, aggressive leadership. Going back further, the company would not have even pursued microprocessors were it not for the leadership of Bob Noyce. In summary, when you step back to consider how power is established in the first place, there are a lot more parts to the puzzle. Leadership, timing, execution, cleverness, and luck can all play decisive roles. Conclusion The Strategy Compass and Seven Powers As I have underscored throughout these pages, strategy's highest calling must be to serve as a real-time strategy compass. To fulfill this role, it must be distilled into a framework that is simple but not simplistic. The first seven chapters built, brick by brick, the seven powers. This is your strategy compass. Then in the final two chapters I addressed the what and when to clarify the terrain you navigating with your compass. With these ideas as your toolkit, you are now fully prepared to blaze your own path to satisfy the mantra. A route to continuing power in significant markets. This is what strategy means, and this is what you must achieve to be a success. Appendix 9.1.”