Counter Positioning — How Upstarts Tackle Incumbents

Talk about any startup long enough and eventually the question will arise:

“…and why can’t [incumbent firm] do this themselves and eat their lunch?”

If you are thinking of starting a company, funding one, or joining one, I’d be willing to bet you will inevitably face this question yourself. What then? Should you admit defeat and give up on your ambition then and there? You could easily make the case that the incumbent will be a fast follower once the upstart proves out its business model and quickly proceed to supplant them, and in most cases, you’d be right.

However, we all know of cases in which a startup manages to build a successful business seemingly right under the nose of the incumbent. How does this happen? How do challenger firms grow from an insignificant after-thought to a major threat? These are often cases where the upstart firm found a business model that is Counter-Positioned to the incumbent firm.

Think of Netflix and Blockbuster, Amazon and Borders, Fidelity and Vanguard, etc., all cases where a scrappy challenger managed to build a business in the face of a strong incumbent. How could this have happened? Did prized executives at incumbent firms suddenly lose their business acumen? Quite the contrary, Counter-positioning often involves cases where good management practices by the incumbent’s executives lead to bad business outcomes. In his seminal book, ”7 Powers”, investor and business strategist Hamilton Helmer outlines what he’s termed Counter Positioning, and in this essay we will set out to gain a better understanding of what Counter-Positioning really is, what it isn’t, and go through what may be a live example.

What Is It?

So what is Counter-positioning really? Simply put, we can say it’s when a challenger firm has a business model that is counter-positioned to the incumbent and adopting the same business model would harm the incumbent’s existing business. This often results in the incumbent either delaying the decision to adopt the business model, doing so in a perfunctory manner, or in some cases, both.

An example can help us think about this concept more clearly. Let’s look at the case of Netflix and Blockbuster. Blockbuster’s main business was video rentals via brick and mortar stores, and a non-trivial portion of its revenues came from late fees. At one point Blockbuster had about 9,000 stores and collected as much as 16% of its revenue from late fees¹. When Netflix opened for business with its DVD-by-mail business in 1997, and a bold promise of ‘NO LATE FEES!’, it was counter-positioned to the video rental powerhouse Blockbuster.

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Blockbuster could easily have launched a DVD-by-Mail service themselves, and launch one they did, albeit a mere seven years past the founding of Netflix. It wasn’t a technological barrier that caused Blockbuster to delay their decision to follow Netflix’s business model, rather it was likely the result of sound management. For Blockbuster, which made its money by renting DVDs through myriad retail stores and charging late fees on those rentals, any gains from a Netflix’esque ‘DVD-by-Mail’ business would have come at the expense of their large businesses. Furthermore, such a business model would run counter-narrative to the core business; to promote DVD-by-Mail is to tacitly admit that this service may be superior to the in-store experience, the same can obviously said for Netflix’s ‘No Late Fee’ policy. Why would the executives at the helm of the company choose to spend a material amount of company resources and effort on initiatives that when successful would result in a negative Net Present Value (NPV) outcome for the company as a whole? They clearly wouldn’t do such a thing, and that is the essence of Counter-positioning.

Counter-positioning often makes the incumbent delay adoption of the challenger’s business model until the point at which the core business has shrunk enough that adopting the business model no longer results in a negative NPV outcome, and by then it’s often far too late. By the time Blockbuster launched its DVD-by-Mail service in 2004, Netflix was already a category king and a household name when it came to the service of DVD-by-Mail, successfully fending off an additional assault from retail giant Walmart.

What It Isn’t

The initial filter we should apply to determine whether we’re dealing with Counter-positioning is quite simple: if the challenger firm’s business model would not be attractive to the incumbent when considered in a vacuum then it can not be said to be counter-positioned.

The next filter we should consider is whether or not the incumbent has the domain expertise necessary to be successful in the challenger’s business model. For this case we can think about Kodak in the face of digital photography. Digital photography required semiconductor memory expertise, an area of expertise that Kodak was not well versed in at the time the technology emerged despite the fact that the first Digital camera was invented within Kodak by Steven Sasson in 1975³. Kodak had expertise in chemical film which did not transfer over to the realm of Digital Photography, and thus had little prospect of withstanding assault from firms with superior expertise with semiconductors. Kodak’s case is one of succumbing to the challenge of a Disruptive Technology, not of Counter-positioning.

Similarities with Disruptive Technologies

As Helmer dutifully explains in ‘7 Powers’, Counter-Positioning is not always Disruptive Technology, although there are many similarities between the two. We can go back to the Netflix and Blockbuster example. Netflix’s DVD-by-Mail business did not incorporate any meaningful new technology that Blockbuster didn’t have access to. Netflix had no monopoly on mail or the usage of distribution centers, and as such it can be said that Netflix’s DVD-by-Mail model was Counter-positioned to Blockbuster but was not a Disruptive Technology. However, when Netflix initiated streaming, and in particular the company’s later decisions to become a producer of content in addition to its reliance on viewership data to guide content creation decisions, they by all accounts fit the definition of a Disruptive Technology.

Apple Podcasts, A Live Example?

I recently had a long discussion with a friend about the business of podcasting as we’ve both been avid podcast listeners for the past ten years. We discussed the emerging business model of personalized advertising delivered via podcasts replacing the old ‘one-size-fits-all’ advertising model where the same ads are delivered to all listeners. At one point our conversation turned to ‘Why hasn’t Apple monetized Apple Podcasts?’, Apple has always opted to avoid monetizing its podcast platform, instead acting solely as a distributor, but why have they done so⁴?

Apple Podcasts is the most dominant player in the space with 27mm monthly active user’s in the US and 66mm world wide, and a market share of over 60% as of Feb ’19⁵. Between Apple Music and Podcasts, the company has enough insights and distribution to deliver personalized advertising that would likely surmount that of any competitor, so why are they ceding this business model to competitors such as Spotify or Midroll? I argue that this is Counter-positioning in the making.

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For years Apple has prided itself for not monetizing its users’ data while other tech giants have become increasingly reliant on such business models, most notably Google. In fact, in 2019 Apple launched an ad campaign under the headline of ‘Privacy. That’s iPhone’. As part of this campaign Apple began displaying redesigns of its famous logo made to resemble a lock, as seen here. At one point the company even took out massive ads on buildings as can be seen below. Why is all of this important, and how does it relate to Counter-positioning?

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Apple’s brand, at least by the company’s own perception and actions, is so embedded with the notion of protecting its users' privacy that to opt for a business model of personalized ads would be a betrayal of their users’ trust. This, in turn, would result in harm to the core business that would likely heavily outweigh any of the gains made by adopting the new business model in the short term. Per IAB and PWC, Podcasting ad revenue in ’18 amounted to $479Mm, and are expected to grow to as much as $1bn by ‘21⁶. Meanwhile, Apple’s net sales of iPhones alone in ’19 amounted to $142bn⁷, and totaled $260bn across all of its products and services.

Thus I would make the claim that Apple is not ceding this territory to the likes of Spotify out of managerial incompetence, rather it is a calculated decision that views their business in a holistic fashion.

Spotify, on the other hand, is well-positioned to execute on such a business model. As of 4q2019 their user base of 271Mm Monthly Actives was comprised of over 150Mm ad-supported users⁸. Spotify’s brand is not one directly tied to protecting users’ privacy, and as such they have little to lose by pursuing this business model. In fact, it may just be the case that this business model would significantly improve the experience for its ad-supported users, who may appreciate more personalized ads as opposed to the current ‘one-size-fits-all’ model, a non-trivial consideration given that over half of Spotify users are ad-supported.

If it is indeed the case that Apple is electing to avoid monetization of the Podcasts platform due to these reasons, we can also take this idea one step further and hypothesize that Apple has not, and will not, pursue such data monetization models due to those models being Counter-positioned to their core business.

In closing, I hope that this has helped build your understanding of what the concept of Counter-positioning is, and how it can be used to effectively tackle what are seemingly insurmountable incumbents. If nothing else, I hope that it gives you something to think about the next time someone asks you: ‘…and why won’t [insert the relevant incumbent] eat this company’s lunch?’

Special thanks to Casey Caruso for reviewing drafts of this post

Footnotes

  1. https://qz.com/144372/a-brief-illustrated-history-of-blockbuster-which-is-closing-the-last-of-its-us-stores/
  2. https://www.wsj.com/articles/SB107645765403826229
  3. https://www.businessinsider.com/digital-photography-revolution-2015-4
  4. Note this question of ad monetization can be asked about Apple’s business more broadly, however, the piece focuses specifically on Podcasting to give it narrower focus, and then extrapolates from the podcasting business to draw conclusions about the broader business.
  5. https://a16z.com/2019/05/23/podcast-ecosystem-investing-2019/
  6. https://www.iab.com/insights/third-annual-podcast-ad-revenue-study-by-iab-and-pwc-reports-significant-growth/
  7. https://s2.q4cdn.com/470004039/files/doc_financials/2019/ar/_10-K-2019-(As-Filed).pdf
  8. https://s22.q4cdn.com/540910603/files/doc_financials/2019/q4/Shareholder-Letter-Q4-2019.pdf

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Some dude. Likes to think out loud. Investing @ Galaxy

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