Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben: I would say, we're sorry to blow your cover, but it's sounding like that's pretty well blown as no longer the best kept secret in Silicon Valley.

Hamilton: I was going to say that the fact that it's the best kept secret says something about my acuity as a good marketer.

Ben: Welcome to the special episode of Acquired, the podcast about great technology companies, the stories, and play books behind them. I'm Ben Gilbert. I'm the co-founder and managing director of Seattle-based Pioneer Square Labs and our venture fund, PSL Ventures.

David: And I'm David Rosenthal. I'm an angel investor based in San Francisco.

Ben: And we are your hosts. David and I had a realization. We talked about Seven Powers in every single episode.

David: Literally every single episode.

Ben: And in March of 2020, we actually interviewed Hamilton Helmer to talk about the framework. But we estimate that only about 2% ever actually heard that since it was an LP episode at the time. So today, to celebrate the LP feed going public, we are releasing the remastered version of that interview. It's a little like getting in a time machine since that was the last recording we did before the pandemic hit, but every single lesson holds up and it is a treat to hear about the Seven Powers framework in Hamilton's own voice, and to hear his story behind the book.

David: You're totally right. All of Hamilton's work is just timeless. But you were going to fly down and we were going to do it at the Strategy Capital Office—Hamilton's fund that he manages in Los Altos—I drove down and was there, and then at the last minute, you said, hey, this Covid thing, I'm a little worried about it.

Ben: I don't feel comfortable getting on a plane right now.

David: So you were on Zoom?

Ben: Yeah. I've never met Hamilton in person, and you have twice, three times?

David: At least. More than that, I think.

Ben: We should do something with him early next year.

David: Maybe another reason to get this out to everybody now to get prepared for more coming in the new year.

Ben: For sure. Listeners, if you like this episode and you want more, we also released a book club that we did with Hamilton from September 2020 as a follow-up. Just like every other previous LP episode, those are now free and accessible in any podcast player just by searching Acquired LP show.

Now onto our presenting sponsor for all of these specials, the SoftBank Latin America Fund. We have a very special guest you've heard from Shu, Paulo, and the CEOs of unicorns in the portfolio like Rappi, Quinto Andar, and Banco Inter. Today we are joined by Marcelo Claure, the COO of SoftBank Group and the CEO of SoftBank International, where he leads the Latin America Fund. Welcome, Marcelo.

Marcelo: Hi, Ben. It's good to see you on. It's good to be here sharing our story.

Ben: You've deployed an impressive $5 billion into Latin America and just signed up to deploy another $3 billion. What is the biggest thing you've seen change in the region since you originally conceived of the idea for the Latin America Fund three years ago?

Marcelo: This has been a pretty wild journey. This started in early 2019. The hypothesis was Latin America had great founders, but Latin America was lacking capital. Our thinking was, if you add significant capital to the founders and show them that they had a path to growth, you will get incredible outcomes.

At that point in time, the total VC investments in Latin America was only $1–$2 billion before we launched our fund. That's crazy because when you look at the size of Latin America, we're half of China. Why is China always getting the $100 billion and why was Latin America only getting $1–$2 billion?

I'm proud to say that we have transformed the region. What to expect in 2022 is to have an excess of $25 billion, so there's another region in the world where venture in such a short period of time has grown to effects. As a Latin American person, I could not be more proud. SoftBank is not that easy because now we have so many competitors. But I guess at the end, competition making is better. We're really starting the system IPOs in 2021, but we expect 2022 to be the biggest IPO year in LatAm history.

Ben: What makes Latin America unique and such a compelling opportunity for founders and investors?

Marcelo: A few things. One is Latin America has the right macro. Latin America is large. Some people don't know that we have the same population as all of Southeast Asia and we're only half the population of India and China. But we have one of the highest GDP per capita, meaning, people make more money in Latin America, twice the amount of money they make in Southeast Asia, and four times the amount of money that people make in India.

As you launch these big, digital, Internet-driven companies, people adopt it. I think it was a huge surprise to a lot of people when Uber did this IPO. Uber had to disclose where were their customers were coming from. Seeding number one, two, and three were coming from Latin America, Sao Paulo, with Rio, with Mexico City competing with New York.

Latin America is an early adopter region. There's so much to be done. When you look at the ecommerce penetration, today's less than 10%. Half the population over 15 years old don't have a bank account. That's the reason why there's so much FinTech disruption. We have seen tremendous success and returns. If you look at our last return, it's 85% IRR in US dollars, which makes it one of the most successful funds ever launched.

For those who have had a chance to invest in China, India, and the US, think about if you could go back five years in history and you knew exactly what's going to happen. That's what makes this region so exciting.

Ben: Thanks to the SoftBank Latin America Fund. If you want to get in touch, you can click the link in the show notes or go to latinamericafund.com.

David: So cool to have Marcelo with us.

Ben: All right listeners, now onto the interview with Hamilton Helmer.

David: Before and in addition to writing Seven Powers, you're an active strategy consultant and a public equities investor at Strategy Capital, which is a firm you founded. Before that, you earned your PhD in Economics at Yale. After that, you worked for Bill Bain at Bain & Company, correct?

Hamilton: Yes.

David: Before going out on your own. We'll get into all this. Thank you so much for being here and joining us.

Hamilton: My pleasure. My son, Andrew, who's a software guy at Google had been told recently, told me, what an amazing group you were and how everybody at Google listened to your show, and do I know these guys? And sure enough, David had reached out to me, so I'm delighted.

Ben: Thank you. Appreciate it.

David: Before we get into Seven Powers and all of your work in strategy and technology, can you tell us a little bit about how you got into strategy, developed a passion for it, and went from Economics PhD student to working for Bill Bain?

Hamilton: It's a funny journey. I won't bore you with too many details, but I'd always had sort of an interest in business. This is audio not video, but David can look on the floor there and see a rug. That rug was my first business.

My brother and I started a rug business while I was still in graduate school. Designed in New York and woven in Ecuador, and there are long stories behind it. My wife looks back in that period and she said, today, it would be called a social enterprise. Back then, it was just called a failure.

David: It's good to have your spouse be your best critique. It makes it better.

Hamilton: I was very interested. But then when I finished my PhD, in those days, it was really odd for somebody with a PhD to go into business, PhD in Econ. You think econ, it's about the business world. It's not. Highly theoretical, mostly math at the time. I loved economics. I still love economics. Fascinating discipline, but unusual.

So I had to kind of scout around. Finally I ended up at isolating strategy consulting. It's the thing that interested me the most. There's a long story about how that happened, but I won't go into that. But anyway, I ended up interviewing at Bain & Company. I think I was the only person at that time to ever cold call the company, because there was all Harvard and Stanford MBAs basically. They have never seen anybody like me.

Ben: How big was Bain at that point?

Hamilton: A couple of 100 maybe.

Ben: Wow.

Hamilton: My partner, John, in Strategy Capital, I think he was the second hired employee. So he goes back even much further than me.

David: Wow. And this was in Boston?

Hamilton: Yeah. That was their only office at the time and they were growing like stink. So I had this funny experience where I had nine interviews of an hour each. There was a quite a lot of skepticism, kind of an egghead, doesn't have an MBA.

Finally, my last interview was with Bill Bain. I sat down in his office and I thought, you know, I'm really interested in what he's doing. I spent the entire interview asking him about how he got it started, what was his entrepreneurial experience, which always has fascinated me.

David: I forget the name of the folks who founded McKinsey, but they created a whole market. They're entrepreneurs.

Hamilton: Yeah. McKinsey goes back further, and then BCG came in as sort of a strategy focus, and then Bain spun out of BCG. Then Bill looks at his watch and he says, oh, our hour is up. I've got to go and I realized, oh my God. I haven't said anything about myself. You idiot, Hamilton.

So we're literally walking towards the door. He's shaking my hand and I said, oh, Mr. Bain, I'm sure I can do the work here. I'm really interested and it's fine. Everybody is worried about me not having an MBA, but that's just not a problem. I'm sure I can do it. He said, oh, I don't have an MBA either.

David: Great.

Hamilton: And that's how I got the job.

David: That was in Boston. What brought you out to California and starting to swim in these Silicon Valley waters?

Hamilton: In 94, I came out here and I was attracted by the economic vitality, but it's also a family decision. My wife just absolutely adored California from her prior experience. Then I got more and more involved. More techie companies, as you saw from my stuff, Adobe was a client, and Raychem was a big client, and so on.

Ben: It really is amazing how much timing plays into these things. People talk a lot about Jobs and Gates being born within those sort of same few years. It really teed them up for the exact moment to start Apple and Microsoft and make them be powerhouses. You moving to the Bay Area in 94, that is an equivalently perfect time to dive headfirst into the community.

Hamilton: Yeah, it's true. At the time, I was an actively involved equity investor, too. A lot of Intel, and Microsoft, and Dell, and Cisco were all big proprietary accounts. So that made me think a lot about it. Those were very formative years, certainly.

David: Yeah, it was Netscape, but it wouldn't be long until Netflix was founded?

Hamilton: Yeah. I still remember vividly the first time that I saw the Internet. One of my clients back east is a techno head like me. He pulled me into his office and fired up Mosaic, and said, hey, this would be for Netscape and said, hey, you got to see this, Hamilton. I went, wow, this is amazing.

David: Okay, let's get into the fun stuff. Seven Powers, to me at least, the thing that was so enlightening about it was, I see this mistake all the time in Silicon Valley and in venture investing of everybody's like, tell me about the TAM. Got to target a big market. But that's only half of the equation of what makes for a great enduring company is targeting a big market.

Of course, you have to have a big market, but you also have to have what you call power in the book within that market. You have to have defensibility, you have to have something that makes your company and your business stand out. Can you tell us a little bit about how you define power and how you came up with it?

Hamilton: Yeah, sure. As I consulted with more and more companies—I ran my own consulting firm for decades—three things started to become evident to me. One was, a really strong performance is persistent. If you look at Intel's results this year and Intel's results next year, the fact that they have high profit margins will probably be true next year. It turns out, there's a lot of empirical work that verifies that there's persistence.

Ben: It's the exact opposite of hedge fund managers year to year.

Hamilton: Yeah, or mutual fund managers. There's no persistence in mutual fund managers. Now, interestingly, you should probably know, there is persistence in venture capital. Then the next thing, if you've done a lot of valuation work—I'm sure you've done a ton and I've done a ton, and I've even taught it—what you learn is, it's all in the future.

If you take a company's growth about 10% to a standard valuation model, what you find is 85% of the value is after year three. So, persistence and in the future. That says that if you can understand the issues that drive persistence, you're going to understand what drives value.

But then as I did more and more consulting work, another thing came into focus, which was that the path to establishing that kind of persistence is not linear, there's a step change. There's a period when a company can establish that, and that window often closes, if you will. It's the kind of business that you're so familiar with. It's in the earlier stage.

David: I think you call it the take-off phase in the market.

Hamilton: Take-off phase, yes. If you think of a founder, there's this period where there's tremendous flux going on. They don't know who the customers are, technologies can change like crazy. They all have a wide variety, different types of competitors. In that, there are all kinds of degrees of freedom about how you move.

The fact that people even talk about pivoting is just suggesting that it is possible (in fact) to pivot. Ask Intel to pivot and it won't happen very easily, even if it's certainly been trying for a long time.

What that says is, there's this moment, but then the problem is, from a strategist point of view is that all the information is changing so radically that the person or the group that has to process that is the founder and his team.

It's not hiring somebody like me and making a recommendation, or a strategic planning, or something like that. It's actually processing all this time. As you move through space and time, understanding, okay, this direction looks a little better than that direction.

What that said to me was that what people needed was not advice from an expert, but rather teaching to fish. Trying to assemble a way of looking at strategy so that the people on the ground who are really making these decisions have a way of thinking about it that it's never perfect, but guide them in the right direction.

The problem in doing that for me was providing a mental model like that. As I say, in the book, it has to be simple but not simplistic as simple so that you can retain it, not simplistic so that it's relatively complete, you don't miss a lot. That's a really high bar in strategy. That's what took me so long. I wrote the book. It took me 20 years of writing it.

Ben: Hamilton, I'll tell you, having read a bunch of business books and having an even larger pile of business books I've bought but haven't read, there's so many different mental models. Thank you for taking the 20 years to do it because the fact that there is a one-page reference card that assembles this whole thing in grid, it actually does make it so you can reference the Seven Powers and make decisions in real time. It's certainly much more accessible than trying to weave your own fabric of lots of different theories.

David: What prompted you to decide to write the book? You've been doing this for so long. You could have just kept this to yourself.

Hamilton: My ideas are my babies. The greatest compliment for me is other people using them and finding them useful. I wanted to get it out there, but I'm not a natural writer and I really hadn't published before or anything. It was a very hard journey because originally, I went to people and said, okay, business book. The advice was, don't do anything very conceptual. It's got to be a lot of stories and stuff.

My first efforts, I think, I wrote a full book this way were fun stories and then occasionally, I kind of slip in a concept. I went to publishers and agents side, a very, very famous literary agent, for example, and I could get no traction at all. I felt like I was hitting a brick wall. Finally, I said, to hell with it. I'm going to write the book that I think needs to be written.

The two of you face this all the time, the issue of want versus need, which I've always admired Steve Jobs for talking about. You don't do breakthrough stuff with market surveys. You have to understand what the need is and then invent. If you really meet the need, then it's useful. Oftentimes, you fall flat. For me, the need here was this metal model that was simple, but not simplistic.

David: Of course, now you're alluding to Charlie Munger-isms here. My biggest question I'm dying to ask you, reading the book, and learning about power and this model that you've come up with, how does it relate to moats? Is power the means by which you create a moat for a business or is it something different?

Hamilton: There are two necessary and sufficient conditions for power. There's a benefit. You've got to come up with something that's better than what other competitors do, but better for you as a business model. It's a better business model somehow, so that's something good. But that happens every day, every little improvement you see in Starbucks, getting a different kind of coffee cup or something.

That happens often, but the thing that's rare is when you do that and it's material—it is enough to tilt the needle—but also it satisfies the second condition which is that not just there's a benefit, but there's a barrier. A barrier means there are lots of smart people out there, they will be aware of what you're doing, and they're going to try and take it away from you. That's how competitive dynamics works.

You have to have something that will prevent that from happening, even if they're motivated and capable. I'm a huge fan of Warren Buffett's, as you might imagine. He's a genius, I think. But the word moat to me, although he means more with the word than that makes you think about the barrier piece. I think it is fair to say that the Seven Powers are, for me, a very careful, and I hope, exhaustive articulation of the nature of moats.

I think when you're thinking about competitive analysis, in particular, when you're thinking about starting businesses, I always tell people, don't focus so much on the competition. You have something unique. Yes, you have to pay attention to him. You don't be stupid, but you don't create a great business by just saying, I'm going to beat the other guy. The benefit side is also very important. It's tightly tied and of course, the whole idea of moats is just a brilliant concept on their part.

David: So there are seven powers in your book. Each of the seven powers is a way to create this power. How did you distill the seven? How did you come up with seven? Do you worry that there's an eighth out there that you haven't found yet?

Hamilton: With great pain and time, it's completely empirical. I've probably led 200 strategy cases. I probably had my students like Giselle and Chenyi sitting here doing another 200. So far, those seven have covered everything that I've seen. I'm always looking for an eighth, because also as an investor, if there is an eight, that's probably really obscure, and it probably means it's not in the price, which probably means it's a good investment opportunity.

David: Good source of alpha.

Hamilton: Right, exactly.

David: We won’t have time to go through all seven, but maybe a good one to start with, since most of our audience is in technology and most of those folks are entrepreneurs or aspiring entrepreneurs, counter positioning. This is such a fun one. I know it's your favorite power. Particularly such a fun one because in many ways, it’s the most relevant for startups and entrepreneurs in a lot of markets. Can you talk to us a bit about this?

Hamilton: I do have a special place in my heart for counter positioning, I have to say, because it's so contrarian and I'm sort of a contrarian person, I guess. A counter positioning occurs if a company comes up with a new business model and challenges often a powerful incumbent with it. But for the incumbent to mimic this model, they would incur (or at least think they would incur) so much immediate financial damage that they just say, I can't go there.

Even though maybe long-term it would be good, they just can't do it. That provides a powerful disincentive for them to respond quickly. If something's happening in the kind of flux that you guys deal with very fast, responding late may mean that you don't do it. I'll give you some examples. Netflix versus Blockbuster.

David: Late fees.

Hamilton: Yeah, late fees. Late fees accounted for half of Blockbuster's income. Netflix said we're not doing it, and Blockbuster eventually mimicked Netflix. Who knows, but my suspicion is, if they had done it a year earlier, I'm not sure Netflix would exist. The place I got to cut my teeth in this was I was a big investor—big for me, not big for them—in Dell in the 90s.

My investment hypothesis was that Compact couldn't respond quickly to them because Dell was going direct and Compact had these lucrative arrangements going through stores. But looking at it as an investor, I could see that was true, but why? So that got me thinking about it from the ground up, and eventually I was able to formalize it.

Ben: Hamilton, one thing to push on there. It seems like—and I'm remembering from your book—the criteria are basically, this new thing is both a good business, but net negative for the big incumbent because of the cannibalization that would occur. Are there any other things you'd add to define that?

Hamilton: Yeah. There are a few flavors of counter positioning. One is that it's a net negative, and therefore, because their current model is so lucrative that actually, even if they did a net present value, they would end up deciding not to do it, even though eventually the business will go to the challenger.

These are not mutually exclusive. It's very often true. I'd say almost always true that there's cognitive bias involved, which is that the incumbent, they've done just great. Their model has worked for years. Blockbuster was saying, oh, we got all these stores, people love it, they come in, they can browse, what's wrong with that? The idea of somebody doing this rough and ready group sending out red envelopes in the mail, they'd say, what the hell, this is just not going anywhere.

They're very cognitively biased towards thinking that their model works and then there were also agency issues, what economists call agency issues, which means that the person who controls the business may not have interest aligned with the long-term interests of the business. For example, CEO comp is often about this year's performance or the next few years performance. To upset the applecart for a gain that will happen four years out, you may say, I just don't want to go there.

David: Obviously for startups, counter positioning can be great. Netflix is a fantastic example. I'm remembering a blog post Bill Gurley wrote a number of years ago in the beginning of when Android was starting to take off. I think the title of it was Less Than Free, the most disruptive business model ever.

You had Android, which cost less than free. They would pay you to use it if you're a handset manufacturer to put it on your phones versus Nokia that's trying to make money or sell their stuff. Even as Google, because they had the separate business model of search, they're able to enter this adjacent market with a completely counter positioned business model.

Ben: Hamilton listeners who have read the Innovator's Dilemma, this is going to sound vaguely familiar. This would be the power that's most similar to that concept in the same way that we asked earlier, what's the difference between power and moat? How do you think about counter positioning relative to that grand theory?

Hamilton: I recommend everybody to read that book, Innovator's Dilemma. It's a brilliant book. Christensen was just a scholar of innovation and deeply research, but it's pretty different. So if you want to get mathematical about it, there's a many-to-many mapping between the two concepts, which is to say that counter positioning doesn't imply disruptive technology. Disruptive technology doesn't imply compensation.

I'll give you some examples. I would argue that In-N-Out Burger is counter positioned against McDonald's. There's no technology involved, particularly at all.

David: It's not disruptive in terms of Christensen's philosophy was low end. This is like an objectively worse product.

Hamilton: Yeah. You're going back to Christensen's original book, which I think is the more interesting one, where there's a product that doesn't satisfy everybody. You could argue that Tesla's first cars were like that. The other direction is that if something is a disruptive technology, it may not be counter positioned. That's straightforward.

The fact that they don't map to each other, and the fact that power maps directly to value, or there's a one-to-one mapping between power and value, that means that disruptive technology does not map to value. The simple thing about that is you can disrupt something and it can be a really lousy business. It happens all the time. You poison the well, but there's no good endpoint for it.

Ben: We may be overly quoting Gurley here, but I think I saw a recent tweet, something along the lines of there is an infinite amount of product/market fit for selling dollars for 90¢.

Hamilton. Yeah. Just pricing something so that people are attracted to it. Losing money, there's no power there.

David: All right, listeners. For our second sponsor of the episode, we have our good, good friends over at the worldwide leader in payment operations. That is right, Modern Treasury. We are so happy for our friends over there, of course, coming off their huge Series C. Ben and I are happy to be small investors. Their platform and flexible APIs enable anyone building products to add money movement and tracking right into the product, so you don't have to have finance teams reconciling everything. It's built right via API's into engineering.

This is crazy. Over $2 billion every month gets reconciled on the platform. They're used by customers like ClassPass, Marqeta, Revolut, BlockFi, Gusto, Pipe, Outdoorsy, TripActions, on and on and on. This company is just such a joy to work with. We're so happy to have them as partners with us on Acquired.

Also, if you haven't listened yet, you should go listen to our reverse interview with them where we had the entire company on the LP show a few months back. They have made that available for everyone. I think we've also put that now in the public LP feed, too, right?

Ben: Yup.

David: Go check that out. If you go to moderntreasury.com/acquired, you can find the link to the episode. Thanks to everyone over at Modern Treasury.

Next one I want to talk about is in many ways classic. I think many of our listeners already have thought a lot about this and know, but we want to ask your perspective on some nuances of it. Network effects. Hugely discussed in Silicon Valley everywhere. Everybody knows what network effects are.

But one of the things you talked about in the book that I think is so accurate, and I've observed as an investor, you can talk about network effects till the cows come home. It's the intensity of the network effect that really matters. It is so hard to know that ex-ante in a market. What is the actual degree to which I care as a participant in the network about other participants in the network? How much do I care about which other participants?

Hamilton: The key thing about it is that they are complex and hard to figure out. Just asserting them gets you 0.001% of the way of understanding what's really going on. We've seen that when we look at investment opportunities. First place to start a course is to try and create a map. Because remember, they're not homogeneous, they're not necessarily linear, they're not symmetrical.

Just to give you some examples, if you think of Uber, this is a platform. It connects drivers with passengers with powerful utility, much better than taxis, and it changes my life for the better. I sit on a board of a startup up in Vancouver, and Vancouver taxi lobbies are strong or however it's worked. They don't have it. I finished my board meeting, I go down to the curb, they've called a taxi. I have no idea whether it's coming, I have no idea where it is, and eventually, I usually just give up and just go to find some corner to hail a cab. So very powerful benefits.

But does Uber have power from network effects in a way that will translate into meaningful profitability? I would say, first order, no. It would be my guess. I'm no expert in this, but first order, I'd say no. The reason is, if you think about what's going on, if there is a similarly-sized or reasonably-sized competitor—Lyft, for example—in this market or others in other markets, that they can achieve a similar network effect. If you look at the density economics as you scale in a region, what we're saying is it's nonlinear. At some point it flattens out. If the market is large enough for more than one company to exist in that flat spot, then it doesn't help you. You have to look at all those nuances.

One of the unusual things about my book is I've always tried to be very careful to make sure that everything maps back to value. If you said what is the fundamental assumption of this book, it's that strategy and value are mathematically, their duels. The mapping function from that desire to join the site versus actually being able to monetize it, which is based on how much time you spend on it and all that kind of stuff, you have to understand that to understand whether there's power or not.

David: The last thing we're going to talk about after this is going to be my favorite. Switching cost. I thought this was super interesting because people think about switching cost as (I think) tend to be like old school industries or whatnot. But I realized, there's a huge amount of switching cost power in a lot of technology companies, too.

Take Slack, for instance. Slack has network effects, but also switching cost. We run on Slack. If we were to switch, that would be a huge cost to our organization. How did you start thinking about that? Have other people in tech, since you published this realized like, oh, this might be more a source of power I'm not thinking about?

Hamilton: I don't know. I think people had thought about it. There are a lot of subtleties around switching cost that you have to think through. One is that, in general, it creates a win-lose situation with your customer. There's sort of a management problem in that.

Another is that there's a competitive dynamic which is if you have something that's attractive and a high switching cost, the competition will try like crazy to create something that mitigates the switching cost. You'll see a lesser app have a translator device. Often the imperfection of those, you look at EDA (electronic design, automation tools), there are libraries that are associated with those, but if you move from one tool company to another, the translation never works very well.

David: Or every CRM system is like, oh, you export your data out of Salesforce. We'll do it for you.

Hamilton: Right, exactly.

Ben: Or exporting a PowerPoint to Google Slides, a problem that I think all of us probably deal with on a weekly basis. The translation is never perfect, and thus, if it's a very important presentation or whatever the thing is, you're not willing to switch.

Hamilton: Right. But then another subtlety is that remember, you can only monetize that if there's a repeated economic interaction. You have to buy more stuff. There's got to be some kind of razor blade aspect to it. If there's just switching cost and you'll never buy anything more, it doesn't matter because it's in those additional transactions. That's when you look at ERP companies, why they acquire so many different things, because these are different tools they can interact with.

They are real and a place where they can be especially strong is when they become embedded in a company process. We were talking before about, there's a company that sells lab equipment or talking about 10 Extranomics before, for example, where a piece of equipment gets embedded in how people do things. They not only get used to it, but there's a whole process designed around it, and switching it out is really hard.

I'm just curious because you've been thinking about this, what would be an example? Slack's an example and there's a question of whether it's still sufficiently monetizable.

David: I was wondering, in particular with this for SaaS companies. Is SaaS a business model innovation that if you have a switching cost source of power, can work really well together? Because the monetization is not like old on-prem software, you sell a big Siebel installation, boom, that's a lot of money up front, now you got to sell more stuff in the future. With SaaS, you're just constantly selling all the time.

Hamilton: Yeah. So if a SaaS model has really good switching cost, boy, does that help. I mean, it really helps.

Ben: I actually think the way that these companies are financed are predicated on switching cost as a primary source of power. You think about people are willing to sell these things at such a low per seat per month price, or even let's say, annual price. People are not necessarily hiring field sales reps, but they're hiring people to do inside sales because once you get one of these SaaS systems in, there's just an expectation of repeat. When you go and you capitalize these businesses in the way that venture capitalists value them, it's kind of predicated on that. The expected churn rates are fairly low.

Hamilton: The thing you have to be careful about in these kinds of businesses is customer acquisition cost. As it becomes more known that there are these high switching cost, people understand that there's essentially a cash flow future associated with each customer, and they'll start to say, oh, yeah, well, we should sign them up for free or actually with a bounty.

What happens over time is that actually the value of the switching cost becomes arbitraged out by the acquisition cost. That's why, if you go back to my power progression, the switching cost is in the take-off phase. That's the period in which the true economics are not yet reflected in the acquisition price. You have to combine it with something that gets you the customers in the first place, because you don't have the customers in the first place. Either you do that through something that's superior or you do it when the pricing of it hasn't fully arbitrage out the value.

See, there are lots and lots of businesses where people just pay too much for customers and it turns out to be a really lousy business, even though it has switching cost.

David: It's interesting. That also really makes me think more of Slack. Slack came on the scene, they were the first real innovator in this phase of consumer grade mobile messaging, it's also useful in businesses. Let's do this. They acquired tons and tons of customers in that phase, built a big company that's going to be enduring now—a public company—but now they're competing to the death with Microsoft and Teams, and the ability to economically acquire customers is at least not what it used to be.

Hamilton: Yeah. The two of you have so much experience, let me ask you this question. On counter positioning, one of the things that is really interesting is this whole software eats the world thing. Do you think that in general, companies that are highly software-centric and how they approach a business, that for an incumbent that isn't that way, that for them to adopt has to blow up their model so much that is counter positioned, it's not only that software eats the world on the benefit side, but the barrier side is that if you develop a company from the ground up that's software-centric, is that just a really tough pill to swallow?

A great example is current auto companies versus Tesla, is the fact that they've thought about software, built things up from that level. Now if you look at the engineering models of BMW, boy, it's tough. Is that generally true? You think?

Ben: I've been thinking a lot about this recently, actually, as it pertains to a couple of different investment opportunities I'm looking at. A distinction that I draw is if the value of the incumbent can actually be replaced by a technology product rather than a technology-enabled product.

To illustrate this, let's say a technology-enabled product is something like Redfin, where there's lots of ways they can apply technology to make the process better. But at the end of the day, it's a traditional brokerage with a person who's showing you the house, and that's the same business model with pretty similar fees on the transaction of the house.

You look at other businesses, a pure technology business like Netflix, where it's a digital service that's distributed digitally, it's software all the way through. If you're thinking about, do the existing incumbents stand a fighting chance, my answer would be yes against technology-enabled businesses because they can tech-enable just as easy as these new entrants can start tech-enabled. Not just as easily, but it's possible to compete on that vector. But when it's a pure technology product that's being sold that is the actual value proposition to the consumer is this unique piece of technology, that's when I think this unavoidable fate starts to happen.

Hamilton: Very, very interesting distinction. One thing I should have mentioned before about counter positioning that your listeners should always keep in mind, which is really critical. It's the only one that's a partial source of power. Remember, power, when you think about it and try and figure out if a company has power, you have to look at power versus every type of competitor. Existing and potential, but also direct and functional. So people that satisfy the same need but a different way.

In the case of counter positioning, it doesn't answer the power question for potential competitors because other people can mimic the same. I gave the example of Dell before. Dell’s power went away, of course, because ultimately, everybody could do the same. If you look at counter positioning and you want real durability in addition to that, you want to have another source of power.

When we're looking at companies, it's very common that one of the either potential or existing competitors are Amazon's trying it out, or Microsoft, or Google, or somebody and often in a vertical integration play. Then you have to think through, can they do it? Also, there can be counter positioning issues involved in something like that. Of course, Slack is straight up against that kind of stuff.

Ben: There's something else that I've been thinking about. I'm curious to get your take on or if you've seen good research on it or it's come up in your career at all. In general, when I'm looking at the competitive landscape for a company that we're starting at Pioneer Square Labs in the studio, I'm trying to figure out, who are we going up against?

The ideal situation is, there are incumbents, big companies that are 20 plus years, they're mature companies. There's maybe one or two other startups that are in our vintage, but there's not somebody that's three or four years old. My logic on that is always, we're competing on a completely different playing field, then to put it in your language, however, that incumbent got power, and whatever that opportunity was for them to create something new and novel.

I'm perfectly fine competing, maybe either with a different strategy or to try and out-execute someone that has the same resources I do. But I don't want to compete against someone that's 3–4 years ahead of me in approximately the same technology vintage with the same sort of world available to them, who just has a lead and may actually be started something at the beginning of the window that is now closing. Does that square with how you would think about that?

Hamilton: Completely resonates. What happens in the take-off phase of a business, think about what's going on. There are more customers than product, nobody knows exactly what the right model is. In certain markets, that means that there can be quite a few competitors that are kind of viable. In some markets, actually, if they're really incredibly robust, there can be wildly profitable companies.

I thought there were 300 automobile companies and there were probably 100 PC companies or something. I remember there's a great experience. This was back in, I think it was 1984 or 1985. I was out visiting Silicon Valley because at that point, I was back in Boston. I'd already started my own business and I was visiting a company called Cromemco.

They were on this incredible trajectory as a PC company. Cash positive, growing triple digits, and doing really well. They just cut a big deal with Sears for distribution. One of their founders toured me through their facility out here. We finished and I said, well, Roger, thanks very much, that was really enjoyable, I appreciate that. But what are you going to do when there's a shakeout?

This cloud came over his face. He almost threw me out of his office. It was that bad. He said, they'll never be a shakeout. It's not going to happen. Because they were in this period when the rising tide was raising all boats. You have this tremendous feeling and yet, their claim to fame was they're the largest S-100 bus computer. Who cares?

David: Right. I have more PCI slots than anyone.

Hamilton: Exactly. What you could see in that situation you're describing, Ben, is that their companies are doing just fine, they're getting customers, but competitive arbitrage hasn't really taken place. What you're worried about, which makes sense, is that if somebody is several years ahead of you, and it's one of the middle phase types of power, which is most common in tech—network, economy scale, economy switching costs; those are the three most common ones—then your size matters. If they're ahead of you, when push comes to shove, when the market settles down, you will not be in a good position.

I'd say an exception to that is that if you have a company like that and you see that they're just gaining an enormous relative market share, there might be some other company that's earlier. But there's something about their business model that just doesn't work as well.

David: Like Google versus Excite or whatever.

Hamilton: Right. So if that's the case, then there's the second order question, which is, why is that happening and will it continue? But that's more of an edge case, so I agree with the basic idea that that's kind of a watch out.

I'll go one step further. An even more interesting investment opportunity—they don't come along very often—is one where it's almost a category of one, where a competitor, somehow, there's something about the way they are that there's nobody really quite like them. That's reassuring in a lot of ways if it's working, if it's scheduled positive.

David: This is the perfect transition to my favorite part of your book. In cases like that, often a power is a cornered resource. As you say, I think this is actually quite rare in tech, yet, I think people in tech think it's not rare. Classic examples of patent. You're in biotech, you have a patent, you have a cornered resource, you have it, nobody else can have it.

I'm curious about your thoughts on cornered resources in general, but in particular, something that just really spun around in my mind reading this is, lots of people in tech, especially lots of VCs think that executive talent and founders are a cornered resource. You make the point in the book that executives are not cornered resources, because their value can be arbitrage by the market. I think that actually, the value of founders gets arbitrage, too, in Silicon Valley. Because if you have a superstar founder, they're going to raise money at such a high price.

Hamilton: Just a comment on leadership. Leadership is unbelievably important. It's unbelievably important in strategy because as I said in the book, all strategy starts with invention and building up something around that. There really is a difference between companies with truly great leaders and ones that aren't as great. So it matters, but the question you're dealing with is sufficiency. Is it enough?

The example I start my book with is a perfect example for this, this little old for you guys, but it's Intel. They had two businesses, they started as the memory company. They started with the best of the best.

David: Gordon Moore, Bob Noyce.

Hamilton: Right, and then it brought an Andy Grove. On the invention side, Bob Noyce. On the execution side, Andy Grove. On the process to a manufacturing side, Gordon Moore. These was the all stars, and yet, their memory business was not working because they have no sources of power. Other people could come after them. Despite their great leadership, and probably being first in, and all kinds of financial resources, it just wasn't enough.

Ben: That ended up having basically a massive race to the bottom with tons of new entrants who were able to spin up everything that Intel had and compete against them.

Hamilton: But then if you go to what they did eventually of power in which is CPUs, again, leadership really mattered. They have come up with this idea for a central processor. The question is, is this a big deal? Do we back this?

Most of the board was against it. Their head of sales was adamant that this would never turn into anything, and he was a sharp guy. Andy Grove was dead set against it, I believe is correct. Bob Noyce went out and kind of talked to people. This is the nature of invention, high uncertainty bars, very large bandwidth, deep insights. If I said, no, I really think this eventually is going to go somewhere. Then the chairman of the board backed Bob Noyce and they committed to it, even though they really didn't have the cash and it was a very hard thing for them.

There's a case where leadership really mattered, but it wasn't enough. So the question here is sufficiency. If you take a great leader and put him in a different business, that doesn't massively reduce the uncertainty bars that the business is going to be a success.

David: That makes a lot of sense.

Ben: How do you square that with Pixar, which is another example in your book in the corner resources segment, where the combination of John Lasseter, Ed Catmull, and Steve Jobs being sort of the best visionary and source of capital, with Steve, the best animator and storyteller, with John, and then the best technologist with Ed? The Pixar brain trust, and you look at all the directors on down that they did recruit, really was their main or a big source of power for them cornering those people resources. Am I missing that there is another big source of power for Pixar?

Hamilton: No. I think there's some subtleties to that story. I just have my own view about this. I've talked about this a little bit in the book. You have to come up with great stories for good animated films. The brain trust itself was insufficient to guarantee that. The marker for that is how many directors had to be replaced that were into their projects. Then you go back and then ask, what was in common with the directors that weren't replaced?

With the exception of Brad Bird, who's a whole story by himself, brilliant guy, the answer is that it was this core group of people that work together, that came up with the original Toy Story movie. They were sort of a band of brothers. Together, they had an experience of what it meant to create really compelling animated films. That was their string of successes that followed from that.

The fact that there was a brain trust, at that time, they weren't able to transfer that into other directors. But then later on, what happened was you saw when Disney acquired Pixar, some of that sensibility, they did revise Disney animation. More recently with Pixar, I'd say that the prospects for a new pool of directors is very good.

It wasn't arbitraged out because those people want to stay together. Certainly, those directors were offered jobs in other animated studios. I'm sure they all were, but they said no, no, I'm staying with Pixar.

David: I'm sure if Bob Iger could have just hired Ed and John, he wouldn't have bought Pixar.

Hamilton: Exactly. I'm a huge fan of Iger's. I think he's a strategist and he made three critical Disney decisions, all of which I thought were brilliant. I think his Pixar decision was he realized that at the heart of Disney was animated films. Even though the price, an investment banker would say, this is really expensive, he realized that actually, they had to revive that or the whole Disney franchise was at risk. So it was worth a much bigger price.

David: We're huge Iger fans on this show. His book is incredible.

Ben: And we try to be a little less partial. But both of us, whatever we get going on anything Disney related, we'll be here for a few hours.

David: All right, listeners. For our final sponsor of this episode, we want to thank Fundrise. We've been talking all season—Ben and I—about the spreadsheet that we collaborate on. It has grown a few rows and tabs, at least on my end. Have you been adding to it this year?

Ben: Yeah, crazy year.

David: Crazy year, indeed. I can't believe it's the end of the year. Fundrise is one of the only platforms that lets anyone—not just accredited investors—buy fractional ownership in custom portfolios of private real estate assets. One of the hardest asset classes to access. Unless you're willing to actually go buy houses or properties and manage them, Fundrise lets you access it the same way that sophisticated institutions like University endowments do, directly and without paying the high management fees of REITs or other public real estate vehicles.

Fundrise was started back in 2012. Fast forward to today, they have over 150,000 active investors and over $5 billion worth of real estate on the platform. Investors can see and track all of the individual properties in their portfolios. Truly, it's the best of both worlds with the low minimum diversification, ease of use that you would get from REITs, but also the granular control and low overhead of buying and managing properties yourself. You can learn more and sign up at fundrise.com or click the link in the show notes.

The potential for power often comes in that sort of flux and change of take-off state in the market. I'm curious as we move towards the end here, have you come up with any good mechanisms for identifying when opportunities for power exist in given markets? Do you just keep a radar screen operating and be like, okay, well, these are interesting areas of flux that are happening and new companies can be built or…?

Hamilton: I'd say there's a little bit of secret sauce in that from my investment perspective.

David: That'll be the next.

Hamilton: Yeah, right. The subscribers have to pay more.

It's kind of what you would imagine. You're in the thick of it. It's a rapidly advancing technical frontier that's seeming to change the possibilities in a whole space.

What I was mentioning to you before I started, genetics is very interesting to us. Of course, we have no insight into therapeutics, but that whole field, you can tell that the incredible cost decline of sequencing and other aspects of it creates the possibility of doing things that were never cost-justified before or time-justified. You look for things like that that are step changes.

Then I think there's an awareness of how technology flows through an economy. Last Friday, I had lunch with one of my old professors at Yale, Dick Nelson is this genius-level person on technical change. He's one of the deep thinkers on it. I think what you see is that you start with a technology with sort of its most gross or macro application, and then it works its way through.

If you think about Moore's law or silicon has been one of the drivers of everything. First, you go straight to where it’s chips, it's the chips themselves, and then the chips work their way into devices, and then devices work their way into applications. So if a technology is fundamental, it moves through different phases where businesses around it become economically viable.

Think of Netflix, for example. Again, if they tried to do streaming when they had started their red envelope business, you had to have storage, you had to have the Internet, all that stuff. So there's a time as technology moves through that it becomes commercially viable. Then there's (of course) precursors to this, which are scientific stuff. Think of quantum computing. First, of course, you got to figure out quantum mechanics, then you got to deal with entanglement, and all that stuff.

David: We're probably not ready for applications just yet.

Hamilton: But hopefully there will be a time. People are now reviving hopes again about fusion based on different models

David: I like that. That's a good transition to the last question. What are you working on now? What's next for the seven and maybe more powers to come?

Hamilton: First of all, I would love to find another power. So far, I haven't. Every company that we deal with faces this question, eventually. Okay, if I'm successful, I've established a company with power. What's next? So, act two.

What I'm trying to figure out is, do we have anything that's interesting and valuable to say about that? From the first step of it, I think we do have something which is to be a little more forthcoming about some of the subtleties about what really comes under a power umbrella.

I'll give you an example. A natural place to go would be geographic expansion. Let's go into another market. It turns out if you think of that in power terms, you get very different answers. If you think about Uber going into a different geography, it doesn't matter because the economics are physical density scale economies. If it turns out there is high branding and there are a lot of foreign visitors, better but it doesn't matter.

Ben: Or impossible to build that fixed cost technology asset.

Hamilton: Right. It's all about market by market. To be honest, their mission statement of transportation of everybody around the world doesn't really map to power. Man, I think they probably know that now. They're smart and able.

Now if you look at Netflix, it's a different matter. If you think of Netflix going into a different geography, the question there is, remember the key competitive advantage there is scale economies. There's fixed content that they can drive across more subscribers, so the cost per subscriber is less. And content's a big part of cost, so that's a big, big advantage.

If you go into different geography, for them, the question then is, does a reasonable percentage of our content from geography A apply to geography B, even if it's only 20%? Let's say you're going into England and 20% of your US content applies. If you're a versus English-only competitor, 20% times that large amount is a gigantic deal. Then the dynamics of it become even more interesting because if they're unbelievably granular data, they can then actually tilt their content development to have more crossover.

Thinking that through of how to extend power, where the power umbrella fits is something that's really interesting. It's important, economically, of course, because getting power is really hard. If there's any place that you can take advantage of your brand, sometimes it's unusual. Think of Disney going into theme parks. Back to Disney again, here we are.

David: As you were mentioning, it made me think of Disney. We talked about this a little bit on our Disney+ episode. Fox actually, I think, did this really well, what you were describing with geography and power of over the last 10 years or so. That's only been around for 10 years. I believe Fox locked up all the streaming rights to Indian Premier League Cricket. You would think like, oh, well, that's relevant in India. No, that's actually relevant all around the world. So that was a big part of the Disney acquisition of Fox.

Hamilton: Right. The fact that if you get a high probability of power, it's a step change in the certainty about the value of the company. Anytime you can extend that to more customers or more situations, then the question after that is, okay, what's beyond that? That's a deeply researched area. There's a lot in that. I'm not convinced yet that we have a lot to add to that.

David: That's book three.

Hamilton: Yeah, we'll think about it.

Ben: Hamilton, where can listeners find you? If they're interested in Seven Powers, where should they go?

Hamilton: Seven Powers is for sale on Amazon, so I suggest you go there.

David: Is that your preferred method of acquisition of the book?

Hamilton: Yeah, just that. That's the right place to go. We started the interview off saying that was the best kept secret. That means I'm just terrible on marketing questions. So maybe that's the wrong question to ask.

David: Great. Listeners, everybody should check out and read Seven Powers. It is well worth your time.

Ben: Or listen. I listen to the book and the thing that makes that doable, because it is an economics book, a very nicely distilled economics book, but boy, there are some formulas in there. I love the insert. There's this great PDF that comes with it that gives you this handy-dandy, filled in Seven Powers card along the way, and writes out the formulas so it makes it very digestible.

Hamilton: I'll just end with a funny anecdote, which is, there's a question of whether I put any math in the book at all to speak of, and then the end, I put it in the appendix so that you don't have to read it, but it is there. The reason I use it is just for precision of logic. It makes things very clear exactly what you're talking about.

The reader response has been utterly bimodal. There are some people that say, God, that's great. Daphne, for example—you mentioned Daphne Koller—said that the best thing she read was the mathematical appendix. It took out her positioning, she said. She didn't really understand it. And then other readers say, complete waste. I don't know why he did it.

David: Tell me more stories.

Hamilton: Right. I guess I know where you stand now, Ben.

Ben: Thank you.

David: The best readers like both.

Ben: Listeners, as mentioned, if you liked this interview with Hamilton and you're like, I need more Hamilton Helmer in my life, good news. In the now public LP feed, you can find a recording that we did of a book club with a bunch of people on Zoom, all of our LPs at the time on asking questions. We led most of the discussion and then opened it up to the group. Pretty fun to have that discussion with Hamilton. You can just search Acquired LP show in any podcast player and find that.

Other than that, I'd say if you want to come talk and hang out with the rest of the group, join at acquired.fm/slack. If you're looking for that next great thing that you want to go do, we have personally curated some great jobs that we think are interesting at acquired.fm/jobs. You can go there too. If you aren't looking for something but you think you might be in the future, we have a place to raise your hand and say, hey, look for something cool for me. So you can drop it in there too.

David: Last thing, though, before we go. We have to say, everybody still listening at this point, if you haven't already, just go buy the book. Buy Seven Powers. I literally have about 100 copies of it sitting in my garage and I've read every single one.

Ben: Quite the super fan.

David: I am a huge super fan. Buy the book and also leave a review on Amazon.

Ben: I think you're the first review or the top review.

David: I think I'm the top review. I, at least, was. Let's go back and check. But seriously, Hamilton's work is just incredible. We can't wait to do more with him going forward. A huge thank you to him for joining us here.

Ben: For sure. Our thanks also to the SoftBank Latin America Fund, to Modern Treasury, and to Fundrise. Listeners, we'll catch you next time.

David: We'll see you next time.

‍