7 Powers — Understanding Competitive Moats

I’ve recently read a great book: “7 Powers: The Foundations of Business Strategy” by Hamilton Helmer.

The Powers discussed are the “set of conditions that create the potential for persistent differential returns”. Said another way, they help create competitive moats that help a company grow and sustain differential margins.

I think strategically considering Power can be especially powerful for startups and early investors. As Hamilton said: “your first step is invention: breakthrough products, engaging brands, innovative business models. The first step, yes, but it can’t be the last step.” There has to to be Power for a firm to be able to create long term business value.

Investors learn a framework to analyze a firm ex ante, helping to spot the Powers that are being development, thus understanding the true value of firm. Strategists can begin thinking of Power development to ensure sustainability.

“7 Powers” helped me better understand the trials and tribulations I personally experienced in super competitive markets. I now, more clearly, see how a firm can develop conditions for persistent growth and returns by escaping competitors. (I’ll outline the Powers developed in the email marketing SMB industry in a future post).

7 Powers

For each Power, I’ve noted:

• Benefit: how it helps the firm
• Competitive Barrier: how it holds competitors at bay
• Exclusivity: is it the only company in a market that can have the Power?
• Phase: which phase of the companies development does the power get established. The phases are Origination (before rapid growth), Takeoff (explosive growth), and Stability (less than 30% annual growth).
• Getting it (how it is developed)
• Example (a quick example of the Power).

Powers:

1. Scale Economies: The quality of declining unit costs with increased business size

• Benefit: Reduced Cost
• Competitive Barrier: Prohibitive Costs of Share Gains
• Exclusive? No, a similarly sized firm could have the same cost benefit.
• Phase: Power established during Takeoff.
• Getting it: 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).
• Example: Netflix’s smaller-scale streaming competitors offer the same deliverable as Netflix, similar amounts of content for the same price, their P&L will suffer. If they try to remediate this by offering less content or raising prices, customers will abandon their service and they will lose market share.

2. Network Economies: A business in which the value realized by a customer increases as the installed base increases.

• Benefit: Higher prices than its competitors
• Barrier: Unattractive cost/benefit of gaining share
• Exclusive? Yes, winner takes all.
• Phase: Power established during Takeoff. Maybe planned during Origination.
• Getting it: you must simultaneously pursue a business model that promises Network Economies (industry economics), while at the same time offering up a product differentially attractive enough to pull in customers (competitive position).
• Example: A lot of value would have to be offered to Facebook users to leave the platform to another platform.

3. Counter Positioning: A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business. Must pass tests: 1) idiosyncratic (peculiar), 2) Non-arbitraged (resource not acquired by fully arbitraged price), 3) transferable, 4) ongoing, 5) sufficient (other compliments not needed)

• Benefit: Biz Model with Reduced Cost and/or Higher Prices
• Barrier: Reaction will lead to Collateral Damage to current biz model
• Exclusive? No, others can have same business model.
• Phase: Power established during Origination.
• Getting it: You pioneer a new, superior business model that promises collateral damage for incumbents if mimicked.
• Example: Netflix charging no late fees where late fees made 50% of Blockbuster revenues. Blockbuster couldn’t respond.

4. Switching Costs: The value loss expected by a customer that would be incurred from switching to an alternate supplier for additional purchases. Types of costs: financial (implementation, migration), procedural (staff training, process updates, errors) and relational (new support, emotional bonds)

• Benefit: Charge current customers higher prices for equivalent follow-on products or services. No impact on potential new customers.
• Barrier: Unattractive cost/benefit of gaining share because competitor can set or adjust prices in a way that puts their potential rival at a cost disadvantage.
• Exclusive? No, others can have similarly high retention rates
• Phase: Power established during Takeoff. Maybe planned during Origination.
• Getting It: you must first attain a customer base, meaning the same new-product requirements demanded of Scale and Network Economies factor in here as well.
• Example: Moving away from Salesforce CRM has high switching costs. Integrated add-ons such as marketing automation systems can demand higher prices.

5. Branding: The durable attribution of higher value to an objectively identical offering that arises from historical information about the seller.

• Benefit: Elicits good feelings about the offering (affective valence) and peace of mind that offering will be as expected.
• Barrier: A long period of reinforcing actions (hysteresis) and a long investment runway with no assurance of an eventual path to significant affective valence.
• Exclusive? No, others can also have Branding.
• Phase: Power established during Stability.
• Getting It: 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.
• Example: Hermes, Gucci, Tiffany

6. Cornered Resource: Preferential access at attractive terms to a coveted asset that can independently enhance value. Must be unique, non-arbitrated (e.g. fee not corresponding to value), transferable, ongoing, and sufficient on its own.

• Benefit: Many fold include: reduced costs, higher prices, or preferential access to a valuable resource offering unique benefits.
• Barrier: Some kind of decree, e.g. legal , that blocks others access to resource
• Exclusive? Yes, the resource is, well, cornered.
• Phase: Power established during Origination.
• Getting It: 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.
• Example: A patent

7. 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.

• Benefit: able to improve product attributes and/or lower costs as a result of process improvements embedded within the organization.
• Barrier: these process advances are difficult to replicate because of complexity and opacity. They can only be achieved over a long time period of sustained evolutionary advance.
• Exclusive? Yes, the same process, if providing Power, is exclusive.
• Phase: Power established during Stability.
• Getting It: 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.
• Example: Toyota Production System process