His fundamental equation of value is:
Value = M0*g*s*m = market scale * power
- M0 is Market at time zero. g is growth. This is about targeting big and growing market opportunities.
- S is long-term persistent market share. How much of it you have
- M is long term persistent margins. (operational margins after cost of capital)
- You can also do potential value = market scale * power.
His break-down of branding is that it evokes positive emotion, leading to increased willingness to pay.
- Affective valence. Built-up associations that elicit good feeling that are distinct from the objective value of the good.
- Uncertainty reduction. Peace of mind because confidence the product will be as expected.
- A brand requires lengthy period of time with reinforcing actions (hysteresis). Legacy brands tend to be powerful. Hard to replicate in short term. Or with copycats.
His break-down of cornered (or scarce) resource is that it must be sufficiently potent to drive high-potential, persistent differential margins (m>>0), with operational excellence spanning the gap between potential and actual. He has five screening tests for cornered resource:
- Idiosyncratic. Such as a brain trust with repeated success over time.
- Non–arbitraged. If a firm gains preferential access to a coveted resource but also pays a price that fully arbitrages out the rents attributable to this resource – then doesn’t matter.
- Transferable. If resources creates value at one company, but cannot if transferred to another, then it is not good. Probably has an essential complement.
- Sufficient. It must be complete enough to continue producing differential returns assuming operational excellence.
Related podcasts and articles are:
- 4 Problems with Hamilton Helmer’s 7 Powers (Jeff’s Asia Tech Class – Podcast 62)
- Economies of Scale and Switching Costs According to 7 Powers (Jeff’s Asia Tech Class – Podcast 64)
From the Concept Library, concepts for this article are:
- Competitive Advantage: Share of Consumer Mind
- Competitive Advantage: Surplus Margin Leader in Network Effects
- Competitive Advantage: Proprietary Technology
- Competitive Advantage: Learning Advantages and Process Advantage
- Competitive Advantage: Scarce Resource
- 7 Powers
From the Company Library, companies for this article are:
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.
This content (articles, podcasts, website info) is not investment, legal or tax advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. This is not investment advice. Investing is risky. Do your own research.
Well, welcome, welcome everybody. My name is Jeff Towson and this is Tech Strategy. And the topic for today, the difference between competitive advantage and seven powers. Now this is, I guess, part three in the final part of sort of my discussion about the very well-known book, Hamilton Helmer’s Seven Powers, often talked about in Silicon Valley, uses a framework. called Seven Powers, obviously. And I’ve done two podcasts on this already. And this is kind of the third one, and final one probably. And I did wanna go through this in detail for those of you who are, you know, sort of following as a subscriber, because a lot of the companies I’m talking about, I’m gonna talk more and more in terms of these frameworks, mine versus Seven Powers versus Seven, you know. So I wanted to sort of lay it out at least. in some detail and then I can point people to it in the future if this is not familiar okay go listen to podcast 63 or whatever. So that’s the point. And yes I’ve changed the title of all of this because as I’ve sort of mentioned in the last couple weeks I’m pivoting much more towards investors and looking at companies making decisions, finding opportunities, laying out the landscape, doing the strategy component. of investment analysis. That’s really where my strength is. And honestly, if I go on a TV show or something and they introduce me as like host of Jeff’s Asia Tech class, it felt a little silly. It felt a little informal. It sounds a little bit more like a research focused equity research type thing. So that’s a little bit of it as well. Okay. My standard disclaimer. Nothing in this podcast or in my writing or website constitutes investment advice. The information and opinions from me or any guests may be incorrect. The numbers and information may be wrong. The views expressed may be incorrect or may no longer be relevant or accurate. Overall, investing is risky. This is not investment advice. Do your own research. And for those of you who are subscribers, I will be sending out one of the updates in a couple hours. So later tonight, Sunday night. And I’m really gonna start to dig into one specific company which I think should be on your short list as something to pay attention to. About a year ago, I started talking about C Limited with this shop in Garena. And it was clear from a strategic viewpoint, which is what I do, that this was a special company. It was an exceptionally high quality company from a strategic approach, what got my attention and I know many of you invested in that and did exceptionally well on that. If you invested in C Limited a year ago or even two years ago, you know, it’s gone up by a factor of four in 2020 and it did the same thing in 2019. So I try and sort of give you a heads up when I think there’s a company that has the strategy just nailed. Anyways, there’s a smaller company I’m gonna send the email out about, which is more of a mixed picture, a lot of fantastic stuff on the strategy side, but then also some problems. But I would say that’s one that people aren’t talking about that you should allocate some of your time and attention to. So that will go out tonight. I’m not saying buy it. I don’t give straight buy or anything recommendations like that. But I’m saying the strategic picture is very interesting. Okay, and for those of you who are not subscribers, feel free to go over to jefftausen.com. You can sign up there. 30 day free trial, try it out, see what you think. And yeah, okay, I’m gonna get into the theory for today. Now in podcast 64, I spoke about economies of scale and switching costs according to Seven Powers, Hamilton Helmer’s book. And he views it differently than I do, but I think it’s the area where we most agree. So I sort of flagged those. And then he has something called counterposition, which I’ve also talked about, which I think is interesting. But those two economies of scale and scope, but that he doesn’t talk about scope and switching cause I think that’s, that’s where we see the world the same way I’m gonna then he has, that’s three of his seven powers, I’m going to talk about the other four today, pretty briefly, because I don’t really agree with his thinking on this very much. But I’ll give you the basics of what he talks about. If you haven’t read his book, Seven Powers, go read it. It’s very interesting. It’s usable. That’s probably its greatest strength. It’s not everything. And he says this, this is not a complete strategy picture. He simplified it, but he’s not made it simplistic. So it makes it much more usable as an investor, as a CEO, as an entrepreneur, which is why people in Silicon Valley really like this book. But at the heart of what he does is what he calls the fundamental equation of value. And by value, he’s talking shareholder value, owner’s value, whether it’s captured by people who own stock or people who own debt or whatever. That’s the value, which is the right way to think about value. It’s a misused term, it’s used all over the place. But he basically says the value of a company is gonna be the product of two. Factors the market scale and power Power is his term the market scale is easy to understand you take the market size today and you multiply it by the growth rate So is this a huge market that’s slow growing or is this a slow mark small market? But maybe it’s fast growing either of those two scenarios will get you a big first term, which means look this has some scale to it This is a big opportunity. So that market scale factor is important. The second part, it’s market scale times power equals value. And I’m putting the equation in the show notes so you can look there. The power term is where he talks about, okay, of that big market, the power term has two components. It’s got your share of that market, and then within that, what is your economic profit after cost of capital? So that’s kind of a combination of like, okay, here’s the market, market scale. The second term is a combination of how much do you dominate that market, your market share, and can you extract profits from that sort of dominance. And I have long separated these two terms. I think they’re different. He has two terms, market scale and power. I think it’s three terms. I think it’s market scale, competitive dynamics, and unit economics. You can be in a big market, market scale, with competitive dominance. and still not make any money because the unit economics are not good. You can dominate unattractive industries. No reason you can’t do that. Just because you have dominance in an industry that doesn’t, which is competitive dominance, competitive dynamics, doesn’t mean you’re going to make a lot of money. That’s Uber. Uber, pretty good competitive advantages, massive market, not making any money because the unit economics are not good. And if you’re a manager, this is very useful because the truth is market scale is by and large outside of your control. If you’re already in that business. And unit economics to a large degree are outside of your control. The one thing you can control. is your competitive strength in whatever world you’re playing in. Now, investors can jump around. That’s nice. Entrepreneurs can jump around, find the best opportunities. But most, if you’re an auto dude, and you’ve been working in auto for 20 years, you’re not going to jump into media. You’re in the space you’re in. You can’t change the market. You can’t change the unit economics. The only play you have is to try and strengthen your competitive position. That’s why I think it’s three factors. And his scenario of powers, I think this is a relatively small subset of the universe of companies you can look at. Most companies don’t have competitive dominance. Most companies don’t have massive markets. Most companies don’t have unit economics that are tracked. Most companies don’t have all three. But you can, you know, if you’re a good investor, you should be able to make money on great companies, good companies, and bad companies. You should have strategies for all three. In this sense, he’s kind of like Warren Buffett. He’s selecting the best of the best companies. He’s actually more like Philip Fisher. Warren Buffett chooses very, very good companies that we would call slow compounders that grow 20%, 15%, you know, return on invested capital year over year for 10 years. He’s a slow compounder. He’s not looking for the rocket ships like Netflix. That’s an even smaller group of truly great companies. That’s what Philip Fisher, investor in 1920s, 30s, 40s, he used to focus on just a few companies like that. I think you wanna be able to play across all the board. I study Carl Icahn a lot, because he’s very good at making money as an investor on bad companies. And there’s a lot more of those than there are Warren Buffett type companies. And there’s more Warren Buffett companies than there are… seven powers, Philip Fisher type companies. It’s a small subset. So that’s kind of my point. That’s why I separate all three. Value is the product of market scale, competitive position and unit economics. It’s all three factors. You got to look it up now. You want to get a picture of them three years in the future, five years in the future. If you can figure that out, you’re in good shape. And his powers thing, it’s a shortcut for a small subset. Now the… of the seven powers, the two I talked about before, scale economies and switching costs. I’ve talked about these before, I did a whole podcast on this last week, go listen to it. I think he’s got some good thinking in there. I really like some of the ways he’s laid this out. I see it a little differently, but I’ve sort of summarized his thinking, which I think is useful. And then counter positioning, which is, counter positioning is basically when, it’s more of a short-term phenomenon. It’s when you come into a market with a business model that undercuts the incumbent. So it’s an attacker advantage in my framework. And the other, the incumbent can’t do what you do or is unwilling to do what you do because they can’t monopolize themselves so much. And so, you know, Blockbuster gets basically hit by Netflix when Blockbuster has all these stores. Netflix comes in by shipping DVDs and then streaming. Blockbuster is put within this difficult position of look if we do what they do We’re gonna hurt our core business So they tend not to for a certain period of time and it’s called counter positioning. It’s a good attacker advantage. Okay Now the four I want to talk about today. These are his other four powers branding Network economies. This is his language not mine cornered resource and process power Now I’m gonna use different language. I’m putting it in the show notes, but I think you wanna think about these things. The four concepts for today, for those of you who are subscribers, is share of consumer mind, which I’ve talked about before, proprietary technology, process advantage, and learning curve, and special resource. Now I’m putting them in the notes. They all go under learning goal 35, competitive advantage. But I’ll go through them. And they kind of overlap with him, They’re a bit different. All right, so his first one here, he calls branding. The idea that this is a power that, you know, he calls it feeling good. And we’re really talking about consumers. B2B tends to be pretty rational, but it’s something about, this is his language, a brand that communicates value. It evokes positive emotion that leads to an increased willingness to pay. And therefore the benefit you get is you can charge a higher price for the same thing. So that’s in theory Coca-Cola versus Jeff Cola, which is sitting on the shelf right next to it, no switching costs, no searching costs, but people still buy the Coca-Cola even though I’m 10% cheaper as Jeff Cola. Um, yeah, I don’t really agree with this. Um, I’ll give you his language. He says the way this happens that you can charge a higher price is because of uncertainty reduction that you get sort of a peace of mind because you’re confident the product will be as expected. That would be one aspect. The other word he uses is historicis, which is over time, a brand. will reinforce in its brain a positive feeling or a positive association that such that you feel good about Coca-Cola. And you can’t get that quickly. It takes, you know, this is why legacy brands tend to be very powerful, because they take decades to build, which makes them hard to replicate. If I’m gonna copy Coca-Cola to a large degree, I’m gonna have to not just match their marketing spending this year, which would be an economies of scale approach. I also have to kind of match the fact that they’ve been spending on marketing for decades. And there is a built up association, that built up aspect of an association, that legacy brand issue is very hard to replicate. Okay, so he sort of pointed to these two things. Now here’s why I think that’s not awesome. Number one, this is about being able to charge a premium. And I think that’s true. I think that’s one metric you wanna look at. If you wanna measure the power of a brand, you can measure, okay, Coca-Cola is $1 and Jeff Cola is 85 cents, but people still buy Coca-Cola. So they are able to charge a brand premium and it doesn’t affect them. So that’s the benefit of having this competitive sort of advantage. I think that’s one good metric to think about when you look at this phenomenon. I think the other one is repeat purchases. And this is one where it’s, look, I can’t necessarily charge a premium, so I can’t get an economic benefit. I can’t get a unit economics benefit, but I can get a sort of competitive position that is dominant. Look, I’m not charging anymore. But all the repeat purchases come back to me. So I’m not getting a premium, but I do have a degree of sort of barrier there. And I think you see that in a lot of companies that don’t have attractive unit economics, but they have dominant competitive positions by repeat purchasing. So I look at both of those metrics when I look at share of a consumer mind, I look at the premium and I look at do they have a repeat purchase phenomenon? People just keep buying the same thing no matter what. We see this with a lot of online activity, that you’re not charging a premium to use, I don’t know, let’s say Gmail or Search Engine or a lot of these things, but you keep using the same one, even though there’s no pricing whatsoever, let alone a premium. So I think that’s the same idea. And I put all of this under the idea of share of the consumer mind, which is a Warren Buffett term, and it’s one of my concepts. You can go to the concept library, click on share of the consumer mind. This is a demand side competitive advantage where you have somehow managed to get part of the consumer’s mind. That every day people get up and they open line and they check for messages. Every time they go into the 7-Eleven, they pick up a Coke when they want a Cola. Every time they walk past a 7-Eleven, I’m talking about Thailand here. Every time they walk past a 7-Eleven, they go in. Even though they weren’t needing to buy anything, it’s just that they just do it. There’s a lot of ways to get into people’s brains that way. You pay more for a Prada bag than a regular bag because it makes you feel good. People pay more for a Tesla than a regular car because they feel good about themselves. It’s a show of wealth and so on. There’s a lot of ways to get to this end point, which is share of a consumer mind. So I think the two things he’s put out here elicit a good feeling by built up associations, and uncertainty reduction. I think those are two types. I actually have a much longer list of things I look for that can get you to share of a consumer mind. And then my two tests are, can they charge a premium or and or are there repeat purchases no matter what? And I’ll give you some of my list. I look for habit formation, things that get in your sort of daily habits. People always go to Starbucks. They always buy a cup of coffee. They always walk into the 7-Eleven. They always, there’s a lot of ways where you can build a habit in people’s brains. There’s a great book called The Power of Habits. This is just neuroanatomy. Our brains do this. It’s very hard to stop once a habit has been built in your brain. Another one I call mindless, which is when you go into the Coca Cola, the 7-Eleven, and you pick up the Coca Cola, you don’t even think about it. Your brain doesn’t even turn on. It’s just a mindless thing you do. I look for emotional payoffs. Things make you happy. I like to watch Star Wars. I love Star Wars. It makes me happy. I don’t know why it makes me happy. It does. I don’t watch Star Trek. I don’t know why. One makes me happy. One the other doesn’t. Fan behavior is a type of share of the consumer mind and fan behavior can be very powerful. People go online and they’re in these chat rooms for Star Wars and they argue and they watch YouTube videos about Star Wars. I mean, there’s a whole thing going on there. Aspirational. People buy a nice car. They order Johnny Walker Blue. They treat themselves to a Prada bag, because it makes them feel good about themselves in terms of this is an aspiration of my life. It’s like an indulgence, a status symbol. Another category I look at is chemical. Is it a big surprise that companies have that have particularly powerful share of the consumer mind? What are they? Tobacco companies, Starbucks, I know Tim Horton’s coffee, Coca-Cola, Red Bull, five hour energy. What do all those things have in common? They’ve all got caffeine, sugar and nicotine. A lot of this is often just chemistry. So there’s multiple buckets here within share of a consumer mind. I have like literally 20 pages of checklists I go through when I look at companies like this, but it’s much bigger than branding. And as we’re in the digital class here, I think this entire category, which I think is a competitive advantage, it’s all getting a lot more powerful as things go digital. A lot of the things I’ve just mentioned are very crude. They’re very brute forced. I’m gonna put a drink out on the shelf and I’m just gonna jam that thing full of caffeine and sugar. That is a brute force approach to getting to hitting your chemistry. I’m gonna try and sell this product. I’m gonna put a scantily clad woman leaning on the, sitting on the motorcycle in the advertisement. That is a brute force approach to appealing to guys in that case, which by the way, totally works. A lot of this gambling, slot machines, these were all very crude. Digital is able to do this in a very subtle, sophisticated way. If you do online gaming, or God forbid, online gambling, online gambling is so subtle in manipulating how it gets into your brain, it’s scary. They call this like addiction by design, where they give you notifications and they pop up and they give you almost wins and they show your friends are doing it. And they are very good at building up this product’s presence in your brain. in a way that you can’t do anything that sophisticated in the physical world. Software, it turns out, and particularly AI, TikTok, are unbelievably effective at hacking the human brain. It’s really spooky. So anyways, I think that’s what Mark Zuckerberg, I think Mark Zuckerberg is in the share of the consumer mind business, psychology. I think TikTok is a master at it and they are just whooping Facebook left and right. Anyway, so that’s part of point number one, power number one. He calls it branding. I’m putting this all under share of the consumer mind. It’s in the concept library on my webpage. Huge amount of thinking in there. I’ve been thinking about this literally every day for eight years. All right. The next of his seven powers, which I guess will be number five in terms of how I’ve been going through them, is network economies. I’ve got enormous amount on this network effects, the various types, I think, you know, network effects that exist on platform business models, network effects that exist without platform business models, how network effects can be different to each user group within a platform. The network effect experienced by, let’s say, Rider on DD or Uber or Grab is going to be different. than the network effect to the person who’s doing the driving. And I’ll give you his definition, which is, this is not bad, it’s not mine, but it’s not bad. The value of a product or service to the customer increases with its use by other people. The value increases as the installed user base increases. I mean, right away, that’s assuming that the user groups, are one group of people as the user base. Well, I mean, I’ve been kind of talking about this forever that look, you can have multiple user groups and the value to each can increase. And the value to each can be based on the usage of that group, which would be a direct network effect or the usage by another group, which would be an indirect network effect. There’s lots of versions to this. And as I kind of teed up when I was talking about learning platforms, You don’t have to build a platform on people. People are a network. You know, you could view a person as a node in a connected network. So the nodes are the people, and the linkages between the nodes would be their interactions or communication. So a social network is a network based on people, and the interactions of those people, communication, sharing information, things like that, that would be the linkages. But you can have networks that are not made of people. A railroad is made up of rail lines and stations. Let’s say express delivery service. That is made up of points of delivery and points of shipping and the connections are packages. Those are the linkages. All of those things are networks. You can have things that are purely just digital creations like ICP and protocols that connect Various types of software. I mean the internet the World Wide Web is a connected network where the connections are based on the Standardization of the interfaces. There’s no people involved in that and It turns out as AI is emerging That you can have Software that can connect with other software the same way people connect with other people so those things there’s a lot of different types of networks and Therefore it’s not just people Now usually the most common way this is done is you sell an app to somebody and then by using the app on a smartphone, the nodes in the network are the people using the app. That’s very common. It’s not the only one. You can have physical networks, digital networks, people networks, lots of types of networks. Therefore the network effects can be very different. I’m just going to go through his summary real quick. I’m not going to go into it much more than that. The benefit of this. in his opinion is that you can increase the price. Again, you can have powerful network economies with no economic benefit. Competitive power, competitive dynamics are not the same thing as attractive unit economics. So you can just have a barrier, that’s enough. Quote, network economies tend to exhibit win or take all. That’s true. They can be winner take most. People use the phrase winner take all a lot. I don’t think that’s a very good term to use because it’s pretty rare. You know, WeChat has it, but almost, it’s very, very rare. Mostly it’s a winner take most. You do it at a tipping point where if you get a certain point, it tips to one, fine. Network economies have quote unquote boundedness. This is his term. Well, I actually think so. Some people use this term. I don’t use it very much. Where the strength of the network is determined by the bounded character of the social network or other type of network. Now this is actually a pretty good idea to think about. It’s so easy to think about the boundaries of an industry or the boundaries of a service as being determined by the product. This is banking. This is media that determines the industry that determines the barrier of the business. Another way to think about that is to think about the boundaries of the network upon which this product or service sits. And so oftentimes you’ll see something like Alibaba. The key to Alibaba is the network. And once they have that network, they can jump into any industry by putting lots of products and services on that network. It’s easier to build a new product on top of a network. Than if you have a good product to then build out a network from that. So oftentimes the right industry barriers to think about are not about the product or service, they’re about the limits of the network. This network is people in Thailand who use Line, which is a very bounded network. That’s a good way to think about that business. And you could slap on a lot of products and services on that. So it’s a different way of thinking about industry barriers is the boundary of the network, not of the product or service. That’s a pretty good idea. One other idea I like here, is when I talked about economies of scale in the last podcast, one of the terms and one of the concepts, which is in the concept library is surplus leader margin, which is this idea of, okay, I have economies of scale versus my competitor economies of scale is always one company versus another company is very specific. I have a factory I’m twice as big as that factory, we’re both making widgets. I have economies of scale because a lot of this business is fixed costs, so I should have a cost advantage. Okay, that’s a qualitative assessment. Can I put a number around that? And the way you put a number about that is you put a quote unquote surplus leader margin, where I look at the idea of, okay, my competitor can make widgets for $1 per widget, but I can make widgets for 80 cents per widget because of my scale advantage. Therefore, the surplus margin leader be like, if I were to make my widgets such that my competitor had zero profits, if I were to set my price at the same level, $1, what would be my product when I zero out my competitor’s business? And in this case, it would be 20 cents on every $1. That’s a sort of magnitude of my advantage. You can put a number around the advantage, surplus margin leader. If you’re curious about that stuff, go back to the last podcast, it’s pretty important. You can do the same thing in network effects. You can look at the leader. Economies of scale are a cost side advantage. Economies of scale are usually called cost side economies of scale. Network effects are often called demand side economies of scale. Where my advantage is based on my size advantage versus another specific competitor. On the cost side, By being bigger, I’m cheaper. On the demand side, by being bigger, my product is better. Okay, how big of an advantage is that? If I have a network, a social network, a communications network, a marketplace, and I’m twice as big as my competitor, that would be a network effect. It would be a demand side economy of scale advantage. Okay, that’s a qualitative assessment. Can I put a number on how powerful that is? Well, I can do the same exercise. I can look at my size differential versus a follower, me versus them, and then I can try and zero out the cost such that if they were gonna match my service, what would they have to spend? And I can put a number on it. Anyways, that’s a cool idea. It’s a little too complicated to go over, but. it’s worth thinking about that when you look at these competitive advantages, you want to try and put numbers on all of them. And sometimes you can do that. And sometimes you can only put a number on the net result. I have a higher return on invested capital than my competitor. I have a bigger stable market share than my competitor. That’s a metric around the result, but not necessarily about how I got there. Sometimes you can put the number on the actual thing like economies of scale, you can put a number. Oftentimes you can’t. Okay, that’s kind of number two. I’m not gonna go through it too much, I just wanted to put out those two terms, surplus margin leader, boundedness. Now we get to the last two, which are powers-wise, cornered resource, and process power. Now these are the two I don’t really agree with, and I’ll give you an explanation as to why. I put competitive advantage, which is kind of my area, my area of expertise, into sort of competitive advantage on the demand or revenue side and competitive advantage on the cost side. And on the demand side, I talk about things like share of the consumer mind, switching costs, searching costs, temporary supply demand imbalances. I put counter positioning there. On the cost side, I put things into several buckets like production cost advantages, and economies of scale advantages. And then I have other buckets like network effects, government advantages, which I’m not gonna talk about. Now within the cost ones. I view them as variable costs, which I would call a production cost advantage, which means, look, I have an advantage, even if I’m not bigger than you, a competitor, I have an advantage because I have an advantage in my variable costs, versus I have an advantage in my fixed costs based on the fact that I’m bigger than my competitor. So as long as I’m bigger, I’m gonna be cheaper on a per unit basis. But if they get as big as me, I lose that advantage. So one advantage on the cost side is based on fixed costs. And the other one is based more on variable costs. So the first one I’m gonna see play out in the operating expenses. And the other one I’m probably gonna see play out in the gross profits or cost of goods sold. Okay. Within this bucket of production cost advantages or manufactured advantages or variable cost advantages, whatever you wanna call it, I have four or five buckets I look at. Now his two buckets, cornered resource, and process power both kind of go within that, but I don’t use this terminology. So I’ll give you his explanation first. Cornered resource as a type of power. The example he uses is the Pixar management team. That you have this team of people who have, you know, are the creative leads at Pixar. They make all these animated movies, they make Toy Story. I think they made Frozen, right? Now, because this is a creative endeavor, it’s very hard to replicate that. If you hire 10 people and you give them a bunch of money, they can’t make Frozen. It’s actually, and it’s very hard to point to the fact of how did they make this. It turns out talent, creativity, sometimes it’s very intangible and it’s very hard to not just intangible, well, one, it is an intangible asset, but it’s very hard to explain to someone how to do that. You can’t just give people a manual for how to follow to do that. Rock bands are like this, U2, The Beatles, Rush, you know. I like Rush, a lot of you won’t know them, they’re an old band in the US. You know, it’s just four people, five people with instruments, but somehow this specific group can do things. And it’s not like you can just give someone a recipe and say, if you do this, you’ll be you too. It’s very hard to replicate that, so that’s a kind of a resource. And you could say the Pixar management team is like that. Now he talks about it this way and I’ll give you his thinking. He says that creative team, that management team, Star Wars is a good example of this. Star Wars when it was under Lucasfilm, George Lucas was amazing, right? Huge fan base, people slept on the sidewalks, very special thing. Then they sold it to Disney. George Lucas stepped out. Kathleen Kennedy, who was arguably the worst CEO in America, takes over and just runs that franchise into the ground in five years. and now they brought in a new team. Basically, I think it’s George Lucas’ comeback, and now it’s starting to come back with the Mandalorian. You know, it turns out it wasn’t just the characters and it wasn’t just the name, it was the team, the creative team that really mattered, and they lost it when they did the acquisition. Okay, so he would say this is a cohesive group of talented battle-hardened veterans, a brain trust, a creative team. It’s very hard to quantify this. He has a very good phrase where he says, for this to be a source of power, it must quote, be sufficiently potent to drive high potential persistent differential margins. So it has to generate an operational margin above competitors that persists. Everyone else is doing this, they’re making 5%, you’re doing this, you’re making 12%. It has to show up in the cashflow. And Continuing the quote, quote, it must with operational excellence, spanning the gap between potential and actual. Now that’s basically saying, okay, you’ve got something special in this brain trust that can create a resource that creates abnormally high return on cashflow, and you didn’t overpay for it. You know, if you overpaid for U2, if you pay U2 a ton of money, now you have the special resource, but that extra premium you’re getting in terms of economic value creation, you’ve already given that away by overpaying to get it. So you gotta have both of those things. So it says, how do you know if something has this? Well, it’s idiosyncratic. You have to look for repeated successes over a long period of time. Can’t be a one-off, can’t be a one-hit wonder. It has to be non-arbitrage. That’s the point I just said, look, if a firm, a creative group, a stock picking team, a team that’s really good at underwriting, if you’re getting access to this coveted resource, but you’ve also paid a very high price, you’re basically arbitraging out those additional rents you’re getting. So it doesn’t matter. You didn’t make money. Yes, you can get Brad Pitt to be in your movie, but if you pay him a ton of money, Having him in your movie doesn’t really matter because you just handed all the extra value creation to him. So ideally what you want is you want to find Brad Pitt when he was just a young guy in a chicken costume on the street selling whatever he was selling as a spokesperson. I feel he was working at a chicken restaurant or something. Okay, it’s got to be non-arbitrised, it’s idiosyncratic, it has to be non-transferable. If you buy it from someone, you can’t just transfer it to someone else because then other people have it. If you buy Pixar, you have to have the team come with you. You know, you got to bring them with you. Sometimes you can’t buy it, sometimes things aren’t transferable. Maybe you bought this great tech startup, but once they got bought by, I don’t know, once Alibaba bought Lazada. Did the core management team of Lazada stay or did they leave because they’re all rich dudes now? Well, they were mostly dudes, but there are some women there too. Okay, if they did that, then it maybe you lost a very valuable resource that was a critical part of that company, which I think is happening. It’s gotta be transferable, it’s gotta be ongoing. What is the ongoing value? One of the best ways to do an ongoing sort of cornered resource is a patent. or intellectual property. You created something, it’s Star Wars, you own the intellectual property, you put that in the bank. Even if George Lucas leaves, okay, you’ve lost some of it, but you actually got the IP. So it’s ongoing, and it’s gotta be sufficient. So I’ll put these terms in the show notes. Idiosyncratic, repeated success, non-arbitrage, transferable, and ongoing. Those would be his definition for a cornered resource. Okay, now I view this pretty differently than all of that. I think this is a very small sub case within a much bigger idea, which is the idea that you can have a competitive advantage in this type of cost. And there’s three things I look at. If I was gonna replicate this, if I were gonna do a reproduction valuation, I would ask myself, and I do ask myself in this, literally every time I look at a company, What would be the cost, timing, and or difficulty to reproduce this asset? And those are the three words I use, cost, timing, and difficulty. Some resources can be expensive to replicate, but that’s about it. And they don’t have to be digital. They could be a granite mine. Now let’s into an easier one. a piece of land on the beach in Waikiki. Let’s say there’s a gazillion hotels in Waikiki, but there is a very small number of them that are on the beach. Let’s say 10. I’m making that up, but it’s probably something like that. If you have one of those plots of land on the beach, that is a cornered resource, because you have suddenly pulled yourself out of the pack of the to such that you’re only one of 10 and you can maybe charge a premium, which you can usually charge. And even if you can’t charge your premium, you have a lot of repeat purchases because you got one of those 10 pieces of land. That’s a cornered resource, has nothing to do with digital, has nothing to do with creative excellence. It’s just a piece of land. The reproduction value of that piece of land would be the cost of buying one full stop. So I could put a number on it. Okay. Compare that to a railroad network. Let’s say I want to do a railroad company in southwest of the United States. Now, and Buffett invested in this because, BNSF, because it has a very powerful competitive advantage. What is it? Well, there’s some network effects there because it’s a railroad. But the other thing is, look, if you want to replicate a railroad network in the southwestern United States, It’s not just about the cost, like buying a piece of land on the beach in Waikiki, it’s the difficulty. Cost, timing, and difficulty. Because you would actually have to get the rights in all of those pieces of land to lay the tracks across the roads, across people’s private property. You know, these railroad tracks were built 100 years ago before all that land was owned by other people. It’s not even about money. It would just be exceptionally difficult to reproduce a railroad network across a built-up, developed country, regardless of how much money you spend. It’s just hard. A lot of patents are like this. I would put something like Star Wars in this category. It’s not that I can’t spend the money and hire a bunch of people to write Star Wars. I just can’t reproduce the magic they had. I can’t reproduce the fact that DigiNee can make Frozen. and Toy Story. The difficulties in the creative aspect. This is why everyone wants to be Disney. Every major media company for 175 years has wanted to be Disney and nobody can pull it off because it’s really hard. Difficulty. The other one would just be timing. Let’s say I want to be Coca-Cola. They have a cornered resource, a special asset which I would call their legacy brand. It’s not even about the fact that, look, I’ll just have to match their spending year this year. That would be cost. Turns out it’s not difficult. I could just put it billboards. The problem is timing. I can’t build up that presence, that hysteresis in people’s brains in one year. For me to have the same effect as them, I literally have to market to people for a decade. And there’s no way around that. The barrier to me doing what they have. and to reproducing their resource is time. There’s no way to force it. So time can be the difficulty, cost can be the difficulty, or just plain difficulty like creating a drug, creating YouTube, creating a railroad network. This cornered resource aspect, I look at those three factors, cost, timing, and difficulty, and some have all three, some have one, some have two, so on and so on. And there’s lots of these out there. I actually like this bucket. Granite mines is a pretty good one. Patents are a good one. You could say government patents are one. Intellectual property is one. Expertise, semiconductors. A lot of the most difficult aspects of doing semiconductors is it is so hard to get the expertise to do semiconductors because there’s so few people that know this incredibly difficult subject that requires PhDs. And all of those people work at Qualcomm and Nvidia. And it’s very hard to hire enough of them. It’s a very rare type of expertise. So I put all of this under two buckets. I’ve broken this into two, well actually three. I’ve broken it into proprietary technology where you have software, trading, algorithms, something that’s just very, very difficult or expensive or has a time component to reproducing. Now that’s part of what he’s talking about, but I think it’s different. And the other one I call special resources or limited options, that can be everything from Saudi or Ramco having all these oil fields. It can be upstream electricity transmission. It can be rail lines. It can be pipelines. It can be a lot of types of things. They can be intangible. They can be tangible assets. It could be all of that. I generally put those into two buckets under the cost. banner and then the third one I just put into government advantages government granted advantages like a patent okay so I think that’s a much broader category of things to think about and the last of the powers process power this one is a bit hand waving this one basically he points to Toyota and just in time production and the idea is somehow over a period of time, an extended period of time, in a complex endeavor, a very complex endeavor, operationally, technology-wise, there are tons of small improvements in the process that become embedded, and they’re very difficult to replicate. It is very difficult to replicate Toyota. Even if you can walk through their factories and you can see how they’re doing just in time production. Replicating it is very difficult because there’s no super manual for here’s how you do Toyota just in time production. It’s a thousand, actually it’s not a thousand, it’s tens of thousands of little things that are all in the brains of all their people that are working that play out in all these ways that make them cheaper and faster at making cars than anyone. And that shows up costs from what we would call process improvements that are embedded within an organization. And these things accumulate over years, if not decades, which is why it’s difficult to replicate. And it doesn’t disappear when you bring in new people. When you bring in new people, they learn and they adapt these same habits and techniques and attributes and culture such that the organization survives. So this would be another example of what he would call hysteresis, reinforcing actions over time, difficult to replicate. It takes a long period of time of sustained evolutionary advance to sort of create. It requires complexity, lots of moving parts. It requires opacity. That you’ve never really fundamentally codified this organizational knowledge. It remains tacit, not explicit. Okay. I think that’s pretty similar to what I was just talking about. And I pull this one out as process advantage and learning curve. And you’ve heard me talk about the rate of learning as an operational dimension that you should compete upon in some businesses. And at a certain point… So that was in my smile marathon was rate of learning is the L in smile. And at a certain point, that rate of learning becomes a competitive advantage like the Model T I always give. If you have cumulative production that doubles in a Model T factory, Henry Ford, you lower your cost by 25%. At a certain point, that learning translates into a cost advantage. which I described as phase one or type one rate of learning advantages, or a type two, which is like, okay, you’re not better at being cheaper, you’re better at creating the next thing. That’s Steve Jobs. He was very good at going from iPod to iPad to iPhone to ITV to whatever. And now we’re at phase three, type three learning advantage, which is merging human and machine learning together in an organization. So I think there’s a whole lot within rate of learning. at the smile marathon level and at the competitive advantage level. And I think there’s process advantage. So I pull that out as a third type of advantage rather than his, what I think is a very small sub case of that. I think that’s a huge issue. I’ve put it in two levels of my strategy pyramid. It’s in the smile marathon and it’s in the competitive advantage level, this idea of learning and process improvements. And I think that’s pretty much the theory I wanted to get through today. This hopefully should wrap it up. The main ideas for today, share of the consumer mind. Super important. It’s one of his powers, a small sub case. I’ve talked about this a lot. I’m gonna talk about this a lot. There’s a huge amount of thinking under this bucket. And I think digital, this is one of the areas where digital meets traditional business really plays out in a powerful way. proprietary technology, process advantages and learning curve, special resource. Those are kind of the four ideas for today. Share of the consumer mind, proprietary technology, process advantage and learning curve, special resource. Those four main ideas are in the show notes. All of this goes under learning goal 35, competitive advantage. This is me fleshing out competitive advantage. So let me just wrap this up. Basic point, seven power is definitely useful. You should have it in your… checklists and your frameworks. I think about it as a real time compass that’s pretty useful for CEOs, entrepreneurs and investors to sort of navigate a company to the highest mountains, the highest return situations in terms of value. This guides you to those rare few peaks. The three ideas that I think they’re combining here is go after the most attractive, big and growing markets. Go after areas where you have a competitive advantage that can give you some degree of dominance in that market. And then third, hopefully those markets have attractive unit economics, three ideas. He combines those two. And that’s his fundamental equation of value, his value axiom. I think one ID he points, okay, if you’re an investor, how does this help you? And he talks about a value moment. which is every now and then a company comes along and I think his favorite example is Netflix, where it starts to change an industry. It starts to shape the industry. I would put that under my two by two matrix as a shaping terrain, as opposed to an adaptive terrain, classical strategy and visionary. This is that BCG two by two matrix. This is in the shaping quadrant, every now, which means it is somewhat of an unpredictable future, but is malleable, which means the company has the ability to shape and change the industry, which I think early Netflix definitely was able to do. He points to this what he calls the value moment. And this happens when a business enters a field like that and it gets a double hit. Because it not only establishes a type of power, which is where it’s gonna get a sizable market share with good economic value. So of the two parts of the equation, the market scale times power, it gets a pop in the power because it has who knows, switching costs or whatever. But at the same time, by changing the nature of the business, by shaping it, it also dramatically increases the market scale. So you get a hit in both of those numbers. So Netflix comes along and it didn’t just disrupt Blockbuster and achieve power in an existing industry, it also dramatically changed the size of the industry. So you get a big increase in market power, market scale. times power. You hit both of them at once and that’s when you get a massive jump in the value of the company. So you’re looking for companies that let’s say C-limited to bring it back around, not only had a degree of power in the market, competitive dominance, attractive unit economics, but also dramatically increased the size of the market itself and you get a hit on both. That’s particularly powerful And what you’re looking for is the moment when this starts to happen and you see it before everyone else and the uncertainty in the market starts to disappear. And you see it a little bit before everyone else, so you get it. And I think that’s what happened with C Limited, Shopee, Garena in the last year. People have recognized that it’s hit both. And I’m questioning this company I’m looking at right now, which is the email going out later tonight. whether they’re coming up to a value moment as well. I think they might be, but I’m not sure. But I’m definitely looking at it. There’s enough uncertainty there that I think it’s interesting. So ideally a competitive framework or a seven powers framework should let you sort of see through the sort of ambiguity and opacity of this type of situation that you get from sort of a fast moving, high flux, high uncertainty scenario. and you can make the call and others can’t, you place your bet, bam, you’re up by 10-fold. And that’s what people who invest this way are looking for. Now, as I mentioned, I think there’s some, this is a very small sub case of companies. I don’t think it really makes the distinction between advantages you can have as an attacker versus an incumbent, which are different. I don’t really think it talks about situations where you have a very good competitive advantage. but the unit economics are not terribly attractive. And I view those as sort of wealth preserving companies instead of wealth generating companies. There’s very good reasons. If you can find a business that’s got a powerful, competitive advantage in a stable industry without great unit economics, you know, if you get in at the right price, that’s a good deal. It’s a nice, stable, predictable scenario. It ain’t gonna go up by 10, but you can do pretty well. And I think you need to have both of those playbooks at the ready. You need to know how to make money from great companies, good companies, bad companies, garbage companies. And there’s a lot more of the former than the latter, sorry, the latter than the former. Changing landscapes, declining businesses, decaying businesses, businesses that are being disrupted. One of my favorite spaces is businesses that are being disrupted. and basically destroyed, but in a predictable fashion. That’s not bad. So anyways, I think there’s a lot of limits. I think it’s a subset, but it’s definitely a good playbook to have in the arsenal. And that’s it for the theory. I’m gonna get back to talking about regular companies, well, not regular, but tech companies next week, a lot more company and industry specific stuff, but I did wanna flesh out the theory and the concepts. If you go on the webpage, jeffthousand.com, there’s two libraries. There’s the company library and there’s the concept library. And I’m always fleshing out both and adding to both. And hopefully you’ll get smarter and smarter over time. Ideas that are a little bit confusing, theory that feels like you’re a little bit underwater. It’s gonna become more and more familiar over time. I’m gonna keep citing the same ideas over and over. And what’s fun about this, I think it’s all fun, obviously. But what’s fun about this is when you start to dig into these ideas, these concepts, network effects, switching, you realize they are very, very different depending on the scenario you’re looking at and the company you’re looking at. There’s a lot of subtlety, company by company, industry by industry. And that’s really where you want your expertise to be, to know when this network effects is not as good as everyone thinks it is, i.e. Uber. And this network effect is far better. than people are recognizing right now, Shopee. So that’s the level you wanna play at, in my opinion. As for me, I’m doing pretty well. I’m just relaxing in Bangkok. Vaccine is on the horizon, hopefully with vaccines on the horizon. We can start to travel again. There’s the WeChat Open Class this week. Last year I went to the… the big meeting in Guangzhou, which WeChat has, and I get to sort of talk with people and learn a lot. And that’s incredibly valuable. I really do like spending time at the Alibaba’s and the Ten Cents and all these companies. It’s incredibly helpful. And obviously travel, that shut a lot of that down. Hopefully with vaccines on the horizon, airlines are on the horizon, travels on, hopefully it’s in the home stretch. I think my good friend got his vaccine a week or two ago. He’s doing great. My parents are scheduled to get vaccinated in a couple days in the United States. So I’m starting to think about that. What else? Oh, I threw out a question for good video games because I finished Finnish Ghosts of Tsushima, which was actually a little bit depressing because it was such a good game. It was actually I was kind of down when I finished it because I was like, man, there’s nothing left to do. It was so good. And now I’m done. It was like when… For me anyways, it was like when Battlestar Galactica the TV show ended because I loved that show I just thought it was the best and when it was over it was kind of depressing So I’m hoping they’re gonna extend that game. But anyways, I threw that out and and one of the listeners Suggested this game Genshin Impact. I think I’m saying that right Genshin G E N S H I M Impact which is you know real Japanese otaku you know, manga. I mean, it’s really deep in the otaku world. So I did I tried that it was a bit too much of that sort of Japan, you know, floating princesses, everyone’s got wings, super cute, all of that, you know, world. It was a bit too much down that path for me. I tried it as I asked too much. And so I went back to playing The Last of Us, which is, you know, just blowing away zombies. Which is great fun. So I think that’s my newest one. I’m gonna focus on this one and see how it goes. But I did try it. Thank you to the gentleman who suggested that. I did appreciate it. I did try it. It was a bit too deep in the Japan world for me, that one. Maybe it’s not Japan specific. I think it is kind of, but my impression was that was kind of in that world more than sort of general gaming. But I may be wrong. Maybe it’s broader than I think it is. Anyways, but it was fun to try it. And that’s it for me for this week. Thank you so much for listening. Thanks to everyone who’s subscribed and part of the class. I appreciate that greatly. I hope everyone is doing well. Everyone’s staying safe and I will talk to you next week. Bye bye.