7 Powers

by Hamilton Helmer

  Intel’s experience imparts a crucial “When?” lesson: the takeoff period represents a singular time. Only then can you initiate three important types of Power: Scale Economies, Network Economies and Switching Costs. If unrealized, these opportunities disappear forever afterward.

  The Clock for the Power Progression

  Given the critical importance of takeoff for establishing Power, the clock for calibrating the acquisition of Power should be parsed into three time windows—before, during and after takeoff:

  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 counter-moves.

  A word of caution: parsing by growth should not create the impression that the phases above are congruent with the well-known product life cycle 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). Business growth best reflects the degree of flux a company faces in that business. Secondly, the breakpoints are entirely different: the origination stage precedes these familiar product life cycle stages and may exhibit no sales for a long time; stability, on the other hand, features considerable growth, and so it overlaps all of the last three stages of the life cycle model. My parsing utilizes takeoff to delineate stages. When trying to discern the availability of Power, this grouping proves essential. The product life cycle 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 7 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. But as I have discussed throughout this book, Benefits are common, and they often bear little positive impact on company value, as they are generally subject to full arbitrage. 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:

  Figure 9.3

  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 Busicom, which they accomplished three years prior to takeoff. Had Intel not regained these microprocessor rights, another company would have wielded this Power over them, possibly preventing them from ever entering this business.

  A good case can also be made for another pre-takeoff Cornered Resource at Intel: the potent triumvirate of Bob Noyce, Gordon Moore and Andy Grove. Arthur Rock once said that Intel needed Noyce, Moore and Grove in that order, and Rock eagerly put his money where his mouth was. Perhaps, in their absence, other leaders or managers might have stepped up to the plate, but it is hard to imagine Intel’s success without all three. All were deeply technically able, but each brought to the table a talent the others lacked. Noyce’s visionary leadership proved essential in spotting the potential of microprocessors and then backing them. Moore’s deep scientific chops helped solve the early and serious production problems of semiconductors. Grove’s implacable focus on execution drove Intel to a level of excellence that might have otherwise eluded them. Putting three such competencies together in a functioning senior management team would be a hard challenge, especially for a start-up.

  Indeed, pre-takeoff Cornered Resources underlie many important transforming successes. For example, drug patents form the foundation of the branded pharmaceutical business, whose transforming successes have created hundreds of billions in shareholder value. 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.111

  Counter-Positioning. Counter-Positioning 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 for the challenger, so it must precede 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 Power Progression below.

  Figure 9.4

  The Power Progression: Stability

  Finally, there are two types of Power that are likely to be established in the stability stage.

  Process 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.112

  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 Hermès, 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, but rare. Consider such failures as Hermès Cognac or Porsche sunglasses. Perhaps the most notable exception would be Disney’s move into theme parks. But again, such cases are rare.

  Figure 9.5

  This then fully populates the Power Progression, which answers the question “For each of the 7 Powers, when does Power first become available?” This is a potent shorthand, because
it enables you to quickly narrow your search for Power to only those types that map to the current growth stage of your business.

  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 7 Powers Chart developed earlier.

  Figure 9.6: Time-Delineated 7 Powers

  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:

  Hysteresis. 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 takeoff 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. 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, etc. As a consequence, the “price” of share usually does not reflect its intrinsic long-term value. 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 have relied upon theory, supported by anecdote, to develop the Power Progression. To provide some empirical validation, I turned to the research of my students, as for the last seven years I have been teaching business strategy in the Economics Department at Stanford University. 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 below displays the results of this distillation.

  Figure 9.7

  This 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: Counter-Positioning 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 = M0 g s m

  Statics concerned itself only with Power and hence just the last two terms (s), market share, and, m, differential margins); primarily, it focused on just one (m). In contrast, in a Dynamics context, a company can profoundly influence both the two market size terms (M0, 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 M0 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 imitable, 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, fifteen 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 three inches to try to reseat dislodged chips. To make matters worse, it was a pricey box, starting at over $4000 and going up to almost $8000 fully loaded. Only a year later, the IBM PC was offered at $1600.

  The Apple III bombed—right 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 takeoff 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, i.e. one without Power. Over and over, I have witnessed Buffett’s axiom play out in the press, with business leaders castigated for poor management ability in the face of seemingly impossible circumstances. Yahoo, Twitter and Zynga come to mind here. That said, when it comes to establishing Power in the first place, make no mistake: leadership is fundamental. 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 7 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 7 Powers. This is your strategy compass. Then in the final two chapters I addressed the “What?” and “When?” to clarify the terrain you are navigating with your compass.

  With these ideas as your toolkit, you are now fully prepared to blaze your own path to satisfying 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: The Power Dynamics Toolkit


  The body of Strategy intellectual capital I have developed is called Power Dynamics. The 7 Powers is its central unifying framework. Overall Power Dynamics is built on and tied tightly to seven perspectives.

  1. The Value Axiom. Strategy has one and only one objective: maximizing potential fundamental business value.

  Commentary. This is an assumption not a proof. My experience is that this narrowing of the scope of Strategy and strategy has a profoundly positive impact on the usefulness of the discipline. Note that this is fundamental not speculative value. Further it is about potential value. Realizing that value requires operational excellence.

  2. 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 3 S’s (Superior + Significant = Benefit and Sustainable = Barrier). However, in the field, the tripartite 3 S test of Power proves useful additionally because, since it calls out “Significant” separately, it makes materiality explicit. For example, businesses often tout network effects but, when looked at carefully, they are not material and therefore do not qualify as Power.