7 Powers: The Foundations of Business Strategy

by Hamilton Wright Helmer

Cornered Resource definition: Preferential access at attractive terms to a coveted asset that can independently enhance value.

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.

Which brings us to our definition of Process Power: Embedded company organization and activity sets which enable lower costs and/or superior product, and which can be matched only by an extended commitment.

But let me offer a first insight right here up front: all Power starts with invention.

When I became an investor in Netflix in 2003, my investment hypothesis had two legs: Netflix’s DVD-rental business had Power: Counter-Positioning to the brick-and-mortar incumbent, Blockbuster; Process Power, as well as modest spatial distribution Scale Economies relative to other DVD-by-mail wannabes. This Power was not properly recognized by the investment community.

Netflix had no yet-evident sources of Power in this new modality—the technology to stream was accessible to many, and the powerful content owners were implacably committed to wringing every penny from their rights. I suspect Netflix management might have agreed with me on this assumption too.

The Netflix response to these predicaments? They tested the waters, investing 1–2% of revenue on streaming79—not a bet-the-company amount, sure, but hardly trivial. This effort culminated in the launch of the Watch Now feature on January 16, 2007. It was a modest beginning, and the initial offering comprised only about 1000 titles, small compared to their DVD library, which was 100 times larger, but significant still.

Netflix realized that content lay at the heart of the problem. After all, great content ultimately represents any streamer’s core value proposition, and for Netflix, it accounted for the bulk of their cost structure. Unfortunately, content holders could “variable cost price” the programming they licensed, charging Netflix according to usage. This put other licensors on an even footing with Netflix, regardless of scale, thus eliminating any chance of Power.

Ted Sarandos, the strategically acute Netflix content head, took the first step in addressing this challenge by pursuing exclusives.

This changed the game. The price of an exclusive was fixed, which meant some content no longer carried a variable cost. All of a sudden Netflix’s substantial scale advantage over other streamers made a difference.

Here’s the first important takeaway from our consideration of Dynamics: “getting there” (Dynamics) is completely different from “being there” (Statics).

For example, in the early days of strategy consulting, the two were frequently conflated: a close study of Statics indicated that high relative market share led to attractive returns; this fed the instinct to gain market share (Dynamics), usually via aggressive pricing. Such policies usually did not create value, as competitors would push back until the cost of share gains typically outweighed their benefits.

With an eye toward deducing a more general understanding, let’s take a step back, reexamine all seven types of Power and ask the Dynamics question “What must you do to get there?

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 ...

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 comm...

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

Counter-Positioning. You pioneer a new, superior business model that promises collateral damage...

Switching Costs. With Switching Costs, you must first attain a customer base, meaning the same new-product requirements demanded of Scale and N...

Process Power. You evolve a new complex process which renders itself inimitable within a reasonable period and yet offers significant ad...

In nearly all cases, both the potential for Power and the size of the market are sufficiently evident to astute investment professionals. In particular, they can often be found in the markers of historical financials. Alpha depends on exceptions to the semi-strong form of the Efficient Market Hypothesis: you need material informational advantage. In these cases the 7 Powers offers no such advantage.

The only places one might expect alpha from applying the 7 Powers are those situations in which such transparency is not the case—opacity in other words—and that such opacity is penetrable by the 7 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 7 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 invent...

So for these 22 years, I was fully in the market for seventeen years, partially for three years and fully out of the market for two years. For the twenty invested years (seventeen full years and three partial years), my gross returns exceeded those of the market for fourteen years and underperformed the market for six. Over these trading days in which I actively invested, I achieved an average annual rate of 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.

Because of the high concentration,102 my approach has higher volatility: 31.6% versus 15.8% for S&P 500 TR when annualized.

So based on both these measures, utilizing the 7 Powers has historically delivered unusually attractive returns over an extended period. I know of no other Strategy framework with this outcome. Thus the 7 Powers seems to have been differentially acute as a tool for identifying the potential for Power ex ante in high flux situations. This provides additional assurance in its utility as a cognitive frame for business leaders in their crucial “value moments,” which are also inevitably high flux.

Over this period, Intel’s market cap soared to the rarefied air of over $100B and stayed there. Its stock price increased more than 8500%, compared to the approximate 2000% increase of the S&P 500 TR. All of this value came from their microprocessor business. More specifically, it resulted from three of the 7 Powers:

Scale Economies. Piggy-backing on the rocket ship of the IBM PC, Intel achieved a large advantage in scale that it has never given up.

Network Economies.

When buying a personal computer, what they’re really purchasing is this: the ability to do certain tasks which are enabled by applications running on PCs, meaning software and hardware go hand in glove; they are complements.

This meant that when other PC makers came on line, they had to utilize IBM clones, or else they would have no programs. This meant that they used Intel, or Intel-compatible, chips. Network Economies were in force.

Switching Costs. If you owned a PC and were considering a switch to something else, the same chip-specific programming

would stop you from moving to a non-Intel machine. Otherwise, all the hours of toil you had put into your cur...

Scale Economies. To establish this advantage, Intel seized 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 are often characterized by a tipping point: once the leader has achieved an edge in installed base, most users will find it to their benefit to choose that leader.

So there we have it: all of Intel’s sources of Power were rooted in the takeoff period. Again, takeoff is the stage when differential customer acquisition can take place at favorable terms, which is why it presents such ideal Power opportunities.

What cut-off 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.

As a strategist and value investor, I cringe every time a CEO or CFO says they are pleased by the entrance into their market of a well-heeled competitor, insisting it “validates the market.” In 1981, at the introduction of the IBM PC, Apple had the temerity to run a large ad in the Wall Street Journal: “Welcome, IBM. Seriously.” They did not understand the nature of Power attainment in the takeoff stage: you and your competitor are in a race for relative scale, and there can only be one winner.

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.

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.

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.

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.

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.

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.