Strategy, and why product-market fit alone isn't good enough

Every week I write a note to our portfolio, and in each one, i share one thought that I think is relevant for our founders to noodle on. This week’s note got some good feedback, so though I’d share it here.

I was listening to my favorite podcast, "Invest Like the Best" where Hamilton Helmer was being interviewed about his book and subsequently spent my Saturday reading the book. Typically, I find most business books sufficiently covered in the 20 min TED talk version, but thought this book had a lot to offer startup founders. Helmer discusses what strategy is, and how all successful strategies can be boiled down to one of the 7 Powers, and in what stage of a company's lifecycle one could be acquiring power.

Now "Strategy" is an over-used and rather abused term, so for the sake of discussion, let's align on definitions:

A successful strategy: The route to creating persistent differential returns to a business; a "MOAT" if you will.

Helmer suggests that a successful strategy must have a BENEFIT, and a BARRIER. The notion of a Benefit is relatively familiar to startup founders; it lines up nicely with ideas around product-market fit; far fewer founders however think about the BARRIER, how to prevent new and current competitors from arbitraging away the benefit you've created.

Benefit: materially augments your business's cash flows by enabling you to increase prices, reduce costs, and/or reduce investment needs
Barrier: prevents existing and potential competitors from arbitraging away the benefit

Value = Market Size * Power; which can be decomposed into Market size today * rate of growth of market * LT share of market * differential margin

7 Key Strategies - business must employ one or more to have persistent differential returns to the business.

For startups, the most interesting to consider initially are (1) counter-positioning - what can you do that incumbents can’t, because it would be detrimental to their current businesses; and (2) Cornered resource; what do you have (IP, talent) that only you have access to? Folks talk about network effects, and economies of scale, but those powers can only be accessed after you have scale, so are not relevant in the earliest stages. An overlooked power is Process power, the most common example is the Toyota Production System, but this is something startups often neglect, not realizing that the ability to accumulate and “productize” in a sense process knowledge can be a formidable barrier (in marketing, in testing, in customer support).

Brief summary of the 7 powers;

Scale economies - per unit costs decline as production scales (familiar to classical software businesses as the marginal cost of each new customer is practically zero)
1. BENEFIT: Reduced costs
2. BARRIER: Prohibitive costs of share gains
Network economies: Value of a product to the customer is increased by the use of the product by others (Linkedin and FB are the classic examples here)
1. BENEFIT: Can charge higher prices than competitors, because of the higher value of product as a result of more users
2. BARRIER: Unattractive cost of gaining share - because users get less value from the small networks, they would have to be compensated (paid) to use the competitive product in an uneconomic way (see Google+ vs FB)
3. Characteristics:
  1. Can often be winner take all markets
  2. Boundedness - the character of the network places natural constraints on the biz (Linkedin couldn't be personal, FB isn't professional; though this is not AS true in markets where Linkedin is not present)
  3. Decisive early product - due to tipping point dynamics, early relative scaling is essential to developing power; scaling determined by who gets the product most right early on
Counter positioning
1. BENEFIT: New business model is superior to incumbent's model due to lower costs and/or the ability to charge higher prices.
2. BARRIER: Incumbents unable to replicate new biz model without putting existing business under significant threat (e.g. Netflix vs Blockbuster where 50% of revenue came from late fees)
Switching costs: The value loss expected by a customer that would be incurred from switching to an alternate supplier for additional purchases (Financial, procedural, relational) - this is the key to delivery as a wedge into ordering (increase switching costs to customers). Biggest opportunity to build this is when people are looking for new systems (much harder to rip and replacee)
1. BENEFIT: A company that has embedded switching costs for its current members can charge higher prices than competitors for equivalent products or services. This benefit only accrues to the Power holder in selling follow-on products to their current customers, no benefit with potential customers, and no benefit if there are no follow-on customers
2. BARRIER: To offer an equivalent product, competitors must compensate customers for switching costs
Branding: An asset that communicates information and evokes positive emotions in the customer, leading to an increased willingness to pay for the product. The durable attribution of higher value to an objectively identical offering that arises from historical information about the seller.
1. BENEFIT:
  1. Affective valence - elicit good feelings distinct from objective value of the good
  2. Uncertainty reduction - "peace of mind" knowing that branded product will be as expected
2. BARRIER: Can only be created over a length period of reinforcing actions, which serves as the key barrier
Cornered Resource: Preferential access at attractive terms to a coveted asset that can independently enhance value
1. Must be: Idiosyncratic; non-arbitraged; transferable; ongoing; sufficient (sufficient to drive continued differential returns, assuming operational excellence)
Process Power: Embedded company organization and activity sets which enable lower costs and/or superior product, which can only be matched by an extended commitment
1. Example: Failure to transfer TPS despite Toyota being extraordinarily open about the process
2. BENEFIT: Able to improve product attributes and / or lower costs as a result of process improvements embedded within the organization
3. BARRIER: These process advances are difficult to replicate, and can only be achieved over a long time period of sustained evolutionary advance; inherent speed limit due to:
  1. Complexity
  2. Opacity
  3. Operational excellence alone is not a strategy - anything that can be readily copied does not contribute to increasing a) Margin or b) market share
  4. So Process power is operational excellence + hysteresis; but having said that, it occurs so rarely that in general OpEx is not a strategy

It is a worthwhile exercise to think about what POWER you are hoping to build in your business, post-PM fit, and whether your current strategies and tactics are actually helping to reinforce whatever nascent powers you might have.