Interview: Hamilton Helmer & Chenyi Shi on How to Build an AWS-Like Second Business

0:00 Oh, I'm sorry, before you keep going, is this gonna be a question of is this a scale economy or network economy? Yes. Oh damn. Go for it, Jenny,'cause I don't know the answer. We've stumped the experts. Who got the truth? Is it you, is it you, is it you Who got the truth now?

0:20 Is it you, is it you, is it you? Me down Another story on the way

0:29 Welcome to this special episode of Acquired, the podcast about great technology companies and the stories and playbooks behind them. I'm Ben Gilbert. I'm David Rosenthal. And we are your hosts. Eight years ago I pitched David on an idea for two different podcasts.

0:45 One was on grading technology acquisitions that became acquired. The other idea was to do episodes on companies that manage to create two separate multi-billion dollar innovations. Our hypothesis is that most companies have really one big founding insight, and that the rest of the company's history is just drafting on that. Well

1:07 Hamilton Helmer. And Shen Yi Shi friends of the show, coincidentally have been exploring literally exactly that idea, and they've been asking questions like what percent of the profits of the biggest companies in the world came from a second business line. They have a new framework in addition to seven powers to help founders answer the transforming question.

1:30 If I were to expand the scope of what my company does. How should I go about it? And this is a particularly Interesting time to do this episode with them because I feel like a bunch of the companies we've covered recently on the show. This has been like a key part of the story, whether it's Amazon and AWS or L VMH and how all the businesses

1:52 LVM H itself have been transformed over the years. And even particularly I'm thinking about Nintendo and our Nintendo series and going from like A supplier for the Yakuza to Dominant video game console manufacturer. Yep. And David, I can say you and I have already recorded this interview with

2:08 Chen Yi and Hamilton and like we address exactly that. So listeners, this is a really fun one to do. And having Hamilton and Chen Yi on, it just concretizes a lot of the very abstract thinking that we sort of banter about on the show, but never quite crystallize. They crystallize it for us. Yep. Well, if you want to go deeper, you can become an acquired LP to come closer into the acquired kitchen. We have bi-monthly Zoom calls and we just announced that we'll be asking our LPs to help us pick future episodes. So you can join at acquired.fm slash LP.

2:41 Subscribe to our second show, ACQ Two, formerly the LP show. Which is now public for expert interviews with founders and investors. Search ACQ two no space in Any podcast player. Join the Slack. There's now over fifteen thousand smart, thoughtful, kind members of the acquired community.

3:00 at acquire.fm slash slack. It's pretty cool. But I will say that only represents like five to ten percent of You who listen to a choir every month. So for the rest of you who haven't joined Come join us in the Slack.

3:12 All right listeners. Now is a great time to talk about a new partner of ours here on Acquired, Lagora. The agentic operating system that is redefining how the world's best legal teams work. Yep. It's sort of obvious that AI is gonna completely change the legal industry. I bet most of you listening have dropped a contract into some sort of AI chatbot out there. Lagora took that insight and asked the question, what if you really built something with that power from the ground up for the legal industry? So the founders did exactly what great founders do.

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5:05 To a hundred million in ARR. In about. Eighteen months. truly insane numbers. And that is the real test.

5:13 Plenty of things demo well, but the question is whether a busy associate actually reaches for it during crunch time, or whether a partner trusts it before going into a conversation with a major client. If your legal team wants to check it out, whether you're a law firm or you're in house at a company, You can learn more at Lagora.com slash acquired And just tell'em that Ben and David sent you. Without further ado, this show is not investment advice. David and I may have investments in the companies we discuss.

5:41 And this show is for informational and entertainment purposes only. Hamilton and Cheny, welcome back for the Third time. To acquire it. Our pleasure. This always great to be here.

5:55 The acquired audience has grown so much since the last time we did this together. We thought it might be fun first to sort of humanize the seven powers a little bit and do a little background of what is this thing that we talk about on every acquired episode and How did the two of you come to Be world experts in this. Yeah, yeah, delighted to do that. So

6:15 As I've said, I think on other episodes my Understanding as an economist is that Ground zero for Economic vitality.

6:26 is the strength of the entrepreneurial sector. So there's a famous economist called Joseph Schumpeter who's sort of posited that and it was different than sort of normal economic theory at the time because it was very dynamic and not sort of mathematical. And so I believe that.

6:45 Very strongly. And of course Silicon Valley is a center for that. So the thing that really interested me was Can I contribute to that in any way?

6:55 Is there anything that I can do that Helps with that. And my discipline is sort of business strategy and so there's a real question about Is there anything useful that business strategy can add to that sort of creative

7:09 Dynamic. Effort of all these people. And I'll queue it up with an example. Yeah. I used to use in my class at Stanford sometimes, which is that

7:19 If you can imagine me holding up two devices. See, that's the iPod with the touch wheel, and I have no idea. Is that calculator? Right. So that's the first handheld calculator in the United States Bumar. And so

7:34 Here's the issue. Is that Here are these two devices. They were wildly successful to begin with. Incredible product market fit.

7:44 Bomar went from maybe three million to you know a hundred million in a couple of years, which back in those days was real money. And of course calculators are an interesting starting point because, you know, the Japanese calculator, Bizcom, was sort of what started the whole CPU revolution. And so tremendously successful, and you all know the story of the iPod, that was the beginning of Apple as incredible business model. But it also was the precursor to the iPhone.

8:14 Bomar, on the other hand, and this speaks to Why. Seven powers. Not exactly a household name today. Right. You'd never heard of it. So that dates me and you.

8:24 So you might be saying that innovation is not sufficient. Yeah, innovation or disruptive technology is not sufficient. It is very disruptive if you're an abacus maker or or a Monroe calculator maker, it puts you out of business. Very disruptive, but completely went out of business after a while and then had tremendous

8:45 Brand recognition. Was the thing. And this huge spin up. And that speaks to strategy. And so what you wonder is

8:55 If you're Helping the people founding those companies, is there anything that you could Say that would be a good thing. maybe guide them to be a little more iPodish and a little less Bomarish, right?

9:08 But the problem with that is that The nature, as the two of you know, from your acquired site as well as all the other things you've done. the nature of developing business Yeah.

9:22 adaptive and evolutionary. It's not like you sit a bunch of bright people in the room and you figure out the strategy and say, okay, we're just going to execute from now. It's You go forward. In time. And effort.

9:34 And new information comes in. Oh, that customer didn't do what I thought. Uh this competitor is coming in this way. The technology frontier has changed, all this stuff. And you have to a adapt to that over time. And so if a problem with that is that Okay, well then If it's that way, how does a body of thought contribute to that?

9:56 And the answer to that is that if you can provide a useful mental model. Or as Chen Yi calls it pattern recognition. You provide something so that as Entrepreneurs are moving through space and time.

10:11 They can see What's A little more likely to end up. IPodish and a little less likely to end up Bomarish. That kind of

10:20 mental model is actually Hard to construct. And what I say in the book is that the very high hurdle that it has to clear is that it has to be simple but not simplistic. So simple. It has to be that way or people won't remember it. If it's some complex theory that you have to go back and look it up every time, it's not gonna help a lot when you're making business decisions.

10:44 And not simplistic means that it's gotta cover most of the situations you face. In other words, it has to be relatively exhausted. And that's a high hurdle. So there were a number of strategy frameworks before that were extremely interesting and made great contributions, but weren't simple but not simplistic.

11:06 Probably the most prevalent was Porter's five forces focused on What he calls industry attractiveness. It was a tremendous contribution, but it's not insufficient. If if you're in an attractive industry, it doesn't get you the kind of security that an iPod has. Right.

11:23 Samsung is in an attractive industry called smartphones, and yet their PL looks quite different than Apple's. Right. And there's been statistical work. Just buttressing that point more generally, that industry attractiveness doesn't explain a lot of firm differences and profitability.

11:42 Another one was Christensen's work on disruptive technologies, which is just phenomenally interesting and highly Ariadite. But this example's perfect. Disruptive is actually not correlated with long term profitability. It has to do with product market fit. It basically says you've come up with a better way of doing something

12:02 That takes out the incumbent. It disrupts it. So very interesting in that frame, but not for the Bomber iPod problem. And then there's a whole strain of thought around capability. Analysis. You can do a lot of things with capabilities, but

12:18 It's not common that that's the basis of why you build great business models. Other people have those capabilities as well. So What that meant from uh Concept development.

12:30 Framework is that Well I sort of had to go back to square one and say Okay. I'm thinking about Pattern recognition for entrepreneurs.

12:40 What's simple but not simplistic. And one of the keys to that question is persistence. Which is that If you were to say Apples.

12:51 profitability next quarter. It's not a random draw, right? It's highly persistent and there's statistical work on that that suggests that's generally true for Yeah, very successful companies. And importantly, not just next quarter, but four quarters from now and eight quarters from now. We don't know

13:11 Ten years from now, and that's what we're gonna get into on this episode, but we know a year from now. Bezos always used to say the line, uh This quarter is already baked. This quarter was baked three years ago. I'm working on a quarter five years from now. Yeah, there's that, but I think also the fact that

13:26 He says that this quarter is baked also sort of tells you about something about the business model in a way. And so that persistence Tells you. That there are Economic structures.

13:41 That create attractive outcomes. And you then ask the question. Can you generalize about those? Cause if you could generalize about those then you know, maybe you can get to something sufficiently simple and yet comprehensive.

13:57 that is useful to entrepreneurs. And so After Looking at that for decades. My conclusion was that actually

14:08 It is simple. There are only seven of'em. And in fact if you're dealing with startups these days that's usually a smaller subset of that.

14:17 And so that to me was a fairly profound insight. And that's what seven powers is. It's just those structures. But if you can get there Make you more iPodish and less Bomarish. And a key

14:31 piece that I always have forced myself to remember whenever I'm analyzing a brand new business idea. And trying to run it through the seven powers framework is Seven powers is about defending the castle. Unless about

14:45 Is this a good idea or not? It is a second invention after product market fit. to create a durable business. That's right. Gee, I wish I had said that. I think you did say that. I think this concept of a second invention is literally your words from a previous episode. So product market fit and power are more or less orthogonal. There's some complexities in that statement.

15:08 And I'll tell you something. occurred to Chenye and myself over the last year which is A little bit different maybe than what's said in the book.

15:19 Which is that I used to think that it was sequential. You get product market fit. And then you deal with power. But

15:28 My biggest education is Talking to founders. I love their intelligence, their creativity. Dare I say they're you've And

15:38 there are deep thoughtfulness about stuff and what I'm finding is that The proper path. is actually to be thinking about those things kind of simultaneously. Because what's going on is you're trying to figure out Okay, what am I doing with this business? You know, I've got this choice and this choice.

15:56 And in the mix of that there are both product market fit questions and power questions. And you don't just say, Well, I'm just gonna do the product market fit stuff and think about power later. You actually need to start thinking about it. You won't solve it completely at the beginning. You won't know, Oh, yeah, I have power for sure, but you should be thinking about it. So persistence then leads you down to those structures and Part of the reason, you know, that it's really cool that you're sort of

16:22 thinking about this in your interviews and we think about it in our work is one thing I've said to you before is the The Genotypes of power are simple. There are only seven. My partner Bill says that it turns strategy from a essay question into a multiple choice question, although I don't know with chat GPT the difference anymore.

16:42 But the phenotypes, that is the exact granular way in which they are articulated. And carried forward. are complicated. Chinese.

16:54 Yeah, and we might struggle for weeks. trying to figure out whether something has power or not. I'll give you an example of how the idea of power so important. So you know, I'm sort of a uh sports car nut and uh used to drive too fast. And Porsche's a great example here.

17:11 Which is think of that. The nine eleven. First one. came out in nineteen sixty four. Sixty years ago.

17:21 Hm. Porsche wasn't sort of the sports car leader of the world at the time by any means. And so what that enable Yeah. Which I don't think was

17:33 conscious exactly, but sort of spun out in an evolutionary way over time. was that They took away. The Design.

17:44 element as part of the mix in What wins over Sports car enthusiasts. So if you looked at a a nine eleven in nineteen sixty four and a nine eleven today. They kinda look the same. Yeah. You know?

18:00 And so what did that allow Porsche to do? It allowed to just constantly Optimize the best performance features. In the context Of

18:13 People would pay for that. you know, handling acceleration, interior ergonomics. and the technology frontier was changing fairly rapidly. Today I'm just astonished at the performance you can get From

18:30 a small scale Honda that'll go a hundred and fifty five miles an hour, you know, faster than a Jaguar XKE right back in my day. And then there but all kinds of parallel developments and other aspects, break, sound dead and everything else. And so they could constantly Upgrade each

18:48 Generation not having to Think about the design aspect. To it. But uh hit the performance envelope. And people would pay for that.

18:58 You needed all those things, right? And consequently they end up with this incredibly durable business model, by far the most profitable automobile maker. And Devoted fans and great cars. They abstracted away the design and they fixed the design meant that it sort of wasn't a hits driven business. It wasn't do people like this design or not?

19:22 Exactly. God why are you interviewing me? Well, you do the hard part, you know, I just get to synthesise. So yes, and then all of these elements like Getting the P D K transmission just right. Those are fixed cost investments.

19:38 And if they can spread that over a larger Number of automobiles. It's Lower cost. So how many times have you seen Sports cars that

19:48 were quite interesting. And then they just couldn't keep upgrading them. To meet the great. I mean, think of the Toyota two thousand or an early version of Alfa Romeo or something. And to your point, it's not just did people like them enough, it's could they predict that enough people would like them to invest in the necessary things they needed to invest in. And if they couldn't be certain or didn't have the Hutzpa to say we're gonna sell a million of these things, then you can't make the investments you need to. Right. And so Portia was the one that just kept

20:20 Performance envelope. because they were able to do all these investments and It's a phenomenal business model. Alright, let's kick it over to Chen Yee. Anything to add, Chen Yi, before we move to transforming?

20:32 I guess I'll just add on to the perspective of a student. of the seven powers framework, not the creator of that. So One thing that struck me as the most useful way to apply the power framework is Really as a cognitive leverage.

20:47 So I think Ben you mentioned it doesn't really tell you what's the next thing you should build or what product's gonna hit the market, but It kinda tells you what's the right strategy question to focus on. I think the way I put it is What is not important is as important as what's important. naturally, you know, as founder and operators, you'll spend ninety, ninety five percent of time on operational excellence. It's so important you have the right team, the right culture.

21:11 The right execution. But there's five percent of time that you may spend on real important strategy questions and those are what determines the eventual margin structure of the business, the competitiveness of the business. And What power structure can tell you

21:27 Is What is that five percent? Out of all the things you're thinking about. What really makes the real strategic importance that you spend all the time Thinking about it

21:35 That's one way I think this would be the most useful, maybe for a lot of members in your audience. And the other comment I'd have is Now that I've kind of had the chance to work on the theory myself, it's actually amazing how it's not done yet. No, I've been in Hamilton's class, you know, seven, eight years ago at Stanford. No, I've been working with him for the past couple years.

21:55 And Yeah, I used to think oh it's all in the book, right? It's just there. There's seven of them and it's all described. But then as we dig into it. Things that we don't know come up. You know, we talked about platform last year and We're going to talk about transforming now. It's about sort of the dynamics part of power and maybe

22:12 even extend into corporate strategy, not just business strategy. So this kind of life with me, the theory is actually really exciting and Fun to explore. Ooh, I know we're gonna get into this in transforming. Can you define the difference between corporate and business strategy?

22:28 I'll kick this one to you, Hamilton. So business strategy is How to Fine power, if you will. in what you would think of as a single

22:41 Defensible entity. And corporate strategy is how you think about strategy in a multi business unit. Corporation.

22:51 And the central problem of corporate strategy is Why is one plus one greater than two? In other words, is there any Reason. From a value point of view.

23:04 For two separate businesses to be under the same roof. And there have been a variety of Efforts in that. If you go back in the days of GE Wildly diversified companies.

23:17 there's a theory for a while that that was really a good thing that you get sort of these diversification benefits turned out not to be true. And so it's really that question. Oh. Why is it that if you're in one thing

23:31 it makes sense or doesn't make sense to be in another thing. And so again, think of Amazon. AWS. Why is that interesting? And the static part is one plus one is greater than two. The dynamic part, and that's what our transforming discussion is about.

23:48 is What is it? about the business that you currently have. That is somehow useful. in doing something else.

23:58 Mm-hmm. So you you guys did the all wonderful episode on AWS demythologizing But Amazon did have Capabilities.

24:08 That made it not completely alien territory. Well let's get into it then. So I'll give you a quick intro to transforming kind of Why we think it's interesting.

24:20 And then Chenny and I can sort of pull it apart a bit and you can ask questions. So There. really three reasons that we think about this. The first is that If you're interested in creating businesses, it's important.

24:36 And by important I can give you a little data on that. So I did a study once of the S P one hundred, the largest market cap companies in the world. And looked at If you Pull the park. They're

24:49 value and looked where their profits came from. And you ask the question. What share of their profits came from businesses that wasn't their original business. What would you think if you were asked that?

25:03 Can you help us with a year of when you looked at this? I did it. Just prior to the financial crisis. So it's two thousand and seven. Hm, David, what was your guess?

25:13 My guess was eighty percent. Knowing that time frame, I maybe dial it down a little bit to Seventy ish percent. I think it's low because I'm thinking, you know, banks, oil companies, like the largest companies in the world to that point weren't technology companies. And I have to imagine that those are more single business line static still drafting off their original innovation companies, but

25:36 Hamilton wouldn't be asking this question if it were a boring answer. I don't know if you consider the answer boring, but it turned out to be about fifty percent. Huh. Ha so In the tech world Which you guys intersect more. Uh you know, you can think of all the examples. We talked about AWS as an example.

25:52 the lead off example in my book of Intel getting into CPUs. Yeah. That's transforming, right? They're in memories. Certainly the lion's share of Apple's revenue is not Right. The iPhone they were not in that business before. Google into Android, Microsoft into operating systems and applications. They were originally a language company.

26:13 But as Both of you said sometimes Not. Harvard started right out of the gate with Facebook. You know, and so

26:21 Fift is a big number. Yeah, half of all corporate profits of the largest companies in America came from something other than their original innovation. Right. So that sort of Flagship. And so it's important as one.

26:34 The second is that it's hard to get right. It's a difficult area. There are reasons that have to do with motivation and there are reasons that have to do with understanding. And Chen Y will talk About some of the

26:50 common business nostrums that sort of fall apart. In this. On the motivation side, I'll just mention that From a founder point of view. They've just found it something that works.

27:01 And so they're accustomed to that success. And so sometimes they may not appreciate all the idiosyncratic, un controlled elements that went into that success. And they're very creative and they wanna just move forward and so they're inclined to do that. And that's a great motive force. I love that.

27:20 That's the lifeblood of an economy, but it also means that you can sometimes get into stuff that you really don't know how to do it. Especially for first time founders, if it works out of the gate Then you have no idea to what to attribute the success. It could be skill, it could be luck. Of course it is some combination of it, but you have no idea the percentage that skill and the percentage that luck. And you say, Well, it worked I will just repeat the exact same process again and surely I will create success again, and that is almost assuredly not the case. I have several companies in my mind that thought that and definitely did not happen. Right.

27:54 And then on the people that often sit on their boards or finance them. There's also a dissonance, which is that If you think of the V C community, the business model and VCs issue find really interesting things to invest in. And then hopefully they go up in value.

28:13 And then there's an exit, which you profit from that increase in value. Which is to this wonderful engine if you think about What? drives the US economy, you know, it's just phenomenal.

28:25 But in the early stages of how people think about value There isn't yet this track record of persistence'cause people are often for example, spending a lot to acquire customers and so profitability may not be evident yet and the fundamental economics haven't really asserted themselves. And so

28:44 The only thing left is kind of how the top line is doing. Yeah, so are you growing like crazy? And so when you hear BCs sometime complain that people waited too long to IPO What that message really means is that

29:00 all of a sudden people's perception of the company changed from the top line to the bottom line and they missed the window. What that says is that that investor community is focused on top line growth, as it should be. 'Cause it's the best marketer available. But it doesn't tell you much about power. And so it's hard to do. And then the third thing, which of course you would expect from us, is that actually understanding power

29:24 Tells you some interesting stuff about transforming. So three things. It's important. It's hard to get right. And power matters. All right, listeners, now is a great time to tell you about a longtime friend of the show, Vanta.

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31:00 We're huge fans of Vanta over here, and literally hundreds of acquired listeners have become Vanta customers at their companies over the years. So you can get$1,000 off Vanta at vanta.com slash acquired. That's V-A-N-T-A.com slash acquired for a thousand dollars off. And just tell'em. That Ben and David sent you. Something else just finally occurred to me. I've never thought about it before, but

31:23 If you Uh Analytical and can figure out And quantify a company's power. then you can assign it a more accurate

31:34 multiple of profit. than anyone else can. Because if you can observe oh a company has a twenty four percent operating margin. many, many years in a row, you can decide, okay, fine, I kind of know what the operating be

31:48 in the future and I can figure out how I want to value this company. But if it's a new company. And it just settled into some steady state of profitability, and you understand the power dynamics, you can be better than other investors at predicting. the sort of net present value of all the future cash flows of that company rather than a very brute force way of doing it of just slapping the same multiple on that everybody else does.

32:12 Yeah, so Ben not only is gonna supplant me in writing Seven Powers, but he's gonna take over strategy capital. I think that job falls to ten year, yeah. So we're sort of constrained about talking about our investment stuff too much, but basically the proposition of strategy capital is if you have a differential understanding of long term competitive outcomes in places where that's really hard to figure out. that you can value things more carefully. And so I completely agree.

32:40 And you Properly constrained it. If there's a long history of financials. It's already in the price. So Does Walmart have power? Sure.

32:48 Right. My dog can tell you that. Right. Right, right. Right. I'd like to meet your dog sometime. So that's why it's important and I'm gonna just give you a quick

33:00 Take on What I mean by transforming When I laid this topic out to the two of you, I said that If you're thinking about increasing value in a company. There's sort of two questions.

33:11 What can I do better and what can I do next? And you spend most of your time on as you should on what can I do better. So you think of Amazon developing a better search engine when you look for a product. You've got to think about that, right? And that's most of your time. But then you also think about Okay, well what can I do next? And that's what transforming is.

33:32 And uh that would be Amazon going into AWS and you can imagine Thinking about Whether to do AWS is a very different exercise than optimizing the search engine. So transforming is sort of a separate topic. uh fundamental thing in strategy is thing called business definition, which is

33:51 What really Are the boundaries. Of Your current business So I think actually in our prior email conversation, David, you had the question of how do we go about research something like this?

34:03 And Typically we start with looking at what others have been talking about. This is exactly where we come across A lot of common narratives of Where do you find our next level of growth?

34:14 We've all heard about, you know, go listen to your customers. There's Amazon school of like customer obsession that's fairly popular. people will go after tem expansion, you know, expand geographically, go different segment. or you know full record competence, et cetera. And As we look through this

34:30 I think one issue we found is They don't seem to be conclusive about The chance of success of these Transforming steps. So

34:40 In other words, you can't say if you do X, you're more s likely to succeed, right? Like for example There's this whole school of thought around marketing myopia. That says. you should define your industry definition widely, right? The reason why railroad industry goes into decline is not because People don't have demand.

34:58 for transportation, but because they can't think of themselves as a broad transportation company. They should have moved themselves into cars and trucks and airplanes and even telephone, which are new forms of transportation. And I think this is uh

35:11 one of the best sellers of Harvard Business Review of all time. Just speaks to the popularity of it. So The question we'll ask is Does companies that follow marketing myopia

35:22 Bog tends to be successful. you know, does that give us a way to predict success? And we can kind of think of examples on either side, right? Like Disney today is not just a theme park company or animation company. They seem to be a broad entertainment company. And they're pretty good at coming up with the next form of entertainment that

35:39 People will love and want to watch. On the other side, Uber at one point was all in. on mobility, right? It was not just about cars. You know, if you have to remember those scooters Scooters, buses, yeah. Bikes. And they were serious about flying cars at one point, right? The Daniel helicopters. Oh, that's right. Yeah. Right. But that didn't seem to end up that well, even if it ends up in the same mobility definition. So what that means is We can't tell.

36:04 Whether following a certain school of thought is definitely going to be leading to success. Which means we don't have a theory. Behind it, right?

36:13 So That's sort of says our problem is can we say something that's A bit more definitive, you know, a bit more Having the predictive power there. And

36:22 As we thought about it, The real reason why we have this issue is A lot of these popular narratives kinda tell you about economic value. But they don't tell you much about business value.

36:35 They tell you about value creation, but not value capture. And saying other words. We're basically saying problem market fitness, not power. Yeah. coming back to the very first conversation about why we did this in the first place is that

36:49 The point Chinyi just made is the fundamental one. Which is that Creation of economic value. Is Pretty orthogonal.

36:58 Two capturing some of that value for yourself, which is to say the creation of company value. So creation of economic value and the creation of company value are different animals. And both are important. And there's a dynamic connection in the sense that if you create economic value, it sort of creates the opportunity to think about capture and so on. But just uh a single slice in time, they're very different. But that's a fundamental point about all this.

37:25 Yeah, I think that's a good way to put it, which basically means All of the common narratives out there are really useful. They're really useful as idea generators. They tell you where to look for the next product market fit. Out there. And we think the understanding of power is the missing link here. We have all these ways to come up with options, but

37:43 How do you assess which one of them is really the best idea? And that's What we're set out to give a better structure too. Yeah, and so I'll just say how power kinda helps you out in a way. So I mentioned this sort of ethereal concept before business definition. So it's rather important. So if you think about Uber versus Netflix Where they go next, right?

38:03 Uber at first their thought was this was an international business. Well that means that going into China. Somehow They're Strength.

38:14 Would be transferable into that effort. And they could be successful. And Netflix thinking about going international. thinking that if they started streaming and

38:25 Korea. that that would make a lot of sense. And are you considering the international a separate business, or are you thinking about this as like, should we expand the core business and just address a broader market? So that's the question. The key

38:41 If you have a established business is the drivers of Power in that. Extensible. to that additional segment you're considering, whether it's geographic or customer or whatever.

38:54 And Because if it is The risk. Reward. Of doing it.

39:01 The calculation beginning. Is so much better. 'Cause being able to carve out value to yourself is really hard. And if you can build on to something that already does that and it works in that environment, then oh boy. Go there.

39:14 'Cause that's so much easier than doing something really new. And so Netflix streaming in Korea. It built on so you're saying you can share content across countries, right? it built in the same fixed cost economics.

39:28 Of content development. And work. Ubers if they have a source of power, it has to do with geographical density in a specific area, like the Bay Area or something. And

39:41 going into China if they're head to head with D D or something, that they don't have any advantage at all. And so it doesn't work. Right. They get to bring their technology platform over. So they're amoritizing all the engineering, design, product management cost. But they have to go reacquire both sides of the marketplace in full and create that density, which is actually the expensive part of the business. Exactly. And if it turned out that the engineering part was seventy five percent of the cost structure I mean content and for Netflix is fifty percent or seventy five percent. Then it would have been fine, but it's not, just as you said. And so when you're thinking about business definition

40:16 In some businesses international is part of the same business, which is to say it's under the same power umbrella. And in some businesses it's not. And you have to understand that. In terms of what you're doing. And if you're thinking about what's next If you can go

40:34 to things that are under your current Power umbrella. Oh boy, is that great. Yeah. Porsche wants to sell cars in China as opposed to selling them in the US. No brainer.

40:45 Right. still all the same unbelievably hard engineering problems that went into creating the car you're selling in the US. You can find a way to distribute that. Yeah, and a Chinese competitor would have to go through the same Calculation, you know. So

40:59 The first point of this conversation is that Two Properly assess Transforming directions the first thing is carefully understanding your current base of power.

41:13 And then looking at this new segment, whether as I say it could be customer geographic, technology, whatever. Product. And seeing whether it relies on that as well. Because Then oh boy, the world looks rosy.

41:27 But on the other hand, if you think it does And it doesn't. It's like Uber and China. I don't know. What did they lose a billion dollars or something? I don't know what it was. Maybe more, once you consider all the divestiture and Yeah. Yeah. And so

41:43 They used to be compensated by the shares and D. I don't know what their shares are worth now. So anyway, so that's starting point. It's interesting, right? Like I'm thinking about we're in the middle of our Nintendo series as we're recording this, and this really is an interesting framework to think about it because on the surface It could be pretty far flung. I'm thinking about, you know, Nintendo made playing cards with

42:04 The Japanese organized crime is their primary customer. And then moving from that to video game consoles is a pretty big leap, but You know, what they had. Originally that is the same thread through the whole business. Is they had an

42:18 absolutely ironclad lock on their distribution networks. Especially and then over time through playing cards into toys, into video games, into Toy retailers. Right. And that's such an interesting case, David, because Oftentimes

42:33 It's that kind of subtlety. about locking in a distribution channel, for example, that's sort of kind of invisible, but may actually be The very thing that makes that such an I mean if you think of Sony, on the other hand, when they went into

42:49 Game consoles. That was a different business, I'd say and brutally hard. And it relied on some capability, so it shows why the capability thing doesn't get you there. I mean Yeah, some engineering. At the time analogue was king there and digital was thought of as a backwater.

43:05 But it was a very difficult and now it's of course the source of their profitability. Right. But it was a long journey for Sony to get there. And like all these things, there are a few principal actors, a few leaders that had they not been there, it's hard to imagine it ever happening. Some innovative, hard driving people.

43:25 So Hamilton and Cheny, can we ask you What are the most common power types? in today's technology driven world where people might find expansion opportunity inside of their current power umbrella. I think

43:41 Particularly for Earlier stage. Companies. The three most common power types that you will find are Scale economies.

43:50 Network economies and switching cost. Well, it's actually often common that you have counter positioning'cause that's how you tackle your incumbent in a space. But there are a couple other power types that doesn't really come in until sort of the more mature phase of the business, and that's laid out in a book, like process power or brand power. You really need to develop them after years and years of experience, you know, honing in on the core business. So

44:13 For the benefit of the audience today, we thought it would be more useful to focus on the three types of power skill, network, and switching cost. Which is probably the most common that we'd find. Out there. And are you not including counter positioning here because it's hard to find a second business under a counter positioning umbrella.

44:33 Let me just weigh in there for a sec. I agree with her sort of leaving it off because to have power, right, you have to have it versus all potential and existing competitors. The counter positioning one is typically the type of power that you would have.

44:46 Against incumbents. But it doesn't work against the wannabes'cause they don't have the same Problems. And so The one that you have to think hardest about.

44:56 Is versus other companies that are doing it just like you. And so for Bomar it would be Texas instruments doing calculators. And so that's why she left it off the list. Yeah, so

45:08 Regardless of what's the core power prospect, I'm calling it a prospect because it's power's a pretty hard bar. But Even if you're still in the make for you and you think this is going to be the mechanism that protects you from competition in long run. The first step is always to get a really clear understanding of what that core business power prospect looks like. So back to your example of Uber

45:31 If the core proud prospect of Uber is actually scale economies, which says The technology framework of doing the matching automatically is so hard. And it requires so much cost to build. then international expansion would have been totally irrational. Right,'cause you're just spreading that fixed cost over more geographies and you're getting a head start in every single place you have.

45:49 But the truth is it's not. The majority of cost of that business actually lies in acquiring and maintaining their customers. Which means if anything, the route you should really try to get to is network economies. If you have one. And the scope of that network defines each market is actually heavily bounded geographically and so everying you

46:10 country, even your city you go into is a complete new business and have to start from scratch. So That's just an example of getting a definitive answer or confidentness or about where core business power Looks like it's not.

46:22 gives you a very different place to look on where to transform or where to take it to the next step for your business. So it's almost like uh okay, so I'm at here in Seattle, if I was operating an Uber like service, I have this power, which is all the drivers and all the riders, or a high density of that. That means nothing where David is in San Francisco. So instead of launching Uber in San Francisco, maybe I should try and figure out other things to leverage my network for here in Seattle. Because that's the place where I have the durable competitive advantage versus others. So Uber Eats. Right.

46:52 Right. So I think the jury is throw out whether rent sharing and food delivery belong to the same business. Maybe they do. But it's more plausible than different geographies. This is one of these things where it seems obvious on the surface and then when you start to dig in, you're like, Oh wait Maybe it's not as overlapping of a network as I would have thought.

47:08 Right. That's the question. Right. The drivers for food delivery are a overlapping, but not that overlapping set of drivers for ride share. And the set of consumers is obviously different as well, which you can see in the corporate action they took to ship a separate app called Uber Eats rather than bundling into one app. So you actually have like two overlapping two sided networks, but not a fully overlapping on either side of the network. Ben, that's such a great example because it speaks to the point that

47:39 of the complication of the phenotypes. That until you peel back the covers. It just sounds oh yeah, Uber eats and ours sounds all the same. But when you start peeling it back, it may not be. So what that says is you have to have

47:53 quite a lot of nuance in your understanding of whether you have power to begin with. And of course for Uber it gets into the nature of platforms and exclusiveness of the sets that occupy either side of the platform and whether they overlap and Yeah, all that kind of stuff. And so without that nuance, you just you miss it. Yeah. What other network economies one that I'm curious to get your take on I see in your notes here is Microsoft versus Slack.

48:21 Can you sort of walk through the Microsoft decision to enter the market of whatever Slack's product is. It's quite hard to define. Async chat work. communication. with teams. Why or why not was that an interesting

48:35 entrance and use of their power umbrella. So The interesting thing here is we can Also think about Microsoft as a platform, right? You operate an operating system where on the two sides you have users and also you have applications. Now the interesting concept here is

48:50 The users of Microsoft's platform has a really high cost of affiliation. Right? It's Not just on the hardware side, you buy a physical machine, but also it's typically an enterprise wide adoption. There's a procurement process attached to it. There's the distribution channels that, you know, similar to how the Nintendo one worked. And

49:08 Because of that Microsoft's network scope basically extends to Whatever. demand my user side. Would have been a little bit more.

49:18 without incurring more cost on their ad. Without they don't have to do the procurement cycle maybe or did not have to buy another hardware for. So that naturally extends to Basically, maybe all of productivity software. And

49:31 That's how you see Microsoft teams create At least the competitive hassle for Slack. I think we all have to experience that Slack as a really, really good product, but Good products don't always win. Because when there is

49:44 competitive vantage from an incumbent in the case of Microsoft, they basically have a network that can extend. into the product Slack is operating in. They create issues. You know, competitively.

49:56 So where we're heading in this conversation is for saying Transforming is a worthwhile topic. And then we're saying that a starting point is understanding the power of your current business because if you can build off of that it creates a wildly preferable risk return. prospect for something you're getting into.

50:15 And so that then takes us to the next topic, which is What if you can't build on your current thing? And you need to get into something that doesn't build in your current source of power. And the two of you with all your interviews actually have so much you know, you have this wealth of information about What goes into people's minds doing that.

50:36 But If you think about that. What are you into? You're basically You're starting a new business, right? Right.

50:45 Congratulations, you don't have to file as a Delaware C Corp and you probably have some people you've already hired that can work on it, but what other assets are you repurposing? Right, exactly. And so remember that thing I said about the S P A one hundred. If you look at What they went into that generated a lot of value. And ask the question.

51:07 Could you generalize it all about that? Uh create some definitions here a little bit. sort of three categories. If you think of Does it satisfy the same needs or does it use the same skills? Those are the two dimensions, right? Because I have a consulting background and the whole world is always two dimensional, right? And if it has neither the same skills nor the same need, I just call that pure diversification.

51:32 And Rarely does that work. That's a very high risk proposition. You're basically creating a new business, something you don't know how to do at all. And when you say skills and need, that's the skills of My company and the need of my customers. The skills of your company. So what your engineers know how to do, what your salespeople know how to do. All those sorts of things. So like in that case you'd be better off either

51:55 having people who are entrepreneurial within your company like leave and start a new company and spin it off or invest your treasury in other companies. And as a big company you have all the agency problems of trying to get something off the ground with a lot of bureaucracy and everything else. Right. There's some advantages, but there's more disadvantages. Right. There's probably more disadvantages than advantages. And data supports that, that unrelated diversification is Typically. Not a great thing to do. So the lower left of this two by two matrix is I

52:25 neither have the team that is great at creating this next new thing, nor do I have the customers that want this next new thing currently. You got it. Right. And then if you look at the upper left, which is it's the same need. But different set of skills. You can call that reinvention. And

52:44 Sometimes you're forced to do that. But the opportunity set isn't that great, really. It's not like you're opening up the whole world to opportunities. And so those are pretty rare. It does happen. I mean, Netflix into streaming is reinvention. It can happen. It's hard to do. You're usually counterposition because you've got a whole group of people that wants to do it the old way. Right. And they have a lot of power in a company typically. 'Cause they've got the P N L It requires sort of the founder sponsor.

53:12 to go pursue it. Yeah, that's Very insightful. Exactly right. Otherwise, you get swamped by agency problems. And so The different needs

53:22 Skills sharing, same skills or not same but shared skills. You can call that category co action. And that's where all the action is. Yeah. That's AWS for sure, right? Exactly. A W S. Right.

53:36 Wait, so this is the lower right? This is kind of the lower middle. It's a bunch of not Perfectly shared skills, but you know quite a bit about the stuff you need to do to get in there.

53:47 But it's a different need. And That accounts I don't know the numbers in front of me, but I think it's ninety percent of the value in the S P one hundred. of the new stuff came from co action. And that's saying something that's

54:02 Pretty straightforward. And I guess there is no top right because that is your current product. Same team, same needs, right? That's right. Same business. And then the extra credit on this will be why are these axes not quite orthogonal, but I'll leave that to another Discussion. So if you think of Sony going into PlayStation

54:22 That was Not the same as Sony going into cars. It was a different business, but they did have, you know, a lot of stuff. And So that basically says that

54:33 you wanna constrain yourself to areas that sort of meet with your current capabilities. Now Occasionally there are companies that have capabilities that are so proprietary that actually that aligns with power automatically, but that's very rare. I mean I'd say like corning and glass technology, for example.

54:55 It's such a weird material science, so they could do glass stuff that other people couldn't do. Is three M a good example of this sort of lower right where they know how to make all kinds of interesting stuff, but for completely different customer bases, completely different use cases? So my view of three M is that They're basically a material science company. And material science is weird. It's

55:19 Not fully or at least it used to be. I'm not so Current on it so much, but I'm not fullopped theoretically.

55:28 They're all kinds of niche idiosyncratic aspects to it. And so they were able to invent stuff. So if you think of post it notes, right? That was a not so sticky glue, right?

55:42 And then they didn't know what the hell to do with it. And it went on for years. There's a champion in the thing that just said no There's something great here. And they almost missed it. It came down to a final marketing trial where they almost

55:57 Then Follow up on it. Wow. It is great. I never really thought about that. I mean I know it's a famous story, but Objectively it was a really crappy product that they made and then they turned that

56:08 Crappiness into a feature. Well I'd characterize it a little differently. I'd say it was a very interesting technology with no profit. It's kinda like web three. It's like a computer. It's like way slow. But like right, right, I love that. Maybe we'll find the sticky note, right? Maybe the fact that it's really slow is irrelevant given it's decentralized. Right. Uh yeah, it's funny. I guess we share a view in that. I I don't find myself very popular on that view, but I agree with you.

56:37 There's all this hand waving about the wonders of decentralization and the world will be a great place and everything. And I'm waiting for the We need the sticky note. Well you need the sticky note, right? Anyway, so I think that is just a simple observation, which is that The stuff that's most likely

56:55 will get you there is a different need. But using some of the skills that you have. And nothing very complicated about it, but I think data bears that out. I would say a lot of tech companies today have the same set of capabilities. So is it about where you have

57:11 differential capability versus other companies or just Hey, you can repurpose a bunch of your engineers to do something interesting, and sure everyone else can kind of do it too. So a really interesting question. I mean Way back when before the idea of core competencies, there's a writer that wrote about I think uh they use the term distinctive competencies.

57:32 Which is exactly what you're getting at. And I would say that that was probably true of corine and glass technology. But it's rare, and I agree with you that a lot of tech companies have a lot of similar sort of stuff.

57:48 And if you had a distinctive capability. And that that had an application in an area so it led to a good product. Then oh boy, that's great, but it's hard. That's not common. And so if you're in this place where you can't build in your current power

58:05 You just have to realize as you were saying before, Ben, you're you're back in Vent space. And yeah, you can build on current capabilities, but that's sort of table stakes, you know? You're into that level of risk. And like all those things, it's adaptive, you know, you sort of try stuff and move forward in a positive way. And so my little mental waterfall so far from everything that you've shared with us is step one, identify the power in your current business and be brutally honest about it. Right.

58:35 Brutally honest and very granular. Yes. Step two. figure out if there is a new business to launch or expand into under that particular power umbrella. If so, great.

58:49 Do that. If not you have to go start a new business and where you should look for the most fertile ground for that new business is using your existing set of capabilities but for a different Job to be done for customers. Look there and especially this is almost step four.

59:07 If You have differential capability versus other companies who could also pursue that same opportunity. I love it. Yeah. Did you write that down, Shiny? I think we should we should remember all that. Yeah, I mean Venture's just uh help us produce theory. Right, right, right. Yeah. No, I think you nailed it.

59:25 Yeah. There's one point I wanna make. There's a reason why it's sequence that way and then may be obvious but still worth iterating. Which is invention is risky. If you have something underneath your existing power umbrella and that's what Amazon did they had this distribution logistics. They started with We all know books and then CDs and then electronics, et cetera. It's a natural extension that not just leverage but also intensifies your existing power.

59:51 That's way less risky. You know you start somewhere new, but with a head start. Compared to anyone. That's a competitor. But the movement into Amazon Web Services is invention. And I loved your guy's story on how there's the four different sources of, you know, starting point of Amazon. People would love to think

1:00:08 It's based on some existing competitive advantage of the business, but it's really not. It's invention. They figured out a new thing that the market wants. But as successful as they are in AWS, they also flopped, you know, Firephone, if you still remember that. They also lost Billains and villains on Alexa. There's

1:00:26 really no track record of a business who can continuously come up with successful invention. And that speaks to the riskiness of that. Which is why it's only uh the point number three or number four on the list.'Cause if you don't have to go there, don't. But if You do have to go there, coaxion is the most

1:00:43 Possible place for success. Thank God these things are power law distributed. Otherwise, to your point, because no one has ever successfully been able to do hit after hit after hit. Like this. it would be net unprofitable to pursue uh innovation. Right.

1:00:58 I just wanna underline what Chinese rightfully kinda pulled that out. as kind of a key point here is That The Risk.

1:01:07 level. Of doing something That's under your current power umbrella. Or not. The difference is gigantic.

1:01:17 So th that should be your starting point. Because it is absolutely gigantic. And I think since invention Yeah, I am a Huge.

1:01:27 fan of Amazon. The fact that they been able to do what they do, I would argue that they couldn't have done it. If they weren't willing to take the risk and have some failures, right? Absolutely. Chinese and I talked to companies.

1:01:43 Well often when we hear it if they have been successful at transforming And we talk about future transforming the narrative that makes us think, Oh boy, this is really gonna have a problem is Oh.

1:01:58 we have a really defined process for innovation here and There is a seventeen step process. And we know exactly who to assign to it and blah blah blah. That's the red flag of all red flags, right? And then there are other in company things. You worry about

1:02:17 Sort of. screening criteria. For example, some companies when they're thinking of doing new stuff Say Well, I won't do it unless it will move the needle corporally, which means the market has to be certain size. This was Microsoft. I mean it was like, Oh, unless you're gonna go create a billion dollar revenue product, I'm not green lighting your document. Right. And usually if it's already a billion dollar

1:02:39 Yeah, too late. But this just a highlight that invention's really hard. It's hard for a large company to do it. It's hard for individuals to do it. And corporate strategy is asking a question on the transforming side at least of

1:02:54 If you do it. Are there cases in which your current platform are significant benefit to you? Where would you put the iPhone in this framework? Oh, iPhone is and the iPod are straight up co action. Similar capabilities, but I mean

1:03:10 They are computers in sort of a generic sense, right? But the iPhone. In a functional way, it does compete a little bit with a desktop. Yeah, right. More so than they realized it would.

1:03:22 They're kinda like Maybe as high up as you can go towards the top right of their Sort of like the existing products of the company. But different on some key dimensions. Yeah, I mean I would say that

1:03:35 one of the things when you're trying to do business definition There's the theoretical side is the power shared. And then there's the empirical side is to look at the composition of competitors and see if they're different. And that's suggestive that they're sort of different. And so The

1:03:53 Competitors for the iPhone are different. largely than the competitors for the MacBook Pro. You know, again it's not perfect, but because sometimes that doesn't develop in in exactly economic ways, but it's a pretty good way to look at it. All right listeners. Now is a great time to thank our longtime friend of the show, ServiceNow.

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1:06:03 It's basically always been co action when they come up with a new multi-billion dollar product line. You've got the iPod. You know, absent going and getting the new type of hard drive, they kinda knew how to build everything about the iPod already. And once they had the tiny hard drive Then great, all of our engineers know how to build something like this.

1:06:22 iPhone, same thing. iPad, same thing. These are new jobs to be done for customers, but they have all the right talent to build them. AirPods same thing. What? Maybe this AR VR device, same thing. We'll have to see if it launches here in the next few months. But interestingly, a thing where they didn't have a

1:06:41 large amount of the talent in house is cars. And so they had to go build completely new skills within the company to try to, you know, they've got what, several thousand people working on this car now, still hasn't launched, change strategy five times. They have no confidence this is gonna be a commercial success. It's a new requirement for customers.

1:07:01 that requires a whole bunch of people that they did not have and capability they did not have And that kind of speaks to where I think you're going with this framework that that product has not been successful or even launched. That's closer to Pure diversification. Right. Yeah. So if you think of the

1:07:19 horizontal axis that thing I was talking about. That's a spectrum. From zero to a hundred percent. If you're in the car business If you go from green cars to red cars, you have almost uh ninety five percent shared skill. Go from

1:07:32 luxury cars to compacts Uh high sharing. So Toyota can do it. Go from Cars to tanks. Pretty different. Portia did it under coercion by the Nazis. Right, right. It's not impossible, but quite different.

1:07:49 And then if you go from cars to refrigerators, it's really different. So yeah, no, I I agree with that analysis. But remember to Not to forget the importance of the entrepreneur in this. Because they are

1:08:04 The locust Of inventiveness. And uh it doesn't happen without them. And This isn't an automatic process or something mechanical.

1:08:15 There's individual human creativity involved. And it's especially evident in Apple. But it's really true everywhere. for all entrepreneurs. And so That's why

1:08:26 Chinese and I have to be fairly modest about what we're doing because what we're really trying to do is to provide pattern recognition for those people. But it doesn't substitute for them. It's just a tool. This is a good lead up actually to what I wanted to Ask you as we

1:08:42 Rap on. Internal. Transforming and new business development. Does this framework apply to thinking about acquisitions as well for companies? Cause I would imagine companies that are starting to think about transforming are also at a stage where they could be contemplating Fairly larger transformative M and A.

1:09:01 Is that different, or should you think about that with the same rubric? Well, it's very related. If you're acquiring a company The primary question you have to ask yourself Is why is this worth more to me?

1:09:15 than to the seller. Because there will always be an information asymmetry. The seller will always know more about the asset than you will. There's a ton of financial analysis work on this and You know, you can't get it perfectly, but basically they look at the stock price before and after acquisition and all this stuff. And

1:09:34 If you distill all that, what it basically says is You know, the choir is kinda break even or whatever and and the seller does very well. And the fact that they Figure that out. For

1:09:46 A large segment of business. was genius. And so that then question of what do you bring.

1:09:56 You can imagine how that touches on the subject of business definition and so on. Then that's why anti trust authorities get so upset about it. If you horizontally acquire in something with scale economies. That just makes your advantage that much more.

1:10:10 And so people get upset about it. And people would love to do it, but you know, Hart Scott Rodina won't let you get away with it, right? And right play so. But you have to be very, very disciplined. Because often what happens if you're inside a large company and facing these decisions and I've been involved in many of them.

1:10:29 What happens is The argument. that's often made to advance that is oh Well We don't have to have the same number of accountants or

1:10:40 we can kind of reduce there's sort of these cost reduction personnel overlap thing. Never works. Because there are diseconomies of being in a large organization as well as economies. And there's sort of a wash is a good assumption about it. And how much money are you really gonna save?

1:10:58 Right. And so that analysis doesn't get you there. You need something more fundamental and usually it's related to power or something like that. One of David and my learnings from doing our episode, the acquired top ten, the best acquisitions of all time. Was There are exceptions, but most of the time something is a wildly successful acquisition, it is because you're able to find more revenue rather than find cost savings, because cost savings are capped. Whereas new revenue has unlimited upside.

1:11:27 Well, I'll add something to that, which is that the cost of that revenue is favorable. Right. So think of Disney. So think of getting Lucas and Cameron stuff and Marvel. Wow. Marvels.

1:11:42 Incredible. Yeah, Iber created a huge amount of corporate value by doing those things and Pixar. And that had to do with him taking franchises like L V M H was taking

1:11:56 powerful brands that weren't fully exploited in figuring out how to economically exploit them, right? And Disney was taking branded entertainment that was powerful and being able to fully exploit it. And so

1:12:09 it answered the question, Why is this worth more to me? So you could take Star Wars stuff, which you sort of had the feeling George Lucas kind of wasn't so interesting to sort of exploit it. He was kind of a creative genius, right? And yet Disney could take it and run with it. So I think that wasn't that you bought revenue that already existed, it was that you were able to exploit that

1:12:32 I'm curious if you have any thoughts on or if there's more nuance to What I always think of as kinda like the highest likelihood of success acquisitions. Our enterprise software acquisitions. Where a

1:12:46 product is bought by one of the top enterprise software, you know, sales forces. And then they plug it into the sales force. Is that similar to what we're talking about here? Like It seems very clear to me why

1:13:02 XYZ good product that is sold in the same manner. That Salesforce sells all of their products would be way more valuable to Salesforce than to It's current owners. And David, real quick, I'll caveat that with like maybe highest likelihood to succeed, but not highest magnitude of success.

1:13:19 Right, yes. And I think that's what's interesting about it. Right. So examples like that. They plug completely into the power structure of the current business. So Yeah, high switching cost stuff, right? And so that they can deploy it.

1:13:33 to all their customers and get the same economics by switching across. I don't know Shane, do you want to add to that? Yeah, it actually occurs to me that there might be Exactly tied to switching costs. There might be another rationale for buying, which is Building takes longer than buying and timing matters, particularly for companies with switching costs. Now, the interesting about switching costs going back to the power itself is it's non exclusive, right? So your competitors, if they're a functional equivalent,

1:13:59 Can also have switching cost. Now If you go down this logic line, it creates the possibility of companies having switching costs but no profits. And the way it happens is if a competitors was able to build the same product, roughly the same product. And they fully realize this is the lifetime value of the customer. Should I acquire them.

1:14:18 then it's rational to invest up to all of those value in the acquisition phase. You know be it. discounting partner incentives, marketing campaigns, whatever it is. It's rational to spend up to all of that lifetime value. to try to win that customer.

1:14:32 And then what you end up with is companies with switching costs but no profits. Right. And so that's why if you're have switching costs the key strategic challenge is to acquire customers when the cost of a customer does not fully arbitrage out the profit stream that you would expect from them. Right. Which is so funny. I'm thinking of like we talked about earlier of Slack and Salesforce and Microsoft and Teams right now.

1:14:56 I haven't. Studied. Either of the businesses, but I would expect that Despite all the ballyhoo about all of it. Neither slack for Salesforce nor

1:15:05 Well, maybe teams from Microsoft is, but are not like huge transformative incremental drivers of profits for those two parent companies. So I think sort of a non obvious point of all this is that If you're thinking of doing something

1:15:21 No. Getting into stuff. That Understanding business definition is critical. Which is to say.

1:15:28 Into what areas? Does your current power umbrella extend? You gotta understand that. Then the next one is the point that Cheney made, which is that Expansion into areas where that umbrella extends

1:15:41 is radically more attractive than starting something utterly new. Oh, and I will add to that that it's not a good to have. If you understand power umbrella is bigger than what you currently offer. And ignore it, you actually are creating competitive openings. For somebody else to take on. Oh, that's a really important point.

1:15:58 Absolutely. You're failing if you don't exploit it. Right. Because you can assume that eventually somebody else will And that may completely ruin your competitive position at, for example, if it's based on scale. So

1:16:11 Point one. Go to business definition. think very hard about where your power ball is too, that if it does extend into an area you're considering to go there'cause it's really attractive. And then the third one is that if you don't have anything there and you still want to do something new, co action's the name of the game, but understand that you're now into invention.

1:16:31 of the new business. And with all the air things around at risk adaptation, you know, everything and Entrepreneurs matter. So Chenny that was such an important point about

1:16:43 How if you miss a business definition, I'm gonna ask you for an example. Can you think of a good example of Companies that Didn't understand the full extent of their business and got taken out as a result of it.

1:16:59 Well I'll throw something out. It's tough because you will tend to have survivorship bias. You only remember the companies that made it. Right, right. Yeah. Who was that? Balmar never heard of them, right? Or the handful of very few colossal failures that were so unbelievable that, you know, they're stuck in all of our psyche.

1:17:16 For example, Blockbuster, it could be the case that Blockbuster failed where they had the distribution network and the customer relationships. So there was a source of power there and they failed to exploit it in using that to launch their own streaming service, which mostly is because of boardroom blunders, but a failure nonetheless. My take of Blockbuster is if they'd done a red envelope business a year earlier, Netflix wouldn't have survived. Maybe another example is the credit card industry and how it evolved. Oh, I love that.

1:17:45 Right. It started basically as branded charge cars for a particular retail store or gas station. And then turn into diners club, which is a card for many restaurants. And then very quickly it turned into Universal Card. It's a card for basically everything. They were basically extending your credit, right? They were saying, This works here and we'll give you some credit at our store and then the over time they would start saying, We yeah, we'll spot you for that restaurant too. We have a relationship with that restaurant. Right. So do either of you have diners clubs cards? I do not. No. Right, and so they missed it. I mean it's a great example. They didn't understand that it was

1:18:21 There's actually a a platform where You want to Cover as many person types as possible. And it shouldn't be constrained. And so they they miss the business definition. And visa is one of the highest margin businesses in the world right now, right?

1:18:36 Yeah, if he's just fifty percent margin, it's astonishing. Wow Wow. We gotta do Visa at some point. I can't believe Visa didn't IPO until like the two thousands. That is an I think actually. Were they owned by banks?

1:18:50 I think it was a B of A Yes, founded in nineteen fifty eight by Bank of America as Bank Americard. Yeah. It was a consortium of banks and That's right. I remember all this now. The IPO happened right in the middle of the great financial crisis. It was March two thousand eight. To talk about bad timing, but Didn't matter.

1:19:10 Yeah. Seriously. All right, Hamilton and Cheny, while we have you here, we gotta ask you something that David and I were debating on our Nintendo episode, specifically in the 1980s. So you've got a console maker, Nintendo. They have a whole bunch of customers that are the people who are buying the consoles and playing the games on them.

1:19:29 And they have a mix of first and third party titles. So they make Mario as a first party title. And they have some third party developers making games for them. Final Fantasy and Dragon Quest and Castlevania. And of course the reason that those third party publishers are making the games for them is because they have Ninety five percent market share of people buying video game consoles. And David and I were really going back and forth and we were like is it a

1:19:54 Scale economy because they can amoritize the cost of game creation across so many Consumers. Or is it a classic two sided network effect or a network economy power? I was thinking about this this morning, it's fun. So

1:20:07 I think it's both. And the reason why It's both. Is because You can think of

1:20:14 Nintendo as a platform that vertically integrated into the production side. Basically all the first party content Is a vertical integration. And that's why they would exhibit economic structure that you would typically find in producers, which is economies of scale.

1:20:30 But at the same time The third party. transactions are a nature of Network economies. Now

1:20:38 Some question we may have to analyze there is is does a platform really stable, which means if there are really high cost of being attached to this platform, can you multi-home, et cetera? We have to go into that. Well, in the eighties there were no other viable platforms. Right. So maybe they're just the one. So That's why you would observe economic structure of both scale economies and network economies. Now there's a deeper question there, which I don't even have an answer to is Is one of them the cause and the other the effect?

1:21:03 Or are both of them. Causes. Flip power. Right. I love the answer and I think she's right. I mean, when we look at platform things, there is the business of running the platform.

1:21:15 So think of for example the fixed cost and Uber of their modeling and all that kind of stuff. And then there's the network economy aspects of a two sided platform of people, you know, and so on. And you could have power in either one of those. But If it turns out that the cost structure is not there isn't a huge lump of fixed cost, then it doesn't matter much.

1:21:37 But I think Jenny, you got it right. Okay. Well, we feel vindicated,'cause that's kind of the conclusion we came to in the episode too, of it's both And they're deeply intertwined. I'll I'll give you an example of intertwine real life. Which is

1:21:50 We all know Amazon in retail has gigantic scale advantage in the infrastructure, right? Just all the warehouse and distribution centers they've built. But at the same time. You observe you know, what you will call flywheels on the retail, right? The more buyers, more sellers and the loop goes on.

1:22:06 And this is what I call the mixing of reality between cause and effect. Because Without a really strong distribution infrastructure, which gives them the cost advantage and faster delivery and and prime and all of those benefits. There really isn't anything that makes their marketplace sticky.

1:22:23 I'm on either side. So The so called network effect you observe is actually an effect of the power. in scale of the infrastructure underneath. But you would just observe economic structure of both because platform just kind of mixed them all together.

1:22:38 Yeah, and this isn't sort of a pointy headed kind of issue because it gets back to If you find the thing that's caused rather than effect, that's the thing that you gotta defend, right? And My intuition about this and I don't know if it's right is that

1:22:53 You have to introduce time as a variable in this to correctly understand the problem. But I think Chenny and I are involved in this deep debate right now about sort of the boundaries and relationship between scale economies and network economies. If you want to m get even more confused, just remember that scale economy typically is defined as a situation which as scale increases cost per unit goes down.

1:23:17 That's often true of network economists, right? But the structural economic conditions that create it are quite different. And understanding those if you're a business operator is really important because then you're less likely to get taken out by your better Well I think this is a great place to leave it.

1:23:35 Hamilton, Cheny, thank you so much for part three. Can't wait for part four in a few years. I don't know. Is this gonna be a book? Is transforming? Are are you guys gonna publish this? Well what we're talking about right now is there are a variety of topics. That's are extremely difficult. Phenotypes, if you will. Two.

1:23:56 Tease out. And Delayer. And we seem to have enough of those that actually we probably could write a book about it. And so it's a topic of conversation. Great.

1:24:09 You all should have a newsletter. There should be a strategy capital newsletter. You'd break up there with Ben Thompson. Even if it's only like quarterly or something. Yeah, yeah. We've thought about certain white papers and this and that. So I'm pretty lazy to probably could do it. Well, this is the problem. You need a bundle of skills to be like a Ben Thompson is You need to be both A great strategy thinker, which

1:24:31 You will. Both are. And you need to be a great writer. Which You are. Seventh powers is really excellently written.

1:24:39 And you need to love writing and want to do it every day or every period. Which I'm not sure that you do. That's the part where David and I fall down too. People keep saying, Oh, you should turn a choir into a book or you should turn these into blog posts and David and I look at each other and we're like, it takes us hours to write. That sounds like hell. I'd say my passion and I think probably Chinese threw the lines for this too is Getting the theory right. It's very satisfying and extremely hard to sort of go through

1:25:10 And Figure out. You know, how this kinda all fits together. And of course that's how you get to simple But not simplistic.

1:25:18 That's the only way you get to simple but not simplistic. And so That's kinda the satisfying part, but I don't know, the idea of writing another book scares the hell out of me. Yeah, it doesn't help when the theory's never done. You know, like it's funny, uh I think David you've mentioned last time we talked about platforms, it doesn't feel completed. Like the truth is it will never be completed and it's always in the work.

1:25:40 I think nowadays we've got a lot clearer about it than a year ago, but it's always in the make. We'll think about something else and it comes back to a platform like, Oh, that's the missing piece. And realize it's actually vertical integration. You know, we were confused about the whole skill of document for a very long time. And they're like, Oh, that's what's missing. And then communication strategy is always a difficult piece as well. I bet the two of you spend a lot of time on each company that you do a episode on and it's things like that. And whenever you want to do an example.

1:26:07 You're like, Is this really true? Then you have to go dig it all back and be like, Am I just misperceiving what this really is about. Yeah, how did you Delayer AWS? That one we actually talked to a lot of people who were around it at the moment of conception or theoretical conception over a variety of years. And there has been sort of canonical

1:26:27 sources. So, you know, we read Bradstone's book and We know Brad, so we asked him, you know, who did you talk to to kinda piece this together and we had our own folks that we knew. So There was a little bit of like actual first party knowledge there, but David and I had this a little bit of an aha moment, a little bit of a sigh of relief when we were like

1:26:45 Oh. We're not gonna figure out what the one story was. So we actually can create an episode out of there's a bunch of stories and like we leave it to you, listener. And that that's probably the right answer is there is no one story. Which being a third party observer. To the extent that our version of what we told Is true or closer to the truth than others. No

1:27:05 person who was personally vested and interested would be able to have that perspective. Yeah. So and channeling Kurosal, right? Yes, exactly. Yes. All right, well that's a great place to leave it. Hamilton, Cheny, thank you so much. Thank you both. Great. Okay. Our pleasure. Thank you.

1:27:23 All right listeners. Now is a great time to talk about one of our favorite companies, StatSig. Yes, there is a reason why the best product teams rely on StatSig, whether they are iterating on their core product features or shipping AI powered experiences at scale. Yep. In the crazy speed of today's AI world. Shipping fast is just table stakes now.

1:27:46 It's basically trivial to build and deploy your app constantly. The real advantage is how quickly you learn what changes actually created value for customers, and how fast you can use that signal to guide what you ship next. This is where StatSIG comes in. It brings experimentation, feature flags, and product analytics into one unified system so teams can ship safely, test rigorously, and directly link what they changed. to how users actually behaved. So if you want to make learning your competitive advantage, whether you're building new AI experiences or just evolving your existing core product, go to statsig.com slash acquired to get started. All right, listeners, thank you. Thanks to Hamilton and Cheny for joining us.

1:28:29 Very clarifying discussion, I felt, David. Totally. I mean they really are too modest to say on the episode, but they are the very best people to do what they do'cause they sit at the intersection of Academia. corporate strategy Hamilton worked for Bain and strategy consulting for many years and active investing and they're working with founders every day getting their hands dirty. They truly are the best.

1:28:51 Well, listeners, we'd love to go deeper with you. You can become an acquired L P to come back into the acquired kitchen. David, are you liking that language? I've been uh I think of Steph Curry every time you say that, cooking in the kitchen. Good, good. Well listeners, we have bi-monthly Zoom calls with our LPs, and we just announced that we are asking LPs to help us pick future episodes. So LPs watch your email for that, and listeners you can join at acquired.fm slash LP. You should subscribe to our second show, ACQ Two. in any podcast player for expert interviews with founders and investors.

1:29:24 Come join the Slack. There's now over fifteen thousand smart, thoughtful members. of the acquired community who have joined at acquired.fm slash slack. And for the other ninety-five percent of you who listen to this show and haven't joined. We would love to chat with you. Alright, listeners, we'll see you next time.

1:29:42 We'll see you next time. Who got the truth? Is it you, is it you, is it you Who got the truth now

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