"If you want to be successful in business (in life, actually), you have to create more than you consume. Your goal should be to create value for everyone you interact with. Any business that doesn't create value for those it touches, even if it appears successful on the surface, isn't long for this world. It's on the way out."
- Jeff Bezos
The quote comes from Amazon’s 2017 shareholder letter “Building a Culture of High Standards”, and demonstrates Bezos and Amazon’s perpetual drive in creating customer value. They obsessively sought to create value through a lens that put the customer front and centre of every decision they made. The company’s worst drawdown occurred from the dot-com bubble and saw them lose 94% of their stock value, but they continued steadfast in their mission. They would continue to provide customers of Amazon with as much value as possible through product differentiation and cheaper prices, weathering the storm through an unwavering commitment to customer experience over short-term profitability.
Every business provides some form of value in the products or services they sell, but value-creation alone isn’t a sufficient strategy in shielding a company from competitive onslaught. Every company needs a strategy for not only creating value—but creating structural barriers to shut their competition out. Something that places the company on a perch.
Amazon’s was optionality, cost and speed. Something Nick Sleep from Nomad Investments termed shared economies. Many companies don’t know their true value, others refuse to seek better value through fear of the sunk cost fallacy, and many don’t have any at all.
Let’s look at the story of two companies: an entertainment household name—infamous amongst boomers and millennials, and the other; a disrupter who looked at the same business model through a completely different lens.
People of a certain age will remember Blockbuster. The place you’d go to rent videos for the family to sit around and watch on a Saturday night when we didn’t have the world at our fingertips. It had a robust business model built around families, couples, friends or movie lovers sitting down and watching their favourite movies together for a reasonable price. The cinemas must have hated them.
But then came DVDs. A direct threat to VHS, and to Blockbuster themselves.
Blockbuster initially snubbed the new technology, and in 1997 even rejected a deal with Warner Bros to rent new releases before they went on sale to the public because they were asking for 40% of rental revenue in return. But in September 2001, Blockbuster finally made their move into DVDs, and announced a reduction of 25% of their VHS inventory to make way for them.
Too little, too late.
The entertainment household name adapted when they had a change of heart towards DVDs, but fatally, they continued with their brick-and-mortar business model. The disrupter—Netflix—saw it differently.
Netflix has long been championed for seeing in DVDs what Blockbuster didn’t—the future. Their DVD-by-mail business was akin to what Jeff Bezos did to retail book stores when he created Amazon. Bezos transformed a capital-intense business model—one requiring high and growing capital expenditures, with physical stores capable of offering only a few thousand books, into a distribution network capable of delivering nigh on every book ever published.
But crucially, Netflix saw past their own nose towards the horizon—digital streaming.
DVD-by-mail and digital streaming are two separate industries, with their own economics, and the prospects of entering the digital streaming industry didn’t look all that appealing. IT costs were getting cheaper by the year; cloud storage was expanding, and with it costs plummeting. The barrier for entry seemed to be getting lower—not higher, and so too was the prospect of making it a viable business model. But Reed Hastings and his team at Netflix were strategists. They knew it was only a matter of time that digital streaming would do to them what they did to Blockbuster. They decided that if they were going to be killed anyway—they’d do it on their terms.
In 2007 Netflix tentatively entered the digital streaming industry by partnering with electronic hardware specialists. They didn’t bet the house and go all-in. They did the leg-work, allowed themselves exposure to this emerging market, and gained the much needed experience before making any big moves. While smart, these tactics aren’t a strategy, and any potential for Netflix to gain a clear competitive advantage in this industry was at the very best muddy.
The way streaming businesses worked back then was like this: streaming platforms like Netflix negotiated for streaming rights with film studios. But the film studios were astute and strategic custodians of their properties, and it was them that held power over the new kids on the block. They split their properties up by geography, region, release dates, contract length, and so on. It’s the equivalent of wanting to get a new iPhone where the contract provider determines the amount of minutes, text and data you get, as well as the price and duration of the contract.
Netflix fought for scraps for 4 years, until 2011 where they finally made their move. Ted Sarandos, Netflix’s Chief Content Officer, believed it vital that Netflix secure exclusive streaming rights to certain properties. It was exactly this type of thinking that would allow Netflix the potential to finally gain power over the film studios: they were going to start creating originals. This shift—from being controlled by the film studios—to creating their own content was not only expensive, but risky. This move was as bold as it was ingenious.
By taking this route, Netflix was now playing a different game. A game of one. Creating originals, such as the hit House of Cards (with that infamous Kevin Spacey look), and gaining exclusive rights to content, would mean that other streaming platforms would have to up their fixed-costs to compete with Netflix, or remain beholden to the whims of film studios. If House of Cards cost Netflix $100m to make, and they had 30 million subscribers, then the cost per customer was just over $3. If a competitor had only one million subscribers, then the cost per customer to make the original would be $100. They created a 10m-high iron-clad barrier where none was before, and told those who wanted to compete they’d have to pay up to do so.
This radical shift in industry economics allowed Netflix to move away from the value-destroying commodity rat race they found themselves in. Value-creation wasn’t enough—it was the barrier that mattered.
How companies create value, and how they ensure they leave their competitors in the rear view mirror, is laid out by Hamilton Helmer in his landmark book on analysing businesses: 7 Powers. Helmer has spent decades trying to work out what separates a bad business from a good one, and a good one from a great one. He starts with two definitions of strategy that answer two distinct questions—one about the nature of value, the other about how to capture it persistently.
Strategy
The study of the fundamental factors that drive potential business value.
The diagnostic lens: what are the foundations of value in this business?
Strategy has two objectives: to reveal the foundations of business value—and attempts to guide businesspeople towards value-creation. It can be split into two topics:
Statics: “Being There”: What makes Netflix’s content so durably valuable?
Dynamics: “Getting There”: What elements helped produce such favourable results?
Looking back at our Netflix case study, we can see that Netflix’s decision to depart from conventional norms and create originals was what set them apart from other streaming platforms, but also what made their business model so durable and valuable. This is the difference between static value—the structural advantage they hold—and the dynamic quality that allowed them to build it in the first place.
strategy
The set of conditions creating the potential for persistent differential returns.
The competitive lens: what conditions allow a company to hold that value against rivals?
Persistence is a non-negotiable element in creating long-term differential returns. 10% growth—per year—for three years, would only constitute 15% of a company’s value. Having stellar returns for three years, and then poor returns the next three, is unlikely to create durable long-term differential returns. How could it? Value is what gives rise to persistent and above average returns. It’s all about establishing and maintaining an unassailable perch.
These differential returns give rise to Power: the underlying conditions that give a company a consistent and unfair advantage over its competitors. This is as difficult to achieve as it is important, but can be attained through two means:
Benefit: The conditions that created the Power must materially grow cash flow through a combination of increased/decreased prices, reduced costs, or less capital expenditure.
Barrier: As well as persistently increasing cash flow, there must be a barrier that prevents competitors from engaging in value-destroying arbitrage.
The astute business strategist knows to look for the barrier conditions first—not the benefit.
Benefits are more common in business: competitive pricing, cost reduction, operational efficiency. But barriers—those which prevent competitors from engaging in tit-for-tat tactics—are less so. Companies that know what a competitor is doing, but won’t engage in trying to replicate them through fear of destroying their own value proposition, do not have Power—at least not yet. Therefore it is barrier conditions that first deserve the strategist’s attention.
An industry’s underlying economics and a business’ specific competitive advantage must interact in ways that are favourable for Power to exist.
You can measure strength, but the concept of Power is relative. When comparing a company’s Power over a competitor, you’re looking for what is measurable—their strengths—those which have the potential to translate into Power.
Good strategy not only requires you to seek out Power (and potential Power) between direct competitors, but indirect ones as well. After all, Power changes hands like a clock face changes time. Value-destroying actions are linked to poor execution of strategy and following conventional wisdom. No business is immune from a fall from grace.
Value gets you to the final. Power is having your name written in the history books.
Through value-creation and impenetrable barriers, Bezos propelled Amazon towards trillions in market cap. Netflix established itself as the number one streaming platform. Helmer didn’t invent these principles. He found them—in companies like Amazon and Netflix—and codified them into a framework any operator can apply.
Here’s what most business owners miss: they can articulate the value they create, but they can’t name the structural barrier protecting it. They know their strengths but confuse them with Power. They work harder, improve operations, cut costs—all necessary, none sufficient.
The question for your business isn’t whether you create value. It’s whether you’ve built barriers that prevent competitors from taking it from you.
Helmer identified seven specific types of Power. Seven structural advantages that, when present, create persistent differential returns. Some you can engineer deliberately. Others emerge only under certain conditions. Knowing which is which is the difference between wasted effort and compounding returns.
But here’s the problem with Helmer’s book: it’s written for investors analysing public companies, not operators running them. The frameworks are sound, the case studies compelling, but they don’t answer the question every business owner needs answered: How do I know if I have this? And if I don’t, can I build it?
That’s what the 7 Powers series does.
Over the next seven essays in this series, I’ll break down each Power—not as an academic exercise, but as a diagnostic framework you can apply to your own business. Each essay will include:
The anatomy of the Power: what it is, how it works, and why it creates barriers
Recognition criteria: the specific conditions that signal its presence or absence
Application for SME operators: how construction firms, professional services, and capital-intense businesses can identify opportunities to build each Power
Diagnostic tools: checklists, frameworks, and questions that move you from theory to action
The first Power we’ll examine is Scale Economies—the same advantage Netflix used to turn content creation from a liability into an unassailable moat. We’ll look at how fixed costs spread over volume create barriers, when scale becomes a trap instead of an advantage, and how to identify whether your business has the potential to build this Power.
If you’re serious about building a business that compounds value rather than just creating it, this series is where theory meets application.
Until next time, Karl.
The 7 Powers series is part of The School of Knowledge, where I translate sophisticated investment frameworks into actionable tools for business owners. £15/month gets you access to the full series, The Case Library, The Toolkit, and The Reading Room which i’m offering to you today, plus access to everything else, for a 20% discount.