0:00

Oh, I'm sorry, before you keep going, is this going to be

0:02

a question of is this a scale economy

0:04

or network economy? Yes. Oh,

0:06

damn. Go for it, Jenny, because I don't

0:09

know the answer. We've

0:11

stumped the experts.

0:12

Who got the truth? Is

0:15

it you? Is it you? Is

0:18

it you? Who got the truth now? Is it

0:20

you? Is it you? Is it you? Is

0:23

it you? Sit it down. Say it

0:25

straight. Another story on the way. Who

0:28

got the truth?

0:29

Welcome to this special episode of

0:31

Acquired, the podcast about great technology

0:33

companies and the stories and playbooks behind

0:35

them.

0:36

I'm Ben Gilbert. I'm David Rosenthal.

0:38

And we are your hosts. Eight

0:41

years ago, I pitched David on

0:43

an idea for two different podcasts. One

0:46

was on grading technology acquisitions

0:48

that became Acquired. The other

0:51

idea was to do episodes on

0:53

companies that managed to create two separate

0:56

multi-billion dollar innovations. Our

0:58

hypothesis is that most companies have really one

1:01

big founding insight and that

1:03

the rest of the company's history is just

1:05

drafting on that.

1:07

Well Hamilton Helmer and Chen

1:09

Yi Xi, friends of the show, coincidentally

1:11

have been exploring literally exactly

1:14

that idea. And they've been asking questions

1:16

like what percent of the profits

1:18

of the biggest companies in the world came

1:21

from a second business line. have

1:24

a new framework in addition to Seven Powers

1:26

to help founders answer the transforming

1:29

question. If I were to expand

1:31

the scope of what my company does, how

1:34

should I go about it?

1:35

And this is a particularly interesting

1:38

time to do this episode with them, because

1:40

I feel like a bunch of the companies we've

1:43

covered recently on the show, this

1:45

has been like a key part of the story,

1:47

whether it's Amazon and AWS or

1:49

LVMH and how all the businesses, LVMH

1:52

itself have been transformed over the

1:54

years. And even particularly, I'm thinking about Nintendo

1:57

in our Nintendo series and going from like,

1:59

supplier for the Yakuza to dominant

2:02

video game console manufacturer.

2:05

Yep. And David, I can say you and I have already

2:07

recorded this interview with Chen Yi and

2:09

Hamilton and like we address exactly that.

2:11

So listeners, this was a really fun one to do. And

2:14

having Hamilton and Chen Yi on, it

2:16

just concretizes a lot of the very abstract

2:19

thinking that we sort of banter

2:21

about on the show, but never quite crystallize.

2:24

They crystallize it for us. Yep. Well,

2:26

if you want to go deeper, But you can become an acquired LP

2:29

to come closer into the acquired kitchen. We

2:31

have bimonthly Zoom calls and we just announced

2:34

that we'll be asking our LPs to

2:36

help us pick future episodes. So

2:38

you can join at acquired.fm slash

2:41

LP. Subscribe to our second show, ACQ2,

2:44

formerly the LP show, which is now public

2:47

for expert interviews with founders

2:49

and investors. Search ACQ2,

2:51

no space in any podcast

2:53

player. Join the Slack. now

2:56

over 15,000 smart, thoughtful,

2:58

kind members of the acquired community at

3:00

acquired.fm slash Slack. It's

3:03

pretty cool. But I will say that only represents

3:05

like five to 10% of you

3:07

who listen to acquired every month. So for

3:09

the rest of you who haven't joined,

3:10

come join us in the Slack. Without further

3:13

ado, this show is not investment advice.

3:15

David and I may have investments in the companies we discuss,

3:18

and this show is for informational and entertainment

3:20

purposes only.

3:23

Ben and Chenyi, welcome back

3:25

for the third time

3:27

to Acquired. Our pleasure.

3:30

It's always great to be here. The Acquired audience

3:33

has grown so much since the last time we did

3:35

this together. We thought it might be fun

3:37

first to sort of humanize the seven

3:39

powers a little bit and do a little background

3:41

of what is this thing that we

3:43

talk about on every Acquired episode and

3:46

how did the two of you come to be world

3:48

experts in this? Yeah, yeah, delighted

3:51

to do that. So as

3:53

I've said, I think on other episodes,

3:55

my

3:56

understanding as an economist

3:59

is that Ground zero for

4:02

economic vitality is

4:04

the strength of the entrepreneurial sector.

4:07

So there's a famous economist called Joseph

4:09

Schumpeter who sort of posited

4:11

that. And it was different than sort of

4:14

normal economic theory at the time because it

4:16

was very dynamic and not sort

4:18

of mathematical.

4:20

And so I believe that very strongly.

4:23

And of course, Silicon Valley is a center for that.

4:26

So the thing that really interested me

4:29

was, can I contribute to

4:31

that in any way? Is there anything that

4:34

I can do that helps with that? And

4:36

my discipline is sort of

4:38

business strategy. And so there's

4:40

a real question about, is there anything

4:42

useful that business strategy can add to

4:44

that sort of creative, dynamic

4:47

effort of all these people? And

4:50

I'll cue it up with an example that

4:52

I used to use in my class at Stanford sometimes,

4:54

which is that if you can

4:57

imagine me holding up two devices.

4:59

See, that's the iPod with the touch

5:01

wheel and I have no idea. Is

5:04

that calculator? Right. So

5:06

that's the first handheld calculator in

5:08

the United States, Beaumont.

5:10

And so here's the issue,

5:12

is that here are these two devices.

5:15

They were wildly successful to

5:18

begin with. Incredible product

5:20

market fit. Ballmar won from

5:22

maybe 3 million to 100 million in

5:25

a couple of years, which back in those days was real

5:27

money. And of course, calculators are

5:29

an interesting starting point because

5:31

the Japanese calculator, Bizikom, was

5:33

sort of what started the whole CPU

5:36

revolution.

5:37

And so tremendously successful,

5:40

and you all know the story of the iPod. That

5:42

was the beginning of Apple as

5:45

an incredible business model, but

5:48

it also was the precursor

5:50

to the iPhone.

5:51

BOMAR on the other hand, and this speaks

5:53

to why seven powers. Not

5:56

exactly a household name today. Right, you'd

5:58

never heard of it. So So

6:00

that dates me and you. So

6:03

you might be saying that innovation is not sufficient.

6:06

Yeah, innovation or disruptive technology

6:08

is not sufficient. It was very disruptive

6:10

if you were an abacus maker or

6:12

a Monroe calculator maker. It puts you

6:15

out of business. Very disruptive, but

6:17

completely went out of business after

6:20

a while. And it had tremendous

6:23

brand recognition

6:24

was the thing and this huge

6:26

spin up. And that speaks to strategy.

6:30

And so what you wonder is if

6:32

you're

6:33

helping the people founding those

6:36

companies, is there anything that you could

6:38

say that would maybe guide

6:40

them to be a little more iPod-ish

6:42

and a little less Beaumarsh, right? But

6:46

the problem with that is that

6:49

the nature, as the two of you know

6:51

from your acquired side as well

6:53

as all the other things you've done.

6:55

The nature of developing business

6:58

is adaptive and evolutionary.

7:01

It's not like you sit a bunch of bright people

7:03

in the room and you figure out the strategy and say, okay,

7:05

we're just gonna execute from now. It's

7:08

you go forward in time

7:10

and

7:10

effort and new information

7:12

comes in. Oh, that customer didn't do what I

7:15

thought. This competitor

7:17

is coming in this way. The technology

7:19

frontier has changed all this stuff and

7:21

you have to adapt to that over time.

7:25

And so the problem with that is

7:27

that, okay, well then if it's

7:29

that way, how does a body of thought contribute

7:32

to that? And the answer to that

7:34

is that if you can provide

7:37

a useful mental model, or

7:40

as Gene Yee calls it, pattern recognition,

7:42

you provide something so

7:44

that as entrepreneurs are moving

7:46

through space and time,

7:48

they can see what's a

7:50

little more likely to end up iPod-ish

7:53

and a little less likely to end up Beaumarsh.

7:56

that kind of metal model

7:58

is actually

8:00

hard to construct. And

8:02

what I say in the book is that the very

8:04

high hurdle that it has to clear is

8:06

that it has to be simple but not simplistic.

8:10

So simple,

8:11

it has to be that way or people won't remember

8:13

it. If it's some complex theory that

8:16

you have to go back and look it up every time, it's

8:18

not going to help a lot when you're making business

8:20

decisions. And not simplistic

8:22

means that it's got to cover most

8:25

of the situations you face. In

8:27

other words, it has to be relatively exhausted.

8:30

And that's a high hurdle. So there

8:32

were a number of strategy frameworks

8:35

before that were extremely

8:37

interesting and made great contributions,

8:40

but weren't simple, but not simplistic.

8:43

Probably the most prevalent was Porter's

8:45

Five Forces, focused on what

8:48

he calls industry attractiveness.

8:50

It was a tremendous contribution, but it's

8:53

not insufficient. If you're in an attractive

8:55

industry, it doesn't get you

8:57

the kind of security that an iPod

8:59

has. Right. Samsung is in

9:02

an attractive industry called smartphones,

9:04

and yet their P&L looks quite different than

9:06

Apple's. Right. And there's been statistical

9:09

work just buttressing that point

9:11

more generally, that industry attractiveness

9:13

doesn't explain a lot of firm

9:17

differences in profitability. Another

9:19

one was Christensen's work

9:22

on disruptive technologies, which is just phenomenally

9:25

interesting and highly erudite, but

9:27

this example is perfect.

9:29

Disruptive is actually not

9:31

correlated with long-term profitability.

9:34

It has to do with product market fit. It basically

9:36

says you've come up with a better way of doing something

9:39

that takes out the incumbent. It

9:42

disrupts

9:43

So very interesting in that frame,

9:45

but not for the BOMAR iPod

9:47

problem.

9:48

And then there's a whole strain of thought around

9:50

capability

9:52

analysis. You can do a lot of

9:54

things with capabilities, but it's

9:56

not common that that's the basis of

9:58

why you build great business.

10:00

other people have those

10:02

capabilities as well.

10:03

So what that meant from a concept

10:06

development

10:07

framework is that I sort of

10:09

had to go back to square one

10:11

and say, okay,

10:13

I'm thinking about pattern recognition

10:16

for entrepreneurs. What's simple but not

10:18

simplistic? And one of the

10:20

keys to that question is

10:22

persistence, which is that if you

10:24

were If you were to say

10:27

Apple's profitability next

10:29

quarter,

10:30

it's not a random draw, right? It's

10:32

highly persistent. And there's statistical

10:35

work on that that suggests that's generally

10:37

true for very successful companies.

10:40

And importantly, not just next quarter, but

10:42

four quarters from now and eight quarters from now. Exactly.

10:45

You sort of have a pretty high level of confidence. You know, we

10:47

don't know 10 years from now, and

10:49

that's what we're gonna get into on this episode, but

10:51

we know a year from now.

10:53

Bezos always used to say the line, this

10:55

quarter is already baked, this quarter was baked three

10:58

years ago. I'm working on a quarter five

11:00

years from now. Yeah, there's that, but

11:02

I think also the fact that he says

11:04

that this quarter is baked also

11:06

sort of tells you about something about the business

11:09

model on the way. And so that

11:11

persistence

11:12

tells you that there

11:15

are economic structures

11:18

that create attractive

11:20

outcomes. And you then

11:23

ask the question, can

11:25

you generalize about those? Because if

11:27

you can generalize about those, then

11:30

maybe you can get to something sufficiently

11:32

simple and yet comprehensive

11:34

that is useful to entrepreneurs.

11:37

And so

11:39

after

11:40

looking at that for decades, my

11:42

conclusion was that actually it is

11:45

simple.

11:46

There are only seven of them.

11:48

And in fact, if you're dealing with startups

11:50

these days, that's usually a smaller

11:53

subset of that.

11:54

And so that to me

11:56

was a fairly profound insight

11:59

And that's what. Seven Powers is. It's just those

12:01

structures that if you can get

12:03

there, make you more iPod-ish

12:06

and less Beaumarsh. And a key

12:08

piece that I always have forced myself to remember

12:10

whenever I'm analyzing a brand new

12:13

business idea and trying to run it

12:15

through the Seven Powers framework is

12:17

Seven Powers is about defending the castle

12:19

and

12:20

less about

12:22

is this a good idea or not. it

12:24

is a second invention after

12:26

product market fit to create a

12:28

durable business. That's right. Gee,

12:31

I wish I had said that. I think you did say that.

12:34

I think this concept of a second invention is literally

12:36

your words from a previous episode. So

12:39

product market fit and power are more

12:41

or less orthogonal. There are some complexities

12:44

in that statement.

12:45

And I'll tell you something, Ben and David, that

12:47

has occurred to Chen Yi and myself

12:50

over the last year, which is

12:52

a little bit different maybe

12:54

than what's said in the book, which is

12:57

that I used to think that

12:59

it was sequential.

13:01

You get product market fit and

13:03

then you deal with power. But

13:05

my biggest education is

13:08

talking to founders.

13:09

I love their intelligence, their

13:11

creativity, dare

13:13

I say, their youth and their

13:15

deep thoughtfulness about stuff. And what

13:18

I'm finding is that

13:20

the proper path is actually

13:22

to be thinking about those things kind of simultaneously.

13:26

Because

13:26

what's going on is you're trying to figure

13:28

out, okay, what am I doing with this business?

13:31

I've got this choice and this choice. And

13:33

in the mix of that, there are both product

13:36

market fit questions and power questions.

13:38

And you don't just say, well, I'm just gonna do the product

13:41

market fit stuff and think about power later.

13:43

You actually need to start thinking about

13:46

it. You won't solve it completely at the

13:48

beginning. You won't know, oh, yeah, I have power

13:50

for sure, but you should be thinking about it.

13:52

So persistence then leads you down to those

13:54

structures. And part of the reason,

13:57

you know, that it's really cool that you're sort of thinking

13:59

it. about

14:00

this in your interviews. And we

14:02

think about it in our work is one thing I've said to you

14:04

before is that the

14:06

genotypes of power are

14:08

simple. They're only seven. My partner

14:11

Bill says that it turns strategy from

14:13

a essay question into a multiple

14:15

choice question, although I don't know with chat GPT

14:18

the difference anymore.

14:19

But the phenotypes, that is the exact

14:22

granular way in which

14:24

they are articulated and

14:27

carried forward are complicated.

14:30

Chinese and I, yeah, and we might struggle for

14:32

weeks trying to figure out whether something

14:35

has power or not.

14:36

I'll give you an example of how the

14:38

idea of power is so important. So, you know, I'm

14:41

sort of a sports star nut and

14:43

I used to drive too fast. And

14:46

Porsche is a great example here, which

14:48

is, Ooh, yes. Think of that. the 911

14:50

first one came out in 1964,

14:52

60 years ago. Porsche wasn't sort of the sports car

14:59

leader

15:01

of the world at the time by any means. And

15:04

so what that enabled Porsche

15:07

to do, which

15:08

I don't think was conscious

15:10

exactly, but sort of spun out

15:12

in an evolutionary way over time,

15:15

that they took

15:17

away the design

15:21

element as part of the mix

15:23

in what wins over

15:26

sports car and enthusiasts. So if

15:28

you looked at a 9-11 and 1964 and a 9-11 today, they kind of

15:30

look

15:34

the same. Yeah.

15:37

You know? And so what did that allow

15:39

Porsche to do? It allowed

15:41

to just constantly optimize

15:45

the best performance features in

15:47

the context of people

15:50

would pay for that, you know,

15:52

handling acceleration interior

15:55

ergonomics and the

15:57

technology frontier was changing

15:59

FAIR!

16:00

rapidly. Today I'm

16:02

just astonished at the performance

16:05

you can get

16:06

from a small scale Honda

16:08

that'll go 155 miles an hour,

16:11

you know, faster than a Jaguar XKE

16:13

right back in my day. And then

16:15

there've been all kinds of parallel developments

16:18

and other aspects, brakes, sound

16:20

editing, everything else. And so they

16:22

could constantly

16:24

upgrade each generation,

16:26

not having to think about the design

16:29

aspect to it, but

16:30

hit the performance envelope

16:33

and people would pay for that.

16:35

You needed all those things, right?

16:37

Consequently, they end up with this

16:39

incredibly durable business model

16:41

by far the most profitable automobile maker

16:44

and devoted fans

16:46

and great cars. Are you saying the fact that they

16:49

abstracted away the design

16:51

and they fixed the design meant

16:54

that it sort of wasn't a hits driven business?

16:56

It wasn't do people like this design or not? Exactly.

17:00

Why are you interviewing me? Well,

17:03

you do the hard part, you know, I just get to synthesize.

17:07

So, yes, and then all of these

17:09

elements like getting the PDK

17:12

transmission just right, those are fixed

17:14

cost investments,

17:15

and if they can spread that over a larger

17:19

number of automobiles, it's lower cost.

17:22

So how many times have you seen sports

17:24

cars that

17:25

were quite interesting, And then they

17:27

just couldn't keep upgrading them to

17:30

meet the great. I mean, think of the Toyota 2000

17:33

or an early version of Alfa Romeo

17:35

or something. And to your point, it's not just

17:37

did people like them enough. It's could

17:40

they predict that enough people would

17:42

like them to invest in

17:44

the necessary things they needed to invest in. And

17:47

if they couldn't be certain or didn't have the

17:49

chutzpah to say, we're going to sell a million

17:51

of these things, then you can't make the investments

17:53

you need to. Right. And so Portia was

17:55

the one that just kept being right

17:57

on that performance envelope. because

18:00

they were able to do all these investments

18:02

and it's a phenomenal business model.

18:05

All right, let's kick it over to Chen Yi. Anything to add Chen

18:07

Yi before we move to transforming?

18:09

I guess I'll just add on to the perspective

18:12

of a student of the Seven Powers

18:14

framework, not the creator of that. So

18:17

one thing that struck me as the most useful

18:20

way to apply the Power Framework is

18:22

really as a cognitive leverage.

18:24

So I think Ben, you mentioned, it doesn't really tell

18:27

you what's the next thing should build or what

18:29

product is going to hit the market, but it

18:31

tells you what's the right strategy

18:33

question to focus on. I

18:35

think the way I put it is, what is not important

18:38

is as important as what's important. Naturally,

18:41

as founder and operators, you will spend 90,

18:43

95% of time on operational excellence.

18:46

It's so important you have the right team, the right culture,

18:48

the right execution, but there's 5%

18:51

of time that you may spend on real important

18:53

strategy questions. Those are what determines

18:56

the eventual margin structure of the business,

18:58

the competitiveness of the business.

19:01

What power structure can tell you is what

19:04

is that 5%? Out

19:06

of all the things you're thinking about, what really

19:08

makes the real strategic importance that you spend

19:10

all the time thinking about? That's

19:13

one way I think this would be the most useful maybe

19:15

for a lot of members in your audience.

19:18

The other comment I'd have is, now

19:20

that I've had the chance to work on the

19:22

theory myself, It's actually amazing how it's

19:24

not done yet.

19:25

I've been in Hamilton's class seven,

19:28

eight years ago at Stanford. I've been

19:30

working with him for the past couple years.

19:32

And I used to think, oh, it's all in the

19:34

book. It's just there. There are seven of them,

19:37

and it's all described. But

19:38

then as we dig into it, things

19:40

that we don't know come up. We

19:42

talked about platform last year, and we're

19:44

going to talk about transforming now. It's about

19:47

the dynamics part of power, and maybe even

19:50

extend into corporate strategy, not just

19:52

business strategy. So this kind

19:54

of life within the theory is

19:56

actually really exciting and

19:58

fun to explore.

20:00

I know we're going to get into this in transforming. Can

20:02

you define the difference between corporate and

20:04

business strategy?

20:05

I'll kick this one to you, Hamilton. Business

20:10

strategy is how

20:12

to find power, if you will,

20:15

in what you would think of as

20:17

a single

20:18

defensible entity

20:20

and corporate strategy is

20:22

how you think about strategy

20:25

in a multi-business unit corporation.

20:28

And the central problem of

20:30

corporate strategy is why

20:33

is one plus one greater than two? In

20:36

other words, is there any reason

20:39

from a value point of view for

20:42

two separate businesses to

20:44

be under the same roof?

20:46

And there have been a variety of efforts

20:49

in that. If you go back in the days of

20:51

GE, wildly diversified companies,

20:54

there's a theory for a while that that

20:56

was really a good thing that you get sort of these

20:58

diversification benefits turned out not

21:01

to be true.

21:02

And so it's really that question

21:04

of

21:05

why is it that if you're

21:07

in one thing,

21:08

it makes sense or doesn't make sense to

21:11

be in another thing. And so again,

21:13

think of Amazon, AWS.

21:15

Why is that interesting? And the

21:18

static part is one plus one is greater

21:20

than two. The dynamic part, and that's

21:22

what our transforming discussion is about,

21:25

is what is it

21:27

about the business that you currently

21:30

have that is somehow

21:32

useful in doing something else?

21:36

So you guys did the all wonderful episode

21:38

on AWS, demythologizing.

21:41

But Amazon did have

21:44

capabilities that made

21:46

it not completely alien territory.

21:49

Well

21:49

let's get into it then. So I'll

21:52

give you a quick intro to transforming

21:54

kind of

21:55

why we think it's interesting

21:57

and then Chenyi and I can sort of pull

21:59

it.

22:00

apart a bit and you can ask questions.

22:02

So there are really three

22:04

reasons that we think about

22:06

this. The first is that

22:09

if you're interested in creating businesses,

22:11

it's important.

22:13

And by important, I can give you a little

22:15

data on that. So I did a study once

22:17

of the S&P 100, largest market

22:20

cap companies in the world,

22:21

and looked at if you pull

22:24

the part, their value and and

22:26

looked where their profits came from.

22:29

And you asked the question,

22:31

what share of their profits came

22:34

from businesses that wasn't their

22:36

original business?

22:38

What would you think if you were asked that? Can

22:40

you help us with a year of when you looked at

22:43

this? I did it just

22:45

prior to the financial crisis. So it was 2007. David,

22:49

what was your guess? My guess was 80%. Knowing

22:52

that time frame, I'd maybe dial it down a little bit

22:54

to 70 ish percent.

22:57

I think it's low because I'm thinking, you know,

22:59

banks, oil companies like the largest

23:01

companies in the world to that point weren't technology

23:04

companies. And I have to imagine that

23:06

those are more single business line

23:08

statics still drafting off

23:10

their original innovation companies. But Hamilton

23:13

wouldn't be asking this question if it were a boring

23:16

answer.

23:16

I don't know if you consider the answer boring, but it turned

23:19

out to be about 50%. Huh? Hahaha,

23:21

so in the tech world, which

23:24

you guys intersect more, you know, you

23:26

can think of all the examples we've talked about, AWS

23:28

as an example, the lead-off example

23:31

in my book of Intel getting into

23:33

CPUs. Yeah. That's transforming,

23:35

right? They're in memories.

23:37

Certainly, the lion's share of Apple's revenue

23:39

is not... Right. The

23:41

iPhone, they were not in that business before,

23:44

Google into Android, Microsoft

23:46

into operating systems and applications.

23:48

They were originally a language company.

23:50

But as both of you said, sometimes

23:53

not. You saw a couple of birds at Harvard started

23:55

right out of the gate with Facebook,

23:57

you know, And so 50% is a big number.

24:00

Yeah, half of all corporate profits

24:02

of the largest companies in America came

24:04

from something other than their original innovation.

24:06

Right. So that sort of flags you. And

24:09

so it's important as one. The

24:11

second is that it's hard to

24:13

get right.

24:15

It's a difficult area. There

24:17

are reasons that have to do with

24:19

motivation, and there are reasons that

24:21

have to do with understanding. And

24:24

Chen Yi will talk about some

24:26

of the common business nostrums

24:28

that sort of fall apart in this. On

24:31

the motivation side, I'll just mention that

24:34

from a founder point of view,

24:35

they just founded something that works

24:38

and so they're accustomed to that success.

24:41

And so sometimes they may

24:43

not appreciate all the idiosyncratic,

24:46

uncontrolled elements that went into

24:49

that success, and they're very creative

24:51

and they want to just move forward. And so they're inclined

24:53

to do that. And that's a great motive

24:56

force. I love that.

24:57

That's the lifeblood of an economy, but

24:59

it also means that you can

25:01

sometimes get into stuff that you really don't know how

25:04

to do it. Especially for first-time founders,

25:06

if it works out of the gate,

25:08

then

25:09

you have no idea to

25:11

what to attribute the success. It could

25:13

be skill, it could be luck. Of course, it is some combination

25:16

of it, but you have no idea the percentage that's

25:18

skill and the percentage that luck. And you say, well, it worked. I

25:20

will just repeat the exact same process again, and

25:23

surely I will create success again. And that

25:25

is almost assuredly not the case. I have several

25:27

companies in my mind that thought that and definitely

25:30

did not happen. Right. And then on

25:32

the people that often sit on

25:34

their boards or finance them, there

25:37

is also a dissonance,

25:39

which is that

25:40

if you think of the VC community,

25:43

the business model and VCs issue find

25:45

really interesting things invest in and

25:48

then hopefully they go up in value and

25:50

then there's an exit which you profit

25:52

from that increase in value

25:55

which is to this wonderful engine

25:57

if you think about

25:58

what drives the US economy. economy,

26:00

you know, it's just phenomenal.

26:02

But in the early stages of how

26:05

people think about value, there

26:07

isn't yet this track record

26:09

of persistence because people are often,

26:12

for example, spending a lot to acquire customers.

26:14

And so profitability may not be evident

26:17

yet, and the fundamental economics haven't

26:19

really asserted themselves. And so

26:21

the only thing left is kind of how the top

26:23

line is doing, you know, so are you growing

26:26

like crazy?

26:27

And so

26:28

when you hear VCs some kind complain

26:31

that people waited too long to IPO,

26:34

what that message really means is

26:36

that all of a sudden people's perception

26:39

of the company changed from the top

26:41

line to the bottom line and they missed the

26:43

window. What that says is that

26:46

that investor community is focused on

26:48

top line growth as it should be because

26:50

it's the best marker available,

26:52

but it doesn't tell you much about power.

26:54

And so it's hard to do. And then the third

26:57

thing, which of course you would expect from us, is

26:59

that actually understanding power tells

27:01

you some interesting stuff about transforming.

27:04

So three things, it's important, it's

27:06

hard to get right, and power matters.

27:09

All right, well we wanna take this moment to pause

27:12

and not only thank our sponsor for this

27:14

episode, PitchBook,

27:15

but bust out some pretty interesting stats.

27:18

So this season we're diving into Pitchbook

27:21

for resources on the companies we're covering.

27:24

And you may know that they've got these

27:27

amazing browsable data set on

27:29

every company, but they've got these research reports

27:31

too. And so I pulled

27:34

one up that is basically

27:36

a high level overview of the gaming industry.

27:39

And you're gonna love the way that

27:41

this research report starts.

27:43

In the 1960s, a group at

27:45

the Massachusetts Institute of Technology

27:47

created Space War, an early

27:49

computer game inspired by science fiction

27:52

novels. You

27:53

like that, David? I love it. It's like

27:55

they listened to our old Atari episode with Nolan. I

27:57

know. I like popped it open and I'm like.

28:00

like,

28:00

all right, where are all the stats gonna be in here? And I'm

28:02

like, oh my God, this is like an amazing way to introduce

28:04

the gaming industry. And it just kind of keeps

28:06

getting better from there. So listeners will link to

28:08

that whole thing to read in the show notes. A couple super

28:11

interesting stats. In 2021, the sector had $16.6 billion

28:13

in VC funding. And

28:19

in 2022, of course we've had this drawdown. It

28:21

was still 13.3 billion. They've

28:24

also got this great ecosystem map.

28:27

I also found what I think is a new

28:29

feature in PitchBook when I was looking up Nintendo's

28:32

page. They

28:32

have a number of patents by

28:35

filing year.

28:36

Nintendo has been declining from a high

28:38

of around 130 patents filed in 2013 to just over 50 in 2021 and

28:44

under 25 in 2022. So it's

28:46

just another interesting lens into companies to see

28:48

their patent velocity. For getting up

28:50

to speed on

28:51

an industry sector,

28:53

it also works really well in tandem

28:55

with acquired episodes. I mean, the number of folks

28:57

who've been texting me, DMing me, they're

28:59

like, I'm a public equities analyst, looking at

29:01

the video game space is way more than I expected.

29:04

Another great place to look for all that is PitchBook. We'll

29:07

link to the gaming report.

29:08

If you're an entrepreneur thinking about fundraising and

29:10

wondering who's the right target for me, PitchBook

29:13

is just for everyone at this point. And I

29:15

can tell you from doing the arena show with

29:17

them last year, they are just great

29:19

people to be in business with.

29:21

So if you want to sign up for PitchBook, they

29:23

will be offering a free week trial

29:25

that is coming up soon. don't miss out.

29:28

So go to pitchbook.com slash acquired

29:30

to get all the details. I think they're also gonna

29:32

link to the research report page there and

29:35

just tell them that you heard about them from Ben

29:37

and David at acquired. Thanks

29:39

Pitchbook. Something else

29:41

just finally occurred to me. I've never thought about it

29:43

before, but if you are

29:46

analytical and can figure

29:48

out and quantify a company's

29:51

power, then you can assign

29:53

it a more accurate,

29:55

multiple of profit than anyone

29:57

else can, because if you

29:59

can. observe, oh, a company has a 24% operating margin. Many,

30:03

many years in a row, you can decide, okay,

30:05

fine. I kind of know what the operating margin

30:08

is going to be in the future. And

30:10

I can figure out how I want to value this

30:12

company. But if it's a new company

30:14

and it just settled into some steady

30:16

state of profitability and you understand

30:19

the power dynamics, you can be better than other

30:21

investors at predicting the

30:23

sort of net present value of all the future

30:25

cash flows of that company, rather

30:27

than a very brute force way of doing

30:29

it. of just slapping the same multiple on that everybody

30:31

else does.

30:33

Yeah, so

30:34

Ben not only is going to supplant me in writing

30:37

Seven Powers, but he's going to take over strategy

30:39

capital.

30:40

I think that job falls

30:42

to tenure, yeah. So we're

30:44

sort of constrained about talking about our investment

30:46

stuff too much, but basically

30:48

the proposition of strategy capital is if

30:50

you have a differential understanding of

30:53

long-term competitive outcomes in places

30:55

where that's really hard to figure out, that

30:57

you can value things more carefully. And

30:59

so I completely agree.

31:01

And you properly constrained it. If

31:03

there's a long history of financials, it's

31:06

already in the price. So does Walmart

31:08

have power? Sure. Right. My

31:11

dog can tell you that. Right. Right.

31:14

I'd like to meet your dog sometime.

31:16

So that's why it's important.

31:19

And I'm going to just give you a quick take

31:21

on what I mean by transforming.

31:23

When I laid this topic out to the two

31:25

of you, I said that

31:27

if you're thinking about

31:28

increasing value in a company, there's

31:30

sort of two questions. What can I do better

31:33

and what can I do next?

31:34

And you spend most of your time on as

31:36

you should on what can I do better. So you think

31:39

of Amazon developing a better search

31:41

engine when you look for a product.

31:43

You've got to think about that, right? And that's most

31:45

of your time. But then you also think

31:47

about, okay, well, what can

31:49

I do next? And that's what transforming

31:52

is.

31:52

And that would be Amazon going into

31:54

AWS. And you can imagine thinking

31:57

about whether to do AWS

31:59

is a very

32:00

different exercise than optimizing

32:02

the search engine.

32:03

So transforming is sort of a separate

32:05

topic, a fundamental thing

32:08

in strategy is a thing called business definition,

32:10

which is what really

32:13

are the boundaries of your

32:15

current business? Nicole Lee So I think actually

32:18

in our prior email conversation, David,

32:20

you had the question of how do we go about research

32:22

something like this. And typically,

32:24

we start with looking at what

32:27

others have been talking about. This is It's exactly

32:29

where we come across a lot of common

32:31

narratives of

32:32

where do you find your next level of growth. We've

32:35

all heard about, go listen to your customers.

32:38

There's Amazon School of Customer Obsession that's

32:40

fairly popular. People will go after 10

32:42

expansion, expand geographically, go

32:45

different segments, or in a fuller

32:47

core competence, et cetera.

32:49

As we look through this, I

32:51

think one issue we found is they

32:54

don't seem to be conclusive about

32:56

the chance of success of these

32:59

transforming steps.

33:00

So, in other words, you can't say if

33:02

you do X, you are more likely

33:04

to succeed. For example, there's

33:07

this whole school of thought around marketing myopia

33:10

that says you should define your industry

33:12

definition widely. The reason why

33:15

railroad industry goes into decline is

33:17

not because people don't have demand for

33:19

transportation, but because they can't think of themselves

33:22

as a broad transportation company. themselves

33:24

into cars and trucks and airplanes

33:27

and even telephone, which are new forms

33:29

of transportation. And I think

33:31

this is one of the bestsellers

33:33

of Harvard Business Review of all time just

33:36

speaks to the popularity of it.

33:37

So the question we will ask is, does

33:40

companies that follow Marketing Myopia all

33:43

tends to be successful? Does that give us a

33:45

way to predict success?

33:47

And we can kind of think of examples on either

33:49

side, right? Like Disney today is not

33:52

just a theme theme park company or animation company,

33:54

they seem to be a broad entertainment company. are

33:57

pretty good at coming up with the next form of entertainment

33:59

that

34:00

people will love and want to watch. On

34:02

the other side, Uber at one point was

34:04

all in on mobility. It

34:06

was not just about cars. You have to remember the

34:09

scooters.

34:09

Scooters, buses, yeah.

34:11

Bikes. They were serious about flying cars at one

34:13

point, the Daniel helicopters. That's

34:16

right. Yeah. Right. That

34:18

didn't seem to end up that well, even if it ends up in the same mobility definition.

34:22

What that means is we can't tell

34:24

whether following a certain

34:26

school of thought is definitely going

34:29

to be leading to success,

34:30

which means we don't have a theory

34:32

behind it. So that

34:35

sort of stays our problem is can we say something

34:37

that's a bit more definitive, a bit

34:39

more having the predictive power there.

34:42

And as we thought about

34:44

it, the real reason why we

34:46

have this issue is a lot

34:49

of these popular narratives kind of tell

34:51

you about economic value, but they don't

34:53

tell you much about business value. state

34:55

in other words, they tell you about value

34:57

creation, but not value capture. And

35:00

say, in other words, we're basically saying product

35:02

market

35:02

fit is not power. Yeah. Coming

35:05

back to the very first conversation about

35:07

why we did this in the first place is that

35:10

the

35:10

point Chen Yi just made is the fundamental

35:12

one, which is that

35:14

creation of economic value

35:16

is pretty orthogonal

35:18

to capturing some of that

35:21

value for yourself, which is to say the

35:23

creation of company value.

35:24

So creation of economic value and the creation of company

35:27

value are different animals.

35:29

And both are important. And there's a

35:31

dynamic connection in the sense that if

35:34

you create economic value, it sort of creates

35:36

the opportunity to think about capture

35:38

and so on, but

35:39

just a single slice in time,

35:41

they're very different. But that's a fundamental

35:44

point about all this.

35:46

Yeah, I think that's a good way to put it,

35:48

which basically means All of the common

35:50

narratives out there are really useful. They're really useful

35:53

as idea generators. They tell you where

35:55

to look for the next part of market fit out

35:58

there.

35:58

And we think the understanding of

36:00

power is the missing link here. We have all these

36:02

ways to come up with options, but how

36:04

do you assess which one of them is really the best idea?

36:06

And that's what we set out to give a

36:08

better structure to. Yeah, and so I'll

36:10

just say how power kind of helps you

36:13

out in a way. So I mentioned this sort

36:15

of ethereal concept before, this definition.

36:17

So it's rather important. So if you think about

36:20

Uber versus Netflix, where

36:22

they go next, right?

36:24

Uber at first, their thought was

36:26

this was an international business.

36:28

That means that going into China,

36:31

somehow their strength

36:35

would be transferable into that effort

36:37

and they could be successful. And

36:40

Netflix thinking about going international,

36:43

thinking that if they started streaming

36:45

in Korea, that

36:47

that would make a lot of sense. And are you considering

36:49

the international a separate business

36:51

or are you thinking about this as like should we expand

36:54

the core business and just address a

36:56

broader market? So that's the question.

36:59

The key thing there is

37:02

if you have an established business

37:04

is the drivers of power

37:07

in that

37:08

extensible

37:10

to that additional segment you're

37:12

considering whether or geographic or customer

37:14

or whatever.

37:15

And because if it is, the

37:19

risk reward of

37:21

doing it, the calculation beginning,

37:23

is so much better because being

37:26

able to carve out value to yourself is really

37:28

hard.

37:29

And if you can build on to something that already

37:31

does that and it works in that environment, then

37:33

oh boy, go there. Because that's

37:36

so much easier than doing something really new.

37:38

And so Netflix streaming

37:41

in Korea, It built on,

37:43

to say you can share content across countries,

37:45

right? It built on the same fixed

37:48

cost economics of content

37:50

development and worked. Uber's,

37:53

if they have a source of power, It

37:55

has to do with geographical

37:57

density in a specific area.

38:00

like the Bay Area or something,

38:01

and going into China, if

38:04

they're head to head with DD or something,

38:06

they don't have any advantage at all, and so it

38:08

doesn't work.

38:09

Right, they get to bring their technology platform over,

38:12

so they're amortizing all the engineering design product

38:14

management costs, but they have to go reacquire

38:17

both sides of the marketplace in full and

38:19

create that density, which is actually the expensive

38:21

part of the business. Exactly, and if it turned

38:23

out that the engineering part was 75% of

38:26

the cost structure, I mean, content and

38:28

for Netflix is 50%, or somebody got

38:30

it, then it would have been fine, but it's

38:32

not, just as you said.

38:34

And so when you're thinking about business

38:36

definition,

38:37

in some businesses, international

38:39

is part of the same business, which is to

38:41

say it's under the same power umbrella. And

38:44

in some businesses, it's not.

38:46

And you have to understand that

38:48

in terms of what you're doing.

38:50

And if you're thinking about what's next,

38:53

if you can go to

38:55

things that are under your current power

38:57

umbrella, oh, boy, is that great. If

39:00

Porsche wants to sell cars in China, as

39:02

opposed to selling them in the US, no

39:05

brainer. Right. Still all the

39:07

same unbelievably hard engineering

39:09

problems that went into creating the car you're

39:11

selling in the US, you can find a way to distribute

39:14

that.

39:14

Yeah, and a Chinese competitor would have to

39:16

go through the same calculation, you

39:18

know. So

39:19

the first point of this conversation

39:22

is that

39:23

to properly assess transforming directions,

39:27

the first

39:29

thing is

39:30

carefully understanding your current base

39:33

of power,

39:34

and then looking at this new segment,

39:36

whether as I say it could be customer, geographic,

39:39

technology, whatever product,

39:41

and seeing whether it relies on that

39:43

as well. Because then, oh

39:46

boy, the world looks rosy. But

39:48

on the other hand, if you think it does

39:52

and it doesn't, it's

39:54

like Uber in China. I don't

39:56

know. What did they lose a billion dollars or something? I don't

39:58

know what it was. Maybe more. once you consider all the

40:01

divestiture and yeah. Yeah.

40:03

And so they used to be compensated

40:05

by the shares and I don't know

40:07

what their shares are worth now.

40:09

So anyway, so that's the starting point. It's

40:11

interesting, right? Like I'm thinking about we're in the middle of our

40:14

Nintendo series as we're recording this. And

40:16

this really is an interesting framework to think about

40:18

it because on the surface, it

40:20

could be pretty far flung. I'm thinking about, you know,

40:22

Nintendo made playing cards with

40:25

the Japanese organized crime as their primary

40:27

customer. And then moving from that

40:29

to video game consoles is a pretty big

40:31

leap. But, you

40:32

know, what they had

40:34

originally that is the same thread through

40:36

the whole business is they had an absolutely

40:40

ironclad lock on their distribution networks,

40:42

especially and then over time through playing

40:45

cards into toys, into video games, into

40:47

toy retailers. Right. And that's such

40:50

an interesting case, David, because oftentimes

40:54

it's that kind of subtlety about

40:57

locking in a distribution channel, for example,

40:59

that's sort of kind of invisible, but

41:02

may actually be

41:03

the very thing that makes that such

41:05

an... I mean, if you think of Sony, on

41:08

the other hand, when they went into game

41:10

consoles,

41:11

that was a different business,

41:13

I'd say, and brutally hard, and it

41:16

relied on some capabilities. So

41:18

it shows why the capability thing doesn't get you there. I

41:20

mean, yeah, some engineering at the

41:22

time, analog was king there, and digital

41:24

was thought of as a backwater, but

41:26

it was a very difficult. And now

41:28

it's, of course, the source of their profitability.

41:31

Right. But it was a long journey for Sony to

41:33

get there. And like all these things,

41:35

there were a few

41:37

principal actors, a few leaders

41:39

that, had they not been there, it's

41:41

hard to imagine it ever happening, some innovative,

41:44

hard driving people.

41:46

So Hamilton and Chenyi, can we ask

41:48

you what are the most

41:50

common power types

41:52

in today's technology-driven

41:54

world where people might find

41:57

expansion opportunity inside of

41:59

their

42:00

current power umbrella? I think, particularly

42:03

for earlier stage companies,

42:06

the three most common power types that

42:08

you will find are

42:09

scale economies,

42:11

network economies, and switching costs. Well,

42:13

it's actually often common that you'll have counter positioning,

42:16

because that's how you tackle your incumbent

42:18

in a space. But there are a couple other power

42:20

types that doesn't really come in until

42:22

the more mature phase of the business. And that's laid out

42:24

in a book, like process power or brand power.

42:27

You really need to develop them after years

42:29

and years of experience, you know, honing in

42:32

on the core business. So for

42:34

the benefit of the audience today, we thought

42:36

it would be more useful to focus on the

42:38

three types of power, skill, network,

42:41

and switching cost, which is probably the most common

42:43

that we'd find out there. And

42:45

are you not including counter positioning here because

42:47

it's hard to find a

42:49

second business under a

42:52

counter positioning umbrella?

42:53

Let me just weigh in every second. I agree

42:56

with her sort of leaving it off because to

42:58

have power, right? You have to have it versus all

43:00

potential and existing competitors. The

43:03

counter positioning one is typically the type

43:05

of power that you would have

43:07

against incumbents, but

43:09

it doesn't work against want to be

43:11

cause they don't have the same problems. And

43:13

so the one that you have to think hardest

43:15

about is versus other companies

43:19

that are doing it just like you.

43:21

And so for Bulmar, would be Texas

43:23

Instruments doing calculators. And

43:25

so that's why she left it off the list.

43:27

Yeah. So

43:28

regardless of what's the core

43:31

power prospect, I'm calling it a prospect because this

43:33

power is a pretty hard bar to clear.

43:35

But

43:36

even if you're still in the make for you, and you

43:38

think this is going to be the mechanism that protects

43:40

you from competition in the long run, the

43:42

first step is always to get a really clear

43:45

understanding of what that core business

43:47

power prospect looks like. So back

43:49

to your example of Uber.

43:51

If the core power prospect of Uber

43:53

is actually scale economies, which says the

43:56

technology framework of doing the matching automatically

43:58

is so hard.

43:59

require so much cost to build, then

44:02

international expansion would have been totally rational,

44:04

right? Because you're just spreading that fixed cost over

44:06

more geographies and you're getting a head start in every

44:09

single place you have.

44:10

But the truth is, it's not. The majority

44:12

of cost of that business actually lies in

44:14

acquiring and maintaining their customers. Which

44:17

means if anything, the route you should really

44:20

try to get to is network economies, if

44:22

you have one. And the scope

44:24

of that network defines each market

44:27

is actually heavily bounded geographically.

44:29

And so every new

44:30

country, even new city, you go into is

44:32

a complete new business and have to start from scratch. So

44:35

that's just an example of getting a definitive answer

44:38

or a confident answer about where

44:40

core business power

44:42

looks like gives you a very different

44:44

place to look on where to transform

44:46

or where to take it to the next step for your business.

44:48

So it's almost like, okay, so I'm

44:50

here in Seattle, if I was operating an Uber-like

44:52

service, I have this

44:54

power, which is all the drivers and all the riders

44:57

or a high density of that. That means nothing

44:59

where David is in San Francisco. So instead

45:01

of launching Uber in San Francisco, maybe I should

45:03

try and figure out other things to leverage my network

45:05

for here in Seattle, because that's

45:08

the place where I have the durable competitive advantage versus

45:10

others. So Uber eats, right?

45:13

Right.

45:13

So I think the jurists go out whether ride

45:15

sharing and food delivery belongs to the same business.

45:18

Maybe they do. But it's more plausible than

45:21

different geographies.

45:22

This is one of these things where it seems obvious on the surface

45:24

and then we start to dig in.

45:26

Maybe it's not as overlapping of a network as I would

45:28

have thought. Right.

45:29

That's the question. Right.

45:31

The drivers for food delivery are

45:33

an overlapping but not that

45:35

overlapping set of drivers for

45:38

rideshare. And the set of consumers

45:40

is obviously different as well, which you can

45:42

see in the corporate action they took to ship

45:44

a separate app called Uber Eats rather than

45:46

bundling into one app. So you actually have like

45:49

two overlapping two-sided

45:51

networks, but not a fully overlapping on

45:53

either side of the network. Then

45:55

that's such a great example because

45:57

it speaks to the point that

45:59

of the complication of the phenotypes,

46:02

that until you peel back the covers, it

46:05

just sounds, oh yeah, Uber eats and drives, it

46:07

sounds all the same, but when you start peeling

46:09

it back, it may not be. So what that

46:12

says is you have to have

46:14

quite a lot of nuance in your

46:16

understanding of whether you have power

46:18

to begin with. And of course, for Uber, it gets

46:20

into the nature of platforms

46:22

and exclusiveness

46:24

of the sets that occupy

46:27

either side of the platform and whether

46:29

they overlap and all that kind

46:31

of stuff. And so without that nuance,

46:33

you just, you miss it.

46:35

Yeah.

46:36

One other network economy is one that I'm curious

46:38

to get your take on. I see in your notes here is

46:40

Microsoft versus Slack. Can you sort

46:43

of walk through the Microsoft decision

46:45

to enter the market of

46:47

whatever Slack's product is? It's quite hard to define.

46:49

Async chat work communication

46:52

with teams. Why or why not

46:54

was that an interesting entrance

46:56

and use of their power umbrella.

46:58

So the interesting thing here is we

47:01

can also think about Microsoft

47:03

as a platform. You operate an operating system

47:05

where on the two sides, you have users

47:07

and also you have applications. Now,

47:09

the interesting concept here is the users

47:12

of Microsoft's platform has a really high

47:14

cost of affiliation.

47:16

It's not just on the hardware

47:18

side. You buy a physical machine, but also it's typically

47:21

an enterprise web adoption. There is a procurement process

47:23

attached to it. the distribution channels

47:25

that, you know, similar to how the Nintendo one

47:28

worked. And because of that,

47:30

Microsoft's network scope basically

47:33

extends to whatever demand my

47:36

user side would have

47:38

without incurring more cost on their end. Without

47:41

they don't have to do another procurement cycle

47:44

maybe or did not have to buy another hardware for.

47:46

So that naturally extends to basically

47:49

maybe all of productivity software.

47:52

And that's how you see Microsoft

47:54

Teams create at least a competitive

47:56

hassle for Slack. I think we all

47:58

have to experience that slack because it really

48:00

really good product, but good products

48:02

don't always win. Because when

48:04

there is competitive advantage from

48:06

an incumbent, in the case of Microsoft,

48:08

they basically have a network that can extend

48:11

into the product Slack is operating in,

48:14

they create issues, you know, competitively.

48:16

So where we're heading in this conversation

48:19

is for saying, transforming

48:21

is a worthwhile topic. And then we're

48:23

saying that a starting point is understanding

48:26

the power of your current business because if you

48:28

can build off of that, it creates

48:30

a wildly preferable risk

48:32

return prospect

48:33

for something you're getting into.

48:36

And so that then takes us to the next

48:38

topic, which is

48:40

what if you can't build on your current

48:42

thing

48:42

and you need to get into something that doesn't

48:45

build on your current source of power.

48:47

And the two of you with all your interviews

48:50

actually have so much, you know,

48:52

you have this wealth of information

48:54

about what goes into people's minds

48:56

doing that. But

48:58

if you think about that,

49:00

what are you into? You're basically,

49:03

you're starting a new business, right? Right.

49:06

Congratulations, you don't have to file as

49:08

a Delaware C Corp. And you probably

49:10

have some people you've already hired that can work on it.

49:12

But what other assets are you repurposing?

49:14

Right, exactly. And so remember

49:17

that thing I said about the S&P, a 100. If you

49:19

look at

49:20

they

49:23

went into that generated

49:25

a lot of value and asked the question,

49:28

could you generalize it all about that?

49:31

I'll create some definitions here a little bit,

49:34

sort of three categories.

49:36

If you think of, does it satisfy the same

49:38

needs or does it use the same skills? Those are

49:40

the two dimensions, right? Because I have a

49:42

consulting background and the whole world is always

49:44

two-dimensional, right? And

49:47

if it has neither the same skills

49:49

nor the same need, I'd just call that pure diversification.

49:52

And rarely does that work.

49:54

That's a very high risk proposition. You're

49:57

basically creating a new business, something you don't know

49:59

how to do at all.

50:00

And when you say skills and need,

50:02

that's the skills of my

50:04

company and the need of my customers. The

50:07

skills of your company. So what your engineers

50:09

know how to do, what your salespeople know how to

50:11

do, all those sorts of things. So like

50:13

in that case, you'd be better off either having

50:16

people who are entrepreneurial within your company,

50:18

like leave and start a new company and spin it off, or

50:21

invest your treasury in other companies. And

50:23

as a big company, you have all the agency

50:25

problems of trying to get something off the ground

50:28

with a lot of bureaucracy and everything else.

50:31

Right. Right.

50:34

There's probably more disadvantages than advantages. And

50:36

data supports that, that unrelated

50:38

diversification is typically

50:41

not a great thing to do. So the lower left

50:43

of this two by two matrix is I

50:46

neither have the team that is great

50:48

at creating this next new thing, nor do

50:51

I have the customers that want this next new thing

50:53

currently. You got it. then

50:55

if you look at the upper left,

50:57

which is it's the same need,

51:00

but different set of skills, you

51:02

can call that reinvention. And sometimes

51:05

you're forced to do that, but

51:07

the opportunity set isn't that great,

51:09

really. It's not like you're opening up the whole

51:12

world of opportunities. And so those

51:14

are pretty rare. It does happen. I

51:16

mean, Netflix into streaming is reinvention.

51:19

It can happen.

51:20

It's hard to do. You're usually counterpositioned

51:23

because you've got a whole group of people wants

51:25

to do it the old way. And they have a

51:27

lot of power in a company typically, because

51:29

they've got the P&L. It requires sort of the

51:31

founder-sponsor to go

51:33

pursue it.

51:34

Yep, that's very insightful. Exactly

51:37

right. Otherwise, you get swamped by agency

51:39

problems. And so the

51:42

different needs, skills sharing,

51:44

same skills are not same, but shared

51:47

skills, you can call that category

51:49

collection. And that's where all the action

51:51

is. Yeah, that's AWS for

51:54

sure, right? Exactly. AWS. Right.

51:56

Wait,

51:56

so this is the lower right? This

51:59

is kind of the lower middle.

52:01

It's a bunch of not perfectly

52:04

shared skills, but you know quite a bit about the

52:06

stuff you need to do to get in there,

52:08

but it's a different need. And that

52:10

accounts, I don't know the numbers in front of me,

52:12

but I think it's 90% of

52:15

the value in the S&P

52:17

100 of the new stuff came from Coaction.

52:20

And that's saying something that's

52:22

pretty straightforward. And I guess there

52:25

is no top right because that is your current

52:27

product. Same team, same needs. Right?

52:29

God, you're too fast for me. That's right.

52:32

Same business. And then the extra

52:34

credit on this will be why are these axes

52:36

not quite orthogonal, but I'll leave that to

52:38

another

52:39

discussion. So if you think of Sony

52:41

going into PlayStation,

52:43

that was not the same as Sony

52:45

going into cars. It was a different

52:48

business, but they did have, you know,

52:50

a lot of stuff. And so

52:52

that basically says that

52:54

you want to constrain yourself to areas

52:56

that sort of meet with your current capabilities.

52:59

Now,

52:59

occasionally there are companies

53:02

that have

53:03

capabilities that are so proprietary

53:06

that actually that aligns

53:09

with power automatically, but that's very

53:11

rare. I mean, I'd say like Corning

53:13

and Glass Technology, for example,

53:16

it's such a weird material science, so

53:18

they can do glass stuff that other

53:20

people couldn't do. Is 3M a good example

53:23

of this sort of lower right where they

53:25

know how to make all kinds of interesting stuff But

53:27

for completely different customer bases completely

53:29

different use cases so my view

53:32

of 3M is that

53:34

they're basically a material science company

53:36

and

53:37

Material science is weird.

53:40

It's not

53:41

Fully or at least it used to be I'm not

53:44

so current on it so much but I'm not

53:46

fully developed theoretically,

53:49

there are all kinds of niche

53:51

idiosyncratic aspects to it.

53:54

And so they were able to invent

53:56

stuff.

53:57

So if you think of Post-it notes, right?

54:00

that was a not so sticky glue,

54:02

right? And then they didn't know what the hell to do

54:05

with it. And it went on

54:07

for years. There was a champion

54:09

in the thing that just said, no, there's

54:11

something great here.

54:13

And they almost missed it. It came

54:15

down to a final marketing trial where

54:17

they almost didn't follow up on it.

54:20

Wow. It is great. I never really

54:22

thought about that. I know it's a famous story, but

54:24

objectively it was a really crappy product

54:26

that they made. and then they turned that crappiness

54:29

into a feature.

54:30

Well, I'd characterize it a little different. I'd say it was

54:32

a very interesting technology with no product.

54:35

It's kind of like Web 3. It's like a computer.

54:37

Yeah. Ha ha ha ha

54:40

ha. It's like way slower. Too

54:42

soon, Ben. Too soon. But like. Right, right.

54:44

I love that. Maybe we'll find the sticky note,

54:46

right? Maybe the fact that it's really slow is

54:48

irrelevant, given it's decentralized. Right.

54:51

Yeah, it's funny. I guess we share a view on

54:53

that. I don't find myself very popular

54:55

on that view. But I agree with you. There's

54:58

all this hand waving about the wonders of

55:00

decentralization and the world will be a great

55:02

place and everything. And

55:04

I'm waiting for the- We need the sticky

55:06

note. We need the sticky note, right? Anyway,

55:09

so I think that is just a simple

55:12

observation, which is that the

55:14

stuff that's most likely will

55:16

get you there is a different need. But

55:19

using some of the skills that you have, and

55:21

nothing very complicated about it, but I think

55:23

data bears that out.

55:25

I would say a lot of tech companies today have

55:27

the same set of capabilities. So

55:29

is it about where you have differential

55:32

capability versus other companies

55:35

or just, hey, you can repurpose

55:37

a bunch of your engineers to do something interesting and

55:39

sure everyone else can kind of do it too.

55:42

So a really interesting question.

55:44

I mean, way back when, before

55:46

the idea of core competencies, there's a

55:49

writer that wrote about it. I mean, they use

55:51

the term distinctive competencies, which

55:54

is exactly what you're getting at.

55:56

And I would say that that was probably

55:58

true of Quarring and Gla-

56:00

technology, but

56:01

it's rare and I agree with

56:03

you that a lot of tech

56:05

companies have a lot of similar

56:07

sort of stuff. And if you had

56:10

a distinctive capability and

56:12

that that had an application in

56:14

an area so it led to a good product, then

56:17

oh boy that's great, but it's hard.

56:20

That's not common.

56:21

And so if you're in this place where you can't

56:24

build in your current power,

56:25

you just have to realize, as you were saying

56:28

before, Ben, you're back in invent

56:30

space. And yeah, you can build

56:32

on current capabilities, but that's sort of table

56:35

stakes, you know?

56:36

You're into that level of risk.

56:39

And like all those things, it's adaptive.

56:41

You know, you sort of try stuff and

56:43

move forward in a positive way. And so

56:46

my little mental waterfall so far

56:48

from everything that you've shared with us is step

56:50

one, identify the power in your current

56:53

business and be brutally honest about it. Right,

56:55

brutally

56:55

honest and very granular.

56:58

Yes. Step two,

57:01

figure out if there is a new business

57:03

to launch or expand into under

57:05

that particular power umbrella. If

57:08

so, great, do that. If not,

57:11

you have to go start a new business and

57:13

where you should look for the most fertile

57:15

ground for that new business is

57:19

using your existing set of capabilities,

57:21

but for a different

57:22

job to be done for customers,

57:24

look there and especially, this

57:27

is almost step four, if you

57:29

have differential capability

57:32

versus other companies who could also pursue

57:35

that same opportunity.

57:36

I love it,

57:37

yeah. Did you write that down, Chani? I think

57:39

we should make sure you remember all that. Yeah, I mean, venture's

57:41

just help us produce theory. Right,

57:43

right, right, yeah. No, I think you

57:45

nailed it. Yeah, there's one point I wanna make. There's

57:48

a reason why it's sequenced that

57:50

way and it may be obvious but still worth iterating,

57:53

which

57:53

is invention is risky.

57:55

If you have something underneath your existing

57:58

power umbrella, And that's what Amazon did. And

58:00

they had this distribution logistics.

58:02

They started with, we all know books

58:04

and then CDs and then electronics, etc. It's

58:07

a natural extension that not just leveraged

58:09

but also intensifies your existing power.

58:12

That's way less risky. You know you start somewhere

58:14

new but with a head start compared to anyone

58:17

that's a competitor. But the movement

58:19

into Amazon Web Services is in mention.

58:22

And I loved your guys' story on how there's the

58:25

four different sources of starting point

58:27

Amazon, people would love to think it's

58:29

based on some existing

58:31

competitive advantage of the business, but it's really not. It's

58:33

invention. They figured out a new thing

58:35

that the market wants, but

58:36

as successful as they are in

58:39

AWS, they also flopped

58:41

Firephone, if you still remember that. They also

58:43

lost billions and billions on Alexa.

58:46

There's really no track record

58:48

of a business who can continuously

58:51

come up with successful invention. And

58:53

that speaks to the riskiness of of that, which is

58:55

why it's only the point number three and number four

58:58

on the list. Because if you don't have to go there, don't.

59:00

But if you do have to go there, collection

59:03

is the most possible

59:04

place for success. Thank God these things are

59:06

power law distributed. Otherwise to your point, because

59:08

no one has ever successfully been able

59:11

to do hit after hit after hit like this,

59:13

it would be net unprofitable to

59:16

pursue innovation. Right.

59:18

I just want to underline what Chinese

59:21

rightfully kind of pulled that out as

59:23

kind of a key point here is that

59:26

the risk level

59:29

of doing something that's under your

59:31

current power umbrella or not,

59:34

the difference is gigantic.

59:37

So that should be your starting

59:40

point

59:40

because it is absolutely gigantic.

59:43

And I think since we're back into invention,

59:46

and I am a

59:47

huge fan of Amazon, the fact

59:49

that they've

59:50

been able to do what they do, I would

59:53

argue that they couldn't have done it

59:55

if they weren't willing to take the risk and have

59:57

some failures, right? Absolutely. and

59:59

so

1:00:00

when Chenyi and I talk to

1:00:02

companies,

1:00:03

often

1:00:05

when we hear it, if they have been successful

1:00:07

at transforming

1:00:09

and we talk about future transforming,

1:00:11

the

1:00:12

narrative that makes us think,

1:00:15

oh boy, this is really, really got our problem

1:00:17

is, oh, we

1:00:20

have a really defined process

1:00:22

for innovation here. And And there

1:00:24

is a 17-step process,

1:00:27

and we know exactly who to assign

1:00:30

to it, and blah, blah, blah. That's the red

1:00:32

flag of all red flags, right?

1:00:34

And then there are other in-company things. You

1:00:37

worry about

1:00:38

sort of

1:00:39

screening criteria. For example,

1:00:41

some companies, when they're thinking of doing new

1:00:43

stuff, say, well, I won't

1:00:45

do it unless it will move the needle corporately,

1:00:48

which means the market has to be certain size. Oh,

1:00:50

this was Microsoft. I mean, it was like, oh, unless

1:00:52

you're going to go create a billion dollar revenue product,

1:00:55

I'm not green-lighting your document. Right.

1:00:58

And usually, if it's already a billion dollar market,

1:01:00

it's either too late.

1:01:01

But this is just a highlight. That invention's

1:01:04

really hard.

1:01:05

It's hard for a large company to

1:01:07

do it. It's hard for individuals to do it. And

1:01:09

corporate strategy is asking

1:01:11

a question on the transforming side, at

1:01:14

least, of if you do it, are

1:01:16

there cases in which your current platform

1:01:19

are of significant benefit to you?

1:01:21

Where would you put the iPhone in this

1:01:23

framework? Oh, iPhone

1:01:26

is and the iPod are straight up collection,

1:01:28

similar capabilities, but I mean,

1:01:31

they are computers in sort of a generic

1:01:33

sense, right? But the iPhone

1:01:36

in a functional way, it does compete

1:01:39

a little bit with the desktop. Yeah, right.

1:01:41

More so than they realized it would.

1:01:43

They're kind of like, maybe as high up as

1:01:45

you can go towards the top right

1:01:47

of their sort of like the existing

1:01:50

products of the company, but

1:01:52

different on some key dimensions. Yeah,

1:01:55

I mean, I would say that one of

1:01:57

the things when you're trying to do business definition.

1:02:00

There's

1:02:00

the theoretical side is the

1:02:02

power shared. And then there's the empirical

1:02:04

side is to look at the composition

1:02:06

of competitors and see if they're

1:02:08

different.

1:02:09

And that's suggestive that they're sort

1:02:11

of different. And so

1:02:13

the competitors for

1:02:15

the iPhone are different largely

1:02:18

than the competitors for the

1:02:20

MacBook Pro. It's a good litmus test.

1:02:23

You know, again, it's not perfect, but because

1:02:25

sometimes that doesn't develop in

1:02:27

exactly economic ways, but it's a pretty

1:02:29

good way to look at it.

1:02:31

All right, listeners, we are back with great

1:02:34

friends of the show Vouch, the

1:02:36

insurance of tech. In this

1:02:38

season, we've decided to share some real

1:02:40

examples of startups who are buying insurance

1:02:43

with Vouch. Today, we're gonna talk about

1:02:45

Vouie Search, which is one of

1:02:48

Vouch's customers. It's Vouie like a play

1:02:50

on Gooey. Hey-o. Vouie

1:02:52

is an AI powered product search

1:02:54

solution for e-commerce. They just raised

1:02:57

a series A, about 18 months into

1:02:59

the journey. Their insurance

1:03:01

story starts when the founder, Phil

1:03:03

Frank, was closing their largest enterprise

1:03:06

contract, yet it was a multi-million dollar

1:03:08

deal that would basically triple their revenue and

1:03:10

transform the company. The customer's

1:03:13

legal team redlined their

1:03:15

contract with a bunch of insurance requirements.

1:03:18

Ba-na-na! Ooh, better

1:03:20

get insurance fast. This is totally

1:03:23

normal, and customers do this to ensure that if something

1:03:25

goes wrong, there's money set aside to make

1:03:27

it right. Suddenly, not having

1:03:30

the right insurance was blocking something

1:03:32

super important, in this case, millions

1:03:34

of dollars of revenue. Insurance went from

1:03:37

a maybe someday problem to literally

1:03:40

one of the most important and urgent things.

1:03:43

So they asked their banking partners for

1:03:45

a recommendation, and they said, you should

1:03:47

go talk to Vouche. Yeah,

1:03:50

the process from there works exactly like

1:03:52

you would expect from a modern tech company.

1:03:54

Phil went to Vouches website, answered some questions

1:03:56

on the company, and was presented with a menu

1:03:59

of coverages that

1:04:00

he could customize. I know because I've gone through this myself.

1:04:02

He had a question. So he hopped on a Zoom call with

1:04:04

a vouch insurance advisor that same

1:04:07

day. The vouch team reviewed Phil's

1:04:09

insurance requirements, double check the limits and help

1:04:12

him push back on one of the client's contractual

1:04:14

requirements to save some money. Now, as

1:04:16

you would expect, this is not at all normal

1:04:19

for the insurance industry. Vui actually

1:04:21

did compare vouch with their previous traditional

1:04:23

broker. That option ended up being

1:04:26

more expensive than vouch

1:04:28

and the timeline significantly

1:04:30

longer since the broker had to shop between carriers

1:04:33

and fill out a bunch of manual applications. I

1:04:35

think a lot of you have probably done this in the past.

1:04:37

The coverage is of course, not

1:04:39

even apples to apples because vouch has 10

1:04:42

exclusive policies that are designed from the

1:04:44

ground up for tech companies.

1:04:47

Phil took a few days to negotiate with the customer

1:04:49

and sync with his board. He hopped back into vouch

1:04:51

for his online account to activate the coverage.

1:04:54

The customer signed the contract and now Vui

1:04:56

is in the next chapter of growth. So

1:04:59

pretty awesome. When

1:05:00

it's time for you to get insurance, save 10% on

1:05:03

your first policy with Vouche at

1:05:05

vouch.us slash acquired, or click

1:05:08

the link in the show notes. Thanks, Vouche.

1:05:11

Thank

1:05:11

you, Vouche.

1:05:13

So here's an interesting, you can tell me if it's

1:05:15

interesting, an observation on Apple. It's

1:05:17

basically always been co-action when they

1:05:19

come up with a new multi-billion dollar product

1:05:21

line. You've got the iPod,

1:05:23

you know, absent going and getting the

1:05:25

new type of hard drive. They kind

1:05:27

of knew how to build everything about the iPod

1:05:30

already. And once they had the tiny hard drive, then

1:05:32

great. All of our engineers know how to build something

1:05:35

like this. iPhone, same thing.

1:05:37

iPad, same thing. These are new jobs

1:05:39

to be done for customers, but they have

1:05:41

all the right talent to build them. AirPods,

1:05:44

same thing.

1:05:45

What? Maybe this AR-VR

1:05:48

device, same thing. We'll have to see if it launches

1:05:50

here in the next few months. But interestingly,

1:05:52

a thing where they didn't have

1:05:54

a large amount of the talent in-house

1:05:56

is cars. And so they had to go build

1:05:59

completely new skills

1:06:01

within the company to try to, you

1:06:03

know, they've got what, several thousand people working

1:06:05

on this car now still hasn't launched, changed

1:06:07

strategy five times. They have no

1:06:10

confidence this is going to be a commercial success. It's

1:06:12

a new requirement

1:06:14

for customers that requires a

1:06:17

whole bunch of people that they did not have

1:06:19

and capability they did not have. And

1:06:21

that kind of speaks to where

1:06:24

I think you're going with this framework that that product

1:06:26

has not been successful or even launched. closer

1:06:29

to pure

1:06:30

diversification, right? Yeah. So

1:06:32

if you think of the horizontal axis,

1:06:34

that thing I was talking about, that's a spectrum from

1:06:36

zero to 100%. If you're in the car

1:06:38

business, if you go from green cars

1:06:41

to red cars, you have almost 95% shared skill.

1:06:43

Go from luxury cars to compacts,

1:06:46

high

1:06:50

sharing, so Toyota can do

1:06:52

it.

1:06:53

Go from cars to tanks,

1:06:56

pretty different. Portia did it

1:06:58

under coercion by the Nazis. Right,

1:07:00

right. It's not impossible, but quite different.

1:07:03

And then if you go from cars to refrigerators,

1:07:06

it's really different.

1:07:07

So yeah, no, I agree with that analysis.

1:07:10

But remember to not

1:07:12

to forget the importance of

1:07:14

the entrepreneur in this,

1:07:16

because they are the

1:07:18

locust of inventiveness.

1:07:22

and it doesn't happen without them.

1:07:24

And this isn't an automatic process

1:07:27

or something mechanical. There's

1:07:29

individual human creativity

1:07:31

involved. And it's especially

1:07:34

evident at Apple,

1:07:35

but it's really true everywhere for

1:07:37

all entrepreneurs. And so that's

1:07:39

why Chenyi and I have to be fairly modest

1:07:42

about what we're doing, because what we're really

1:07:44

trying to do is to provide

1:07:47

pattern recognition for those people,

1:07:50

but it doesn't substitute for them. It's just

1:07:52

a tool.

1:07:53

This is a good lead-up actually to what I wanted to

1:07:55

ask you as we wrap on internal

1:07:58

transforming and new business. business development,

1:08:01

does this framework apply

1:08:03

to thinking about acquisitions as well for

1:08:05

companies? Because I would imagine companies that

1:08:08

are starting to think about transforming are also

1:08:10

at a stage where they could be contemplating fairly

1:08:12

larger transformative M&A. Is that

1:08:15

different or should you think about that with

1:08:17

the same rubric? Well, it's very

1:08:19

related. If you're acquiring

1:08:21

a company, the primary question

1:08:24

you have to ask yourself is

1:08:27

why is this worth more to me

1:08:29

than to the seller?

1:08:31

Because there will always be an information

1:08:33

asymmetry. The seller will always know more

1:08:35

about the asset than you will.

1:08:37

There's a ton of

1:08:39

financial analysis work on this

1:08:41

and you know you can't get it perfectly but

1:08:44

basically they look at the stock price before

1:08:46

and after acquisition and all this stuff and if

1:08:48

you distill all that what it basically says

1:08:50

is, you know, the acquirers kind

1:08:52

of break even or whatever, and the seller does

1:08:55

very well.

1:08:56

And the fact that they

1:08:58

figured that out for

1:09:00

a large segment

1:09:02

of business was genius. And

1:09:05

so that then

1:09:07

question of what do you bring,

1:09:10

you can imagine how that touches on this

1:09:12

subject of business definition and so on.

1:09:15

And that's why antitrust authorities get

1:09:17

so upset about it. if you horizontally

1:09:19

acquire in something with scale economies,

1:09:22

that just makes your advantage that much more. And

1:09:25

so people get upset about it and people

1:09:27

would love to do it, but you know, Hart Scott,

1:09:29

Rodino, we'll let you get away with it, right?

1:09:31

And rightfully so.

1:09:33

But you have to be very, very

1:09:35

disciplined because often what

1:09:37

happens if you're inside a large company

1:09:40

and facing these decisions, and I've been involved

1:09:42

in many of them,

1:09:43

what happens is the argument

1:09:46

that's often made to advance that is,

1:09:49

oh,

1:09:49

well, we don't have to have

1:09:52

the same number of accountants

1:09:54

or we can kind of reduce their

1:09:56

sort of these cost reduction

1:09:58

personnel overlap. thing never

1:10:01

works because they're diseconomies

1:10:04

of being in a large organization as well

1:10:06

as economies and they're sort of a wash

1:10:08

is a good assumption about it. And how much

1:10:10

money are you really going to save? Right. And

1:10:13

so that analysis doesn't get you there. You need

1:10:15

something more fundamental and usually it's related

1:10:17

to power or something like that. One of David

1:10:19

and my learnings from doing our

1:10:21

episode, the acquired top 10, the best

1:10:24

acquisitions of all time was

1:10:26

there are exceptions, but most

1:10:28

of the time something is a wildly successful

1:10:31

acquisition is because you're able to find

1:10:33

more revenue rather than find cost

1:10:35

savings because cost savings are capped, whereas

1:10:38

new revenue has unlimited upside.

1:10:41

Well, I'll add something to that, which

1:10:43

is that the cost of that revenue

1:10:45

is favorable. Right. So

1:10:48

think of Disney. So think of getting

1:10:50

Lucas and Cameron's

1:10:53

stuff and... Marvel. Oh,

1:10:55

wow. Marvel is incredible.

1:10:57

Yeah. Iver created a huge amount of

1:10:59

corporate value by doing those things

1:11:02

and Pixar.

1:11:03

And that had to do with

1:11:05

him taking franchises like

1:11:08

LVMH was taking

1:11:10

powerful brands that weren't fully exploited

1:11:12

and figuring out how to economically

1:11:14

exploit them, right?

1:11:16

And Disney was taking branded

1:11:18

entertainment that was powerful and being

1:11:21

able to fully exploit it. And so

1:11:23

it answered the question, why is this worth more

1:11:25

to me? So you could take Star Wars stuff,

1:11:27

which you sort of had the feeling George Lucas

1:11:30

kind of wasn't so interesting

1:11:32

to sort of exploit it. He was kind of a creative

1:11:34

genius, right?

1:11:35

And yet Disney could take it and run

1:11:38

with it. And so I think

1:11:40

that wasn't that you bought revenue that

1:11:42

already existed, it was that you were able

1:11:44

to exploit that.

1:11:46

I'm curious if you have any thoughts

1:11:48

on or if there's more nuance to what

1:11:51

I always think of as kind of like

1:11:53

the highest likelihood of success

1:11:55

acquisitions. are enterprise

1:11:57

software acquisitions where

1:11:59

a

1:12:00

product is bought by one of

1:12:02

the top enterprise software, you know,

1:12:04

Salesforces, call it Microsoft or Oracle

1:12:06

or Salesforce or the like, and then they

1:12:08

plug it into the Salesforce.

1:12:11

Is that similar to what we're talking about here?

1:12:13

Like, it seems very clear to me why

1:12:16

XYZ Good Product that is sold

1:12:18

in the same manner that Salesforce

1:12:21

sells all of their products would be way more

1:12:24

valuable to Salesforce than to

1:12:26

its current owners. And David, real quick, I'll caveat

1:12:29

that with like, maybe highest likelihood to succeed,

1:12:31

but not highest magnitude of success. Right,

1:12:34

yes, and I think that's what's interesting about it. Right,

1:12:36

so examples like that, they plug

1:12:38

completely into the power structure of the current

1:12:41

business. So, you

1:12:42

know, high switching costs stuff, right?

1:12:45

And so that they can deploy it

1:12:47

to all their customers and get the

1:12:49

same economics of high switching costs. And I'm just, Shany,

1:12:51

do you want to add to that? Yeah, it actually

1:12:53

occurs to me that there might be exactly

1:12:56

tied to switching costs. There might be another rationale

1:12:58

for buying, which is

1:13:00

building takes longer than buying and timing

1:13:02

matters, particularly for companies with switching

1:13:05

costs.

1:13:06

Now, the interesting about switching costs going back to

1:13:08

the power itself is it's non-exclusive, right? So

1:13:11

your competitors, if they are functional equivalent,

1:13:13

can also have switching costs. Now, if

1:13:16

you go down this logic line, it creates the

1:13:18

possibility of companies having switching

1:13:20

costs but no profits.

1:13:22

And the way it happens is if your competitors

1:13:24

was able to build the same product, roughly

1:13:26

the same product, and they fully realize

1:13:29

this is the lifetime value of the customer.

1:13:31

Should I acquire them? Then it's rational

1:13:33

to invest up to all of those value

1:13:35

in the acquisition phase, be it discounting,

1:13:38

partner incentives, marketing campaigns, whatever it

1:13:41

is.

1:13:41

It's rational to spend up to all of that lifetime

1:13:44

value to try to win that customer.

1:13:46

And then

1:13:46

what you end up with is companies with switching

1:13:48

costs but no profits.

1:13:50

Right. And so that's why if you're

1:13:52

have switching costs, the key

1:13:55

strategic challenge is to acquire customers

1:13:58

when the cost of a customer does

1:14:00

not fully arbitrage out the

1:14:02

profit stream that you would expect from them. Right,

1:14:04

which is so funny. I'm thinking of, like we talked about

1:14:07

earlier, of Slack and Salesforce and Microsoft

1:14:09

and Teams right now.

1:14:10

I haven't studied either of

1:14:13

the businesses, but I would expect that despite

1:14:15

all the ballyhoo about all of it, neither

1:14:18

Slack for Salesforce nor, well, maybe

1:14:20

Teams for Microsoft is, but are not like huge

1:14:23

transformative incremental drivers of profits

1:14:25

for those two parent companies.

1:14:27

So I think sort of a non-obvious

1:14:30

point of all this is that

1:14:32

if you're thinking of doing something new,

1:14:35

getting into stuff,

1:14:37

that understanding business definition

1:14:39

is critical,

1:14:40

which is to say, into what areas

1:14:43

does your current power umbrella extend?

1:14:46

You understand that. Then

1:14:47

the next one is the point that Cheni made,

1:14:50

which is that

1:14:51

expansion into areas where that

1:14:53

umbrella extends

1:14:55

is radically more attractive

1:14:57

than starting something utterly new. Oh,

1:14:59

and I will add to that, that is not

1:15:01

a good to have. If you understand power

1:15:03

umbrellas bigger than what you currently offer, and

1:15:05

you ignore it, you actually are creating competitive

1:15:08

openings for somebody else to take

1:15:09

on. Oh, that's a really important

1:15:11

point. Absolutely. You're failing

1:15:14

if you don't exploit it.

1:15:15

Right, because you can assume that eventually

1:15:17

somebody else will,

1:15:19

and that may completely ruin

1:15:21

your competitive position and for example, if it's

1:15:23

based on scale.

1:15:25

So point one,

1:15:26

go to business definition, think very

1:15:29

hard about where your power umbrella is. Two,

1:15:31

that if it does extend into an area

1:15:33

you're considering to go there because it's really

1:15:35

attractive. And then the third one is

1:15:37

that if you don't have anything there

1:15:39

and you still want to do something new, co-action's

1:15:42

the name of the game, but understand that you're

1:15:44

now into invention of a new business

1:15:46

and with all the things

1:15:49

around it, risk adaptation, you

1:15:51

know, everything and entrepreneurs matter.

1:15:53

So Jenny that was such an important

1:15:56

point

1:15:56

about how if you miss

1:15:59

a business stuff

1:16:00

I'm going to ask you for an example. Can

1:16:02

you think of a good example of

1:16:04

companies that

1:16:06

didn't understand the

1:16:08

full extent of their business and

1:16:10

got taken out as a result of it? Well,

1:16:13

I'll throw something out. It's tough because

1:16:15

you will tend to have survivorship bias. You only remember

1:16:18

those companies that made it.

1:16:19

Right, right. Yeah. Who

1:16:22

was that? BOMAR never heard of them, right? Or the handful of

1:16:24

very few colossal failures

1:16:26

that were so unbelievable that,

1:16:28

you know, stuck in all of our psyche. For example,

1:16:31

Blockbuster, it could be the case that

1:16:33

Blockbuster failed where they

1:16:36

had the distribution network and the customer

1:16:38

relationships. So there was a source of power there

1:16:40

and they failed to exploit it in using

1:16:42

that to launch their own streaming service, which

1:16:44

mostly is because of boardroom blunders, but

1:16:47

a failure nonetheless.

1:16:48

My take of Blockbuster is if they'd

1:16:50

done a red envelope business a

1:16:52

year earlier, Netflix wouldn't have survived.

1:16:55

Maybe another example is the credit card industry

1:16:57

and how it evolved. Oh, I love that. Great.

1:17:00

It started basically as branded charge

1:17:02

cards for a particular retail store or gas

1:17:04

station, and then turn into Diners Club,

1:17:07

which is a card for many restaurants.

1:17:10

And then very quickly, it turned into Universal Card.

1:17:12

It's a card for basically everything.

1:17:13

And they were basically extending your credit, right?

1:17:16

They were saying, this works here and we'll give you some credit

1:17:18

at our store. And then over time, they would start

1:17:20

saying, yeah, we'll spot you for that restaurant

1:17:22

too. We have a relationship with that restaurant.

1:17:24

Right. So do either of you have Diners Club's

1:17:26

cards? I do not. No. Right.

1:17:30

And so they missed it. Yep. I mean, it's

1:17:32

a great example. They didn't understand that

1:17:34

it was actually a platform

1:17:38

where you want to cover as many

1:17:40

purchase types as possible and

1:17:42

it shouldn't be constrained. And so they missed the

1:17:44

business definition. And Visa

1:17:46

is one of the highest margin businesses in

1:17:48

the world right now, right?

1:17:50

Yeah, Visa is 50% margin. It's astonishing.

1:17:52

Wow. Wow. We

1:17:54

gotta do Visa at some point. I can't believe

1:17:57

Visa didn't IPO until like the 2000. That

1:18:00

is nice and natural.

1:18:02

Were they owned by banks? I

1:18:04

think it was a B of A, yes,

1:18:07

founded in 1958 by Bank

1:18:09

of America as Bank AmeriCard. Yeah,

1:18:11

it was a consortium of banks and that's

1:18:14

right, I remember all this now. The IPO happened

1:18:16

right in the middle of the great financial crisis.

1:18:18

It was March 2008. Talk about bad timing, but

1:18:22

didn't matter. Probably a good time to buy the stock. Yeah.

1:18:25

Seriously. All

1:18:26

right, Hamilton and Cheny, Well, we have you here. We got

1:18:28

to ask you something that David and I were debating on our

1:18:30

Nintendo episode, specifically in the 1980s.

1:18:34

So you've got a console maker, Nintendo.

1:18:37

They have a whole bunch of customers that

1:18:39

are the people who are buying the consoles

1:18:41

and playing the games on them. And they

1:18:43

have a mix of first and third party titles.

1:18:46

So they make Mario as a first party title and

1:18:48

they have some third party developers

1:18:50

making games for them. Final Fantasy

1:18:53

and Dragon Quest and Castlevania. And

1:18:55

of course, the reason that those third party publishers

1:18:57

are making the games for them is because they have 95% market

1:19:01

share of people buying video game

1:19:03

consoles.

1:19:04

And David and I were really going

1:19:06

back and forth and we were like, is it a scale

1:19:08

economy because they can amortize

1:19:10

the cost of game creation across so

1:19:13

many consumers or is

1:19:15

it a classic two sided network effect or a network

1:19:17

economy power?

1:19:18

I was thinking about this this morning. It's fun. So

1:19:21

I think it's both. And

1:19:23

the reason why it's both is

1:19:25

because you can think of Nintendo

1:19:29

as a platform that vertically

1:19:31

integrated into the production side.

1:19:33

Basically, all the first-party content is

1:19:36

a vertical integration. And that's

1:19:38

why they would exhibit

1:19:40

economic structure that you would typically find in producers,

1:19:43

which is a kinds of scale. But at the same

1:19:45

time, the third party transactions

1:19:48

are a nature of network

1:19:50

economies. Now some

1:19:52

question we may have to analyze there is this

1:19:54

platform really stable, which means is there really high

1:19:56

cost of being attached to this platform, can you multi-home,

1:19:59

etc. We have to go. into

1:20:00

that. Well, in the 80s, there were no

1:20:02

other viable platforms. Right. So

1:20:04

maybe they're just the one. So that's

1:20:06

why you would observe economic structure

1:20:08

of both skilled economies and network economies.

1:20:11

Now, there's a deeper question there, which I don't even have an answer

1:20:13

to is,

1:20:14

is one of them the cause and the other

1:20:16

the effect? Or are both of them causes

1:20:19

for power? Right. I love the answer.

1:20:22

And I think she's right. I mean, when we look at

1:20:24

platform things, is the business

1:20:27

of running the platform. So

1:20:29

think of, for example, the fixed cost and

1:20:31

Uber of their modeling and all that

1:20:33

kind of stuff. And then there's the network

1:20:37

economy aspects of a

1:20:39

two-sided platform with people, you

1:20:41

know, and so on. And you could have power in

1:20:43

either one of those. But if it

1:20:45

turns out that the cost structure is

1:20:47

not, there isn't a huge lump of fixed cost,

1:20:50

then it doesn't matter

1:20:50

much. But I think, Jenny, you got

1:20:53

it right. vindicated because that's

1:20:55

kind of the conclusion we came to on the episode two

1:20:57

of it's both and they're deeply

1:21:00

intertwined.

1:21:00

I'll give you an example of intertwined

1:21:03

real life, which is

1:21:04

we all know Amazon in retail has gigantic

1:21:07

scale advantage in the infrastructure, right?

1:21:10

Just all the warehouse and distribution centers they've built. But

1:21:13

at the same time, you observe what

1:21:15

you will call flywheels on the retail, right?

1:21:17

The more buyers, more sellers and the loop goes on.

1:21:20

And this is what I call the mixing of reality

1:21:23

between calls and effect. Because

1:21:25

without a really strong

1:21:27

distribution infrastructure, which gives them the

1:21:29

cost advantage and faster delivery and

1:21:32

prime and all of those benefits, there really

1:21:34

isn't anything that makes their marketplace

1:21:36

sticky among either side.

1:21:39

So the so-called network effect

1:21:41

you observe is actually an effect

1:21:43

of the power in scale

1:21:46

of the infrastructure underneath. But you would

1:21:48

just observe economic

1:21:49

structure of both because platform just kind

1:21:51

of mixed them all together.

1:21:52

Yeah. And this isn't sure about pointy headed

1:21:55

kind of issue because it gets back to, if

1:21:57

you find the thing that's caused rather than a fact

1:21:59

that

1:22:00

the thing that you got to defend, right?

1:22:02

And my intuition about this,

1:22:04

and I don't know if it's right, is that

1:22:07

you have to introduce time as a variable in

1:22:09

this to correctly understand the problem.

1:22:11

But I think Jenny and I are involved

1:22:14

in this deep debate right now about sort

1:22:16

of the boundaries and relationship between scale

1:22:19

economies and network economies. If you want

1:22:21

to get even more confused, just remember

1:22:23

that

1:22:24

scale economy typically is

1:22:26

defined as a situation which as

1:22:28

scale increases cost per unit goes down.

1:22:31

That's often true of network economists, right?

1:22:33

But the

1:22:36

structural economic conditions that

1:22:38

create it are quite different.

1:22:40

And understanding those if you're a business

1:22:42

operator is really important because then

1:22:44

you're less likely to get taken out by your better.

1:22:47

Well,

1:22:47

I think this is a great place to leave it. Hamilton,

1:22:50

Chen, you thank you so much for part three.

1:22:52

Can't wait for part four in a few years. I don't know, is this

1:22:54

going to be a book? Is Transforming? Are

1:22:56

you guys going to publish this? Well,

1:22:58

what we're talking about right now is there

1:23:01

are a variety of topics

1:23:04

that are extremely

1:23:06

difficult phenotypes, if you

1:23:08

will,

1:23:09

to tease out and

1:23:11

delayer. And we

1:23:14

seem to have enough of those that actually

1:23:16

we probably could write a book about it. And

1:23:18

so it's a topic of conversation.

1:23:21

Great. At a minimum,

1:23:23

you all should have a newsletter. There should be a strategy

1:23:25

capital You'd break up there with Ben

1:23:27

Thompson. Even if it's only like quarterly or

1:23:29

something. Yeah, yeah. We've thought about

1:23:32

sort of white papers and this and that. I'm

1:23:34

pretty lazy. Jim, you probably could do it. Well,

1:23:37

this is the problem. You need a bundle of skills to

1:23:40

be like a Ben Thompson is you need to

1:23:42

be both

1:23:43

a great strategy thinker, which you

1:23:46

both are,

1:23:47

and you need to be a great writer,

1:23:49

which you are. Seven Powers is

1:23:52

really excellently written, and

1:23:54

you need to love writing and want

1:23:56

to do do it every day or every period, which

1:23:59

I'm not sure. that you do. That's the part where David

1:24:01

and I fall down too. People keep saying, oh, you should

1:24:03

turn a choir into a book or you should

1:24:06

turn these into blog posts. And David and I look at each

1:24:08

other and we're like, it takes us hours to

1:24:10

write. That sounds like hell.

1:24:12

I'd say my passion and I think probably

1:24:14

Chinese verbal lines for this too, is

1:24:17

getting the theory right.

1:24:18

It's very satisfying and

1:24:21

extremely hard to sort of go

1:24:23

through and figure out,

1:24:24

you

1:24:25

know, how this kind of all fits together.

1:24:28

And of course, That's how you get to simple

1:24:31

but not simplistic. That's the only way

1:24:33

you get to simple but not simplistic.

1:24:35

And so that's kind of the satisfying

1:24:37

part, but I don't know the idea of writing

1:24:39

other books scares the hell out of me. Yeah,

1:24:41

it doesn't help when the theory

1:24:44

is never done. You know, it's funny, I think

1:24:46

David, you mentioned last time we talked about platforms,

1:24:49

it doesn't feel completed. Like the truth is

1:24:51

it will never be completed and it's always in

1:24:53

the work. I think Nowadays, we got

1:24:55

a lot clearer about it than a year ago,

1:24:57

but it's always in the make. We'll think

1:25:00

about something else and it comes back to a platform like, oh,

1:25:02

that's the missing piece. And realize it's actually

1:25:04

vertical integration. We were confused about the whole

1:25:06

skill for a very long time. And

1:25:09

now like, oh, that's what's missing. And the communication

1:25:11

strategy is always a difficult piece as

1:25:13

well. I bet the two of you spend a lot of time

1:25:15

on each company that you do an episode

1:25:18

on, and it's things like that. And whenever you

1:25:20

want to do an example, you're

1:25:21

like, is this really true? then you have to go

1:25:24

dig it all back and be like, am I just misperceiving

1:25:27

what this really is about? Yeah,

1:25:28

how did you delayer AWS? That

1:25:31

one we actually talked to a lot of people who were around

1:25:34

it at the moment of conception or theoretical

1:25:36

conception over a variety of years.

1:25:39

And there has been sort of canonical sources.

1:25:41

So you know, we read Brad Stone's book

1:25:43

and we know Brad, so we asked him, you

1:25:46

know, who did you talk to to kind of piece this together

1:25:48

and we had our own folks that we knew. So there was

1:25:50

a little bit of like

1:25:51

actual first party knowledge there,

1:25:54

but

1:25:54

David and I had this a little bit of an aha

1:25:56

moment, a little bit of a sigh of relief when we were like, oh.

1:26:00

we're not going to figure out what the one story

1:26:02

was. So we actually can create an episode

1:26:04

out of, there's a bunch of stories and like, we

1:26:06

leave it to you, listener. And that that's probably

1:26:09

the right answer, is there is no one story, which being

1:26:11

a third party observer, to

1:26:13

the extent that our version of what we told is

1:26:15

true, or closer to the truth than

1:26:17

others, no person who

1:26:19

was personally vested and interested would

1:26:21

be able to have that perspective.

1:26:23

Yeah, so and channeling Kurosawa,

1:26:26

right? Yes, exactly. Yes.

1:26:29

All right, well, that's a great place to leave it. Hamilton,

1:26:31

Chenyi, thank you so much. Thank you both. Great.

1:26:34

OK, our pleasure. Thank you.

1:26:37

All right, listeners, thank you. Thanks

1:26:39

to Hamilton and Chenyi for joining

1:26:41

us. Very clarifying discussion, I felt,

1:26:43

David.

1:26:44

Totally. I mean, they really are too modest

1:26:46

to say on the episode. But they are

1:26:48

the very best people to do what

1:26:50

they do, because they sit at the intersection of academia,

1:26:54

corporate strategy. Hamilton worked for

1:26:56

Bain in strategy consulting for many years, and

1:26:59

active investing. And they're working with founders

1:27:01

every day, getting

1:27:02

their hands dirty. They truly are the best. Well,

1:27:04

listeners, we'd love to go deeper with you. You

1:27:06

can become an acquired LP

1:27:08

to come back into the acquired kitchen. David,

1:27:10

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1:27:13

think of Steph Curry every time you say that, cooking in the

1:27:15

kitchen. Good, good. Well, listeners,

1:27:17

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