In which I call BS on one of the 7 Powers
Adding Hamilton Helmer's 7 Powers to the market analysis tools we've already learned
This is the fifth and final Divinations Market Analysis Workshop post. If you’ve been reading them, you have powerful new tools for thinking about how products fit into markets.
In this post I’ll be explaining the 7 Powers concept by Hamilton Helmer, lifelong business strategist and occasional Stanford business school professor. And, as I’ve been doing in the other posts, I’ll apply it to fintech.
As business strategists do, Helmer studied successful businesses—ones that dominate their markets, and asked himself why. He believed that success in capitalism comes from power, and so he invented an equation to define power:
Power = market size * market share * profit margin
This definition surprised me. I expected market power to be about something other than already owning the market. But this is literally: the bigger the market, and the more you have of it, and the more profitably you have it, the more power you have. It’s an equation that says what we know intuitively. Big companies have a ton of power.
I’m going to keep writing about fintech specifically from the point of view of PMF, building great products, and market positioning. Please subscribe and share.
So if we agree that big businesses are big, and big businesses are powerful, then how did they get that way and how to they retain that power? That’s where Helmer’s concept of the 7 powers comes in. He says there are 7 and only 7 “conditions for creating the potential for persistent differential returns.”
These conditions will provide a benefit to the power holder (the already big company) and a barrier to the challenger (competitors in the market). From here, I’ll list the seven powers, define them and talk about how traditional credit card companies in the US use them to hold onto their dominant position in the market—making it difficult for other types of payments to gain ground.
1. Scale economies
According to Helmer, “When per unit cost declines as production volume increases.”
Traditional credit card companies from Visa and Mastercard to independent sales organizations to issuing banks like Chase, Citibank, BofA, and Capital One all enjoy economies of scale. There are super obvious examples like printing 1,000,000 cards with chips in them is a lot cheaper per card than printing 100. But there are less obvious economies of scale like per transaction storage costs. Storing trillions of transactions and retrieving them reliably is a difficult problem for computer programmers, but the per transaction cost of that storage is extremely low. For the new entrant, the fixed cost they spend on computing infrastructure is a bigger proportion of their business than for the incumbents.
2. Network economies
According to Helmer, “When the value of a product to a customer is increased by the use of the product by others.”
Network economies is the strongest of the 7 Powers in the credit card universe. It is so powerful, in fact, that Mastercard and Visa have chosen to hold onto the network while letting go of everything else. Card processing, card issuing, acquiring merchants, and point of sale systems go to third parties. The vast network that recognizes the cards by their unique numbers, allows transactions to take place, and is “everywhere you want to be” is owned by Visa.
According to Helmer, “When a newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.”
Counter-positioning is weird in this list. It’s the only one that doesn’t help the incumbent retain their power. In the case of the credit card industry, it seems like Buy Now Pay Later (BNPL) is a classic case of counter-positioning. Issuing banks could build BNPL products, and would probably have an immediate market advantage because of their strong brands, but they would be undercutting their existing business by offering customers a way to get credit without very profitable high interest loans. They won’t want to do this until they absolutely have to.
4. Switching costs
According to Helmer, “The value loss expected by a customer that would be incurred from switching to an alternate supplier for additional purchases.”
The credit card industry is an interesting one when it comes to switching costs because it’s a two sided market. On the demand side (consumers), switching costs are low. The simplest example is switching credit cards. Many consumers already have cards from multiple issuing banks in their wallets. (Note: rewards programs are issuing banks’ way of manufacturing switching costs for consumers.) Switching how we pay is also easy. When BNPL started appearing as an option on e-commerce checkout pages, people tried it because it cost them nothing to switch.
But, for the supply side (merchants), the switching cost is much higher. The way they accept payments is built into their software and processes. For them to accept a new way to pay, it better be already built into their store management and point of sale software, and the settlement process better work really similarly to what they are used to with credit cards.
According to Helmer, “The durable attribution of higher value to an objectively identical offering that arises from historical information about the seller.”
Brand value in the credit card world is important but subtle. You can see companies like American Express working hard to maintain an identity as an aspirational brand in a commodity business, and you can also see collateral damage when a bank brand like BoA gets wrapped up in unethical behavior such as during the financial crisis of 2008. Apple seems to be using the value of their brand well because they are getting people to use Apple cards despite having a generally lower rewards yield than other competing cards.
It’s also important to distinguish between brand loyalty and brand reputation. I don’t think most issuing bank brands inspire people in the same way as Disney or Apple can, but Chase, for example, has developed a reputation as having good rewards and customer service, so if a new issuing bank came along with the same rewards and better customer service than Chase, people wouldn’t find out because they wouldn’t bother doing research and rely on the brand reputation already in their heads.
Brand power in credit cards is limited to credit cards and doesn’t prevent competition across all of payments. People don’t seem to mind that BNPL comes from brands they haven’t heard of like Klarna.
During our class, Nathan toyed with the idea that Brand power is really just a form of Network economy. I liked this notion since I’m always a fan of distilling ideas into their fundamental abstractions, but another student in the class made a nice point that network economies are when the product itself is more valuable the more people that use it. Brand recognition doesn’t make the product itself better, it makes the product easier to sell at higher prices. A subtle, but important distinction.
6. Cornered resource
According to Helmer, “Preferential access at attractive terms to a coveted asset that can independently enhance value.”
The key to cornered resources is preferential access. We discussed a few businesses in our workshop that appeared to have a cornered resource but on inspection they had payed market prices for the resource and did not receive preferential access to them by fiat or inheritance. An example I noted is exclusivity rights to a certain performer in the entertainment industry. While those rights do prevent other companies from access to that performer, they aren’t preferentially obtained.
I can’t think of any examples of a cornered in the credit card payments market. Can you?
7. Process power
According to Helmer, “Embedded company organization and activity sets which enable lower costs and/or superior product, and which can be matched only by an extended commitment.”
So I just have to call bullshit on Helmer for this last one. All the other ones feel like specific things you can work on and improve as part of your strategy, but this one feels like “Welp, the other thing you could do to build a better business is to do business-ing better.” To me it’s a catch all and it’s the one that if you could demystify it would be the true path to success for so many businesses.
Does your culture have a je ne sais quoi that causes them to steamroll past inflexible city officials like Uber did? That’s process power. Did you execute a series of pivots and data analysis to uncover perfect product market fit that eluded every other competitor? That’s process power.
In the credit card world, you might be able to point to Stripe and it’s deep understanding of building and marketing tools with developers in mind as a strong example of process power and why they outcompeted other card processing gateways that were going after the same market including Paypal, Authorize.net, and my previous employer, IP Commerce.
I think a better way to think about process power is to think of it as execution excellence and to realize that stacking small execution advantages on top of each other in repeated processes has a compounding and exponential effect. When I see startups that are struggling to retain customers that otherwise seem to have a valuable product, I often share this post from Nathan Baschez with them about the strategic importance of great execution.
Viewed from that perspective, it’s not that there’s some secret process that’s hard to teach or repeat that makes a company powerful, it’s that executing well across all functions is super hard to do and when you do it, you’ll tend to significantly outcompete other players in your market all else being equal.
So those are the seven powers. Helmer says that choosing strategy is about prioritizing business efforts across those seven powers. If you’ve followed all these essays in this series from Jobs to be Done, to Basis of Competition, to the Law of Conservation of Modularity, the way to put the seven powers into your toolkit is that you’ve used the other four tools to decide that you’re in a good market that’s ripe for disruption, so now you can think about what powers the competitors in your market have that are most vulnerable, and which ones you might be able to accumulate if you start to gain success.
I highly and unreservedly recommend signing up for Nathan’s workshop if he runs it again. Even if you already read all these essays, having direct access to him and his thoughtful approach, and learning alongside a cohort of really impressive students is worth the price of admission.
See you again next week! Thank you so much for reading and sharing.
About examples of a cornered in the Credit Card, could it be “with a Black Master Card you can enter the VIP lounges in the airports”?