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BusinessNotes:

MeasuringtheMoat,MichaelMauboussin(CreditSuisse,ManagingDirector)

Whatissustainablevaluecreation?1.Magnitudeofreturnsinexcessofthecostofinvested
capital(ROI+totalamountcompanycaninvestabovecostofcapital).2.Howlongcanyouearn
returnsinexcessofcostofcapitalcalledCompetitiveAdvantagePeriod(CAP).

Sustainablevaluecreationvs.SustainableCompetitiveAdvantage.Togetcompetitive
advantage,acompanyneedstwothings:1.Generatereturnsabovethecostofcapital(Value
Creation).2.Earneconomicreturnsthatissubstantiallyhigherthancompetitors.

SustainablecompetitiveadvantageisRARERthansustainablevaluecreation.

EconomicMoats.Buyingbusinessequivalenttobuyinganeconomiccastle(valuecreation
mechanism)surroundedbyamoat.Moatneedstobedeep+widetofendoffcompetition.Moats
areNEVERstable;eitherwideningornarrowing.

PeterLynch(FidelityMagellanFundManager):Buybusinessthataresogoodthatidiotscanrun
thembecauseatsomepointanidiotwill.

CFROI:CashFlow/MarketValueofCapitalInvested.

Valuecreatedcanbemeasuredby:CFROIDiscountRate.

Inallindustries,therearevaluecreatingbusinesses(CFROIDiscountRate),andvalueneutral,
andvaluedestroyingbusinesses.Industryaffectsdistributionofnumberofeach,butisnot
destiny.

Mustunderstandbothindustrydynamicsandfirmdynamics.

IndustryAnalysis

McGahan+Porter:AbnormalprofitEMERGENCE+SUSTAINABILITYdefinedmainlyby
industryandfirmspecificfactors.Lowperformersaregenerally90+%firmbased.

Howto:1.Getlayofland(buildanindustrymaptounderstandcompetitivelandscape,
constructingprofitpoolsovertime,classifyindustry)2.Assesindustryattractivenessthroughan
analysisofPorters'fiveforces.3.Likelihoodofinnovation/disruption.

GettingLayofLand.

1. IndustryMap.
Shouldincludeallcompaniesandconstituentswithanyimpactonacompanysprofitability.
Goal:understandbothCURRENTandFUTUREinteractionsthatshapesustainablevalue
creationprospectsforindustry+firms.

Threetypesofinteractions:1.Supplier(costofinputs)2.Customer(willingnesstopay)3.
External(governments,otherfactors,etc.).

Points.
Listfirmsintermofmarketshare.
Considerpotentialnewentrants+existingplayers.
Understandnatureofeconomicinteractionsbetweenfirms(whatarepayment
termsandwhatareincentives?)
Externalfactors(e.g.
regulation).
2.ProfitPools.

Howisvaluecreationdistributedataparticularpointintime.Horizontalaxis:percentageof
industryinvestedcapital.Verticalaxis:measureofeconomicprofitability.Areaofeachrectangle
=economicprofit.

Analyzenotatonepointintime10yearsago,5yearsago,present.
Example:Healthcare.
CreatingaNARRATIVEtoexplaintheriseandfallofvariouscompetitors(backedupbydata)
providescluesaboutwhatittakestosustainvaluecreation.

3.Industryclassification/stability.

Generally:stableindustriesmoreconducivetosustainablevaluecreation.Unstableindustries
havecompetitivechallenges,butalsoopportunities.

Measuringstability:1.steadinessofmarketshare.2.trendinpricing.

Allesleequal,morestablepricingreflectsmorestableindustries.
Goodbusiness=theabilitytoraiseprices10%withoutlosingbusinesstoacompetitor.

Classesofindustry.

Fragmented(Consolidatetodiscovereconomiesofscaleandalterownershipstructure)
Emerging(Firstmoveradvantagesliketechnologicalleadership,creatingcustomerswitching
costs)
Mature(Refinetheproduct,investinprocessinnovation)
DecliningIndustry
International(Multinationalopportunities,transnationalopportunities)
Network(Firstmoveradvantages,Markettipping)
Hypercompetitive(Flexibility,ProactiveDisruption).

FiveForcesAnalysis:

TakenfromMichaelPorter.Dontjustdeclareanentireindustryattractiveorunattractive.Use
thisframeworktounderstand1.Wherecompetitionisand2.Whattherootcauseofprofitability
is.

5Forcesdetermineanindustryspotentialforvaluecreation,butdoesntsealfate.

Forces.
1. Supplierbargainingpower.
2. Bargainingpowerofbuyers
3. Threatofsubstitutes.
4. Threatofnewentrants(barrierstoentry).
5. Rivalryamongexistingfirms

SupplierPower:Leverageasupplierhaswithcustomersinareaslikeprice,quality,service.
Supplierswellpositionedif1.Moreconcentratedthanbuyers,2.Substituteproductsdonot
burdenthem,3.Productshavehighswitchingcosts.4.Productiscriticaltobuyer.5.Industry
theyselltoreflectssmallpercentageofsalesvolume.Buyersofsuppliersproductshouldbe
abletopassonpriceincreases.

BuyerPower:Bargainingstrengthofbuyers.Functionof1.Buyerconcentration2.Switching
costs3.LevelsofInformation4.Substituteproducts5.Importanceofproducttobuyers.

SubstitutionThreat:Dosubstituteproducts/servicesexist?Whatsthelikelihoodthatapotential
buyerwillswitchtoasubstituteproduct?Ifpricesarenotcompetitiveandifcomparable
productsareavailable,businessfacessubstitutionthreat.Substitutionthreatlimitsprices
ceilingonreturn.

ThreatofNewEntrantsandBarrierstoEntry:

Somethingstothinkabout.Considerthehistoryofentry/exitforthespecificindustryyoure
analyzing.Dependsonwheretheindustryisinthelifecycle.

Earlystageleadstohigherratesofentry/exit,maturityleadstostableoligopoly.

Howdochallengersdecidetoenteranewmarket?Theyweigh1.ExpectedReactionof
Incumbents2.AnticipatedPayoff3.MagnitudeofExitCosts.
Generallycognitivedissonance;entrepreneursNEGLECThighratesofbusinessfailure.

ExpectedReactionstoIncumbents:
1. AssetSpecificity:Howspecificaretheassetsofthecompanytothemarket.Firmsthathave
assetsonlyusefultoonemarketwillmountfierceresponse.
1. Sitespecificity:companywilllocateassetsnexttoacustomerforefficiency
2. Physicalspecificity:Companytailorsassetstoatransaction.
3. Dedicatedassets:Assetsthatsatisfyaspecificbuyerneed.
4. Humanspecificity:Companydevelopstheskills,knowledgeofemployees.
2. LevelofMinimumEfficientProductionScale:Unitcostsdeclineinmostindustriesasvolume
risestoapoint,thenstops.Relevantforhighfixedcostindustries.Wheredoesthepointstop?
Afteralotofproductionoralittlebitofproduction?
1. Ifalotisneededtogettonomoreeconomiesofscale,entrantsaregoingtohavetoprice
productbelowtheaveragecostforalongtimetogettothatscale.
Newentrantsoffsetthisbuyincludingdifferentiatedfeaturestojustifypricepremium.
2. Appliestobothmanufacturingbusinessaswellassoftware/knowledgebusinesses,e.g.
OperatingsystemshavehighminimumefficientscalebecauseofHIGHFIXEDCOSTS.
3. ExcessCapacity:Ifindustryhasalotofexcesscapacity(demand<<supply),thennewentrants
increasecostofidlecapacity,soexistingplayersverymotivatedtodefendandwilldropprices.
4. IncumbentReputation:

Expectedmagnitudeofpayofffornewentrant:Ifincumbentshaveinsurmountableadvantages,
lowexpectedpayoffs.Incumbentadvantagesinclude:
1. Precommittmentcontracts:Companiessecurefuturebusinessesthroughlongtermcontracts
thesecontractsreducesearchcostsforsuppliers+customersThesediscourageentryforobvious
reasons.
1. E.g.incumbenthasfavorableaccesstoessentialrawmaterialsviaexclusivecontracts.
2. E.g.longtermdealstosecureamarketagainstcompetition.
3. Quasicontractsbasedonlowestcost.
2. Licenses/Patents:Licensetodobusinessacquiringthisiscostly,createsabarriertoentry.
Patentsdifferentspirit(allowtemporarymonopoly),butsameresult.
3. Learningcurvebenefits:Learningcurveistheabilitytoreduceunitcostsasafunctionof
experienceintheindustry.Generallygoeshandinhandwitheconomiesofscalebutdistinct
concepts.
4. NetworkEffects(Demandsideeconomiesofscale):Goodorserviceincreasesinvalueasmore
membersusethatgoodorservice.E.g.Ebay,Uber,Facebook,etc.
1. Positivefeedbackloopsensureone/twonetworksbecomedominant(tipping).

CompetitiveRivalry:

FINISHNOTES.

ANoteonDisruption.
SustainingInnovationsfosterproductimprovement.Operatewithinadefinedvaluenetwork
addressthesamevaluechain.Disruptiveinnovationsapproachthesamemarket,butadifferent
valuechain/network.

E.g.Amazonvs.Superstoresvs.Smallbookshops.Superstoresoperateonsamevaluenetworkas
smallbookshops.Amazonintroducedanewvaluechain.

Disruptorsacceptloweroperatingprofitmarginforhighcapitalturnover(magnitudeandgrowth
ofsales).

Twotypes:
1. Lowend:Offeraproductthatalreadyexistsbutstrippingawaynonessentialsandgettingatthe
coreofwhattheconsumerwants.
2. NewMarket:Competesagainstnonconsumption.Appealstoanewgroupofcustomerswho
didnotbuyadifferentproductbecauseofashortageoffundsorskills.
Generallydisruptiveinnovationsinitiallyappealtorelativelyfewcustomerswhovaluedifferent
featuresthanthemainstreamproductoffers(e.g.lowprice,smallersize,convenience,abletodo
differentthings).

Point:Innovationsimprovetheircapabilitiesatafasterratethanthemarketdemands.Sustaining
innovationsdriveperformancepasttheneedsofmainstreamcustomers:theproductis
OVERSHOT(overserved+underservedcombinationfromAlexDanco).Customersgenerally
dontusemanyoftheextra,unnecessaryfeaturesthattheproductoffers.Oncethe
product/marketisovershot,competitionshitsawayfromperformancetowarddelivery
flexibility.
Trajectoryofproductimprovementallowsdisruptiveinnovationstoemergebybeing
competitivetomorrow.

PassingovertheseinnovationsisRATIONALforestablishedcompanies.Why?1.Lower
margins2.Marketisinsignificant/small3.Notindemandbysegmentthatgenerallydrive
incumbentprofit.

Thereisusuallynoincumbentresponsetonewmarketdisruptiontheyjustignoreit.

Industriescanshiftfromvertical(initiallywhencostsofproductbuilding/coordinationarehigh)
tohorizontalascomponentsbecomecommoditized/modularized.(AggregationTheory
disagreeshereinthecontextoflowenddisruptionduetotheimportanceofcontrollingthe
consumerexperiencetheylikethatandarewillingtopaypremiumforitallowingyoutostart
atthehighendandpushdownthecustomerverticalasyoumaketheprocesscheaper.

FirmSpecificAnalysis

Coretounderstandingsustainablevaluecreationisaclearunderstandingabouthowacompany
generatesshareholdervalue.

Strategy:howdoesacompanysactivitiesdifferfromitscompetitors.Operationaleffectiveness:
howwellacompanyperformsactivitiesthatarethesameasothers.

AFrameworkforAddedValueAnalysis

ValueCreated=CustomerWillingnesstoPayOpportunityCostofProduction.

Willingnesstopay:Theamountofmoneyatwhichacustomerisindifferenttohavingaproduct
isthedefinitionofwillingnesstopay.Consumersurplus=buyingtheproductforlessthanyou
werewillingtopay.

OpportunityCostofProduction:Amountofcashthatmakesthesupplierperceivetheresourceit
issellingisequivalenttocash.

Howtocreatemorevalue?1.Increasethewillingnesstopayofyourcustomers.2.Decreasethe
willingnesstoPayofyourcompetitors.3.ReducetheOCofProductionforyoursuppliers.4.
IncreasetheOCofproductionforyourcompetitors.FitswellwithPortersstrategiestoachieve
competitiveadvantage:produceradvantage(lowercostsructure)andconsumeradvantage
(productdifferentiation).

Valuenets(AdamBrandenburgerandHarborneStuart).
Componentsofthenet:1.Suppliers2.Customers3.Company4.Competitors5.
Complementers.

AddstheideaofcooperationtoPortersanalysis.Termtolookup:CooperativeGameTheory.

TheValueChain

ValuechainanalysisisapowerfultooltoIDacompanyssourceofcompetitiveadvantage.
ValueChain:Sequenceofactivitiesacompanyperformstodesign,produce,sell,deliver,and
supportitsproducts.
Focusonverydiscreteactivities(e.g.Notmarketing,ratherthespecificmarketingstrategy
employed).
Objectiveistoasseseachactivitysspecificcontributiontothecompanysabilitytocaptureand
sustaincompetitiveadvantage.
Steps:
1. Createamapoftheindustrysvaluechain,i.e.replicatethecompanyanalysisfortheaverage
companyintheindustry.
2. Comparethecompanyofinteresttotheinterest.Lookforpointsofdifferencethatreflecta
competitiveadvantageordisadvantage.Ifcompetitorspursuesimilarstrategiesacrossthesame
activities,thenyougetintopricewars.
3. IDthedriversofpriceorsourcesofdifferentiation.Tocreatesuperiorvalue,companiesneedto
lookforexistingorpotentialwaystoperformactivitiesdifferentlyorperformdifferentactivities.
CancomefromANYWHEREonthevaluechain.
4. IDthedriversofcost.EstimatethecostsassociatedwitheachactivitiesLookfordifferences
betweencompanyandcompetitorsandadvantages/disadvantages.

SourcesofAddedValue:

Threebroadsourcesofaddedvalue:
1. ProductionAdvantages:Deliverproductsthathavealargerspreadbetweenperceivedconsumer
benefitandcostthancompetitorsbyoutperformingontheCOSTside.
1. ProcessAdvantage:
Indivisibility:conditioninwhichcompanycantscaleproductionbelowaminimumlevelevenif
outputislow.E.g.baking,trucks,bakers,driversmustallexistnomatterwhatthedemandis
like.Ifafirmhastobearcoststhataredemandinvariant,thosepartsofthevaluechainare
indivisible.
Complexity.Simpleprocessesareeasytoimitatenotsourceofcompetitiveadvantage.More
complicatedprocessesrequiremoreknowhoworcoordinationcapabilitiesandCANbeasource
ofadvantage.E.g.P&GTidePodsspent6yearsandhundredsofmillions.
Rateofchangeinprocesscost.Insomeindustries,technologicaladvancesleadtoproductcost
declineovertime.E.g.processcostsofbuildingwebstartupshasdroppedduetoAWS.When
thereisdecliningprocesscost,theincumbenthaslearningcurveadvantages,butstartuphas
potentiallylowerfuturecosts.
Protection.Patents,copyrights,trademarks,andoperatingrightsthatprotectafirmsprocess.
ResourceUniqueness.
2. Economiesof
Scale.
Ascompanyincreasesoutputvolume,marginal+averageunitcostdeclineTOAPOINT.
Companybenefitsfrompositivefeedbackonthesupplysideduetoloweringcosts.Howeverthis
tendstodissipatebecauseofbureaucracy,complexity,orinputscarcity(formanufacturing
companies).Generallyseemstohappenatalevelwellbelowdominance.
Positivefeedbackonthedemandsideseemstohappenprimarilyfromnetworkeffects.
Distribution.Doesthefirmhavelocal,regional,ornationaldistributionscale?Veryfewfirms
havenationalscale.OneexampleisWalmart.Howtotell?Lookatfirmsoperationsand
revenuesonamap.Firmslikelyhaveadvantageswhereassets+revenuesareclustered.
Purchasing.Somefirmscanpurchaserawmaterialsatlowerpricesduetoscale.Somefirmsare
loweringsupplierOCbyprovidingsupplierwithbetterinformationaboutdemand.
ResearchandDevelopment:EconomiesofSCOPEexistwhenacompanylowersunitcostsasit
pursesavarietyofactivities,e.g.PharmaR&D,ideasfromoneresearchprojectcantransferas
theydidincreationofViagra.
Advertising.Advertisingcostperconsumerisafunctionofthecostperconsumerofsending
message*reach.Iffixedcostsinadvertisingarethesameforallcompanies,thebigger
companieshaveadvantagebecausetheycanspreadthatcostoveralargerconsumerbase.
Globalizationcan1.Undermineeconomiesofscaleinlocalmarketscantmaintainthis
advantageinnewmarketsorwithnewentrantproducts.2.Undercuteconomiesofscaleinsome
entireindustries.Marketleaderscanmoreeasilymaintaindominanceinrestrictedmarkets.If
marketisbigger,startupcanachieveeconomiesofscaleatloweroverallmarketshare.
WHYARECOMPANYSCOSTSLOWERTHANCOMPETITORS.Mustbeabletoanswer
thisquestionforproductionadvantages.
Productionadvantagesusuallyleadstolowergrossmarginsthanconsumeradvantage.
2. ConsumerAdvantages:Createvaluebydeliveringproductsthathavealargerspreadbetween
perceivedconsumerbenefitandcostthancompetitorsbyoutperformingonthebenefitside.
1. HabitandHighHorizontalDifferentiation.Ifsomeconsumerspreferaproducttocompeting
products,thenitishorizontallydifferentiated.Thisisreallysignificantifconsumersusethe
producthabitually.Doesnthavetobeunambiguouslybetterthanthecompetingproduct,itjust
hastohaveasetofafeaturesthatconsumersfindattractive.E.g.CocaCola.
2. ExperienceGoods.Anexperiencegoodisaproductthatconsumerscanassessonlywhen
theyvetriedit(e.g.medicalcare).Searchgoods.Consumercaneasilyassesqualityattimeof
purchase.Companiessellingexperiencegoodscandifferentiatebasedonimage,reputation,
credibility.Oftentechnologicallycomplexgoods.
3. Switchingcostsandcustomerlockin.Customersmustbearcostswhentheyswitchfromone
producttoanother.Themagnitudeofthesecostsdeterminesthedegreeoflockinthatcustomers
experience.Sometimestheyreobvious(companyhastoswitchEMRsystemstothetuneof
$100Million),sometimestheyresmallbutsignificant,sometimestheyrenotevenmonetary
(e.g.withFacebook,othernetworkeffectbusinesses).
Typesoflockin.1.Contractualcommitments.Costiscompensatorydamagesforbreachof
contract.2.Durablepurchases.Costisreplacementofequipmentdeclinesovertime.3.Brand
specifictraining.Costistimeandexpensetolearnanewsystemrisesovertime.4.
Informationanddatabases.Costistheconvertingofdatatonewformatrisesascollection
grows.5.Specializedsuppliers.Costisfundingofanewsupplier.6.Searchcosts.Costis
combinedbuyer+sellersearchcostsincludinglearningaboutqualityofalternatives.7Loyalty
programs.Costislostbenefitfromincumbentcompany+needtorebuildcumulativeuse
advantageswithanothercompany.
4. NetworkEffects.Hugesourceofconsumeradvantage,especiallyinbusinessesbasedon
information.
Twotypes.RadialandInteractive.Radialisahubandspokenetworkwhereacentralhubfeeds
thenodes.Airlinersandretailers(chains)areanexampleofthis;networkeffectsexistbutare
modest.Secondisinteractive.Nodesarephysicallyorvirtuallyconnectedtooneanother.E.g.
Visacard/creditcardplatforms.
Positivefeedbackiscriticalininteractivenetworks.Ifmorethanoneinteractivenetworkis
competing,thenetworkthatpullsaheadwillbenefitfrompositivefeedbackleadingtowinner
takesmosteffects.SwitchingcostswillRISEasthenetworkbecomelarger.Defactoexampleis
MicrosoftwithPCOS.
5. Consumeradvantagequestion.WHYistheconsumerwillingnesstopayHIGHandlikelytostay
high?Generallyappearfinanciallyashighgross
margins.
3. ExternalAdvantages.Usuallygovernmentalrelated.Issuesincludesubsidies,tariffs,quotas,and
bothcompetitiveandenvironmentalregulation.Changeingovernmentpoliciescanhavea
meaningfulimpactonaddedvalue,e.g.ACAinhealthcare.

FirmInteractionCompetitionandCooperation:

Howfirmsinteractwitheachothershapessustainablevaluecreation.

Gametheoryisoneofthebesttoolstounderstandinteractions.Forcesmanagerstoseetheother
companiesperspective.

Particularlyusefulinconsideringpricingstrategiesandcapacityadditions.
Companiescanalsocomplement;thistendstomakethatvaluepiebigger.

Brands:

Abrandisnotsufficienttoensurethatacompanyearnseconomicprofitsustainably;ofthetop
10mostvaluablebrandsin2012,2didnotreturnthecostofcapital.

Considerwhatjobaconsumerishiringaproduct/servicetodo.Companiesgenerallystructure
theirtargetmarketsbycustomercharacteristicsand/orproductcategory.Butconsumersdont
buysomethingbecausetheyresupposedto.Theyhireproducts/serviceswhentheyfindthat
theyneedsomethingtogetdone.Acompanycandifferentiateitselfandbuildabrandifit
understandsthejobcustomerwantsdoneanddevelopsitsproductsaccordingly.

Brandrepresentsaproduct/servicethatiseffectiveatgettingajobdone.

Approachbrandsfromtheperspectiveofhowthebrandaddsvalueandbyhomuch(i.e.goback
tothesourcesofaddedvalueandfindwhatspecificallythebrandaccomplishes)Abrandthat
confershorizontaldifferentiationorrepresentsanetworkeffectmayincreasecustomerwillingto
play.

Willingnesstopayforabrandishighif1.Customerisinhabitofusingit2.Haveemotional
connectiontoit3.Trustit,or4.Believethatitconferssocialstatus.

Lesscommonforbrandstoaddvaluebyreducingsupplieropportunitycost.

ADozenLessonsonGrowth,TrenGriffin

6. Whatisthejobofagrowthteam?Responsibilitytomeasure,understand,andimprovetheflow
ofusersinandoutoftheproductandthebusiness.Thatstheroleofgrowth.Everybusiness
mustaccomplishsomeobjectives:
Measuringfinancialmetrics.
Marketingproducts.
Optimizingproductstoenablethebusinesstogrow.
2. Allcompaniesneedtogrow,whetheritsasmalloneorTwitter.Everyaspectofaproducthas
thepotentialtohelpmakethebusinessgrowornot.CANNOTdesignaneutralproduct,
whethersitsanautomobile,building,orsoftware.Choicehavetobemadeinofferinga
product,andtheycanimpactgrowthpositivelyornegatively.
7. Numberoneproblemforstartupisthinkingtheyhaveproduct/marketfitwhentheyactually
dont.Howdoyoudrivegrowth?MakesomethingpeopleWANT.Ifpeopledontlikeyour
product,nothingelsematters.
1. Product/MarketFit:Beingagoodmarketwithaproductthatcansatisfythatmarket.
ValueHypothesis:Articulationofthekeyassumptionthatunderlieswhyacustomerislikelyto
useyourproduct.Findingproduct/marketfitrequiresyouhaveacompellingvaluehypothesis.
Valuehypothesiscoversboth1.PRODUCTFEATURES2.BUSINESSMODELrequiredto
enticeacustomertobuytheproduct.
Relatedconcept:CoreProductValue:Whatdoesthemarketdesireabouttheproduct.
GrowthHypothesis:Thoughtsabouthowyoucanscalethenumberofcustomersattractedto
yourproductorservice.Includesquestionslike:
Whatisthebestwaytocosteffectivelyacquirecustomers?
Pursuingthegrowthhypothesisbeforethevaluehypothesisisdeadly.DONOTDOTHIS.
8. "OnceyouunderstandwhatthecoreproductvalueisyoucancreateLOOPSthatexposethat
coreproductvalueoverandoveragain.Youhavetoworkbackwardsfromwhatisthething
thatpeopleareheretodo?,WhatistheAhamomentthattheywant,togivingthattothemas
fastaspossibleChamathPalihapitiya.
1. Inadditionto1.Findingproductmarketfit2.Identifyingcoreproductvalueyouneedto3.
identifyMagicorAhamomentsthatcustomersexperienceabouttheproductthepositive
experienceoftheproduct.
2. Ahamomentsrepresenttheopportunitytobuildagrowthhypothesis.Thesoonerpotential
customersgettothatAhamomentthebetterforthebusiness;EVERYMOMENTthatpasses
beforethenincreasestheprobabilitythatpersonwillnotbecomeacustomer.Abusinesswhich
deliversaseriesofAhamomentsasapartofFEEDBACKLOOPSwillexposecustomersto
coreproductvalueEARLYANDOFTEN.
9. Facebookfamouslydirectedemployeestogetusertoaspecificumberoffriendsinaaspecific
numberofdaysbecausethatwasanAHAmoment.OtherAHAmomentsincludegettinga
like/retweetonTwitter,orfindingtherightproductatacheappriceonAmazon.Theseare
METRICSthatquantifytheAHAmoment.
1. Characteristicsofleadingindicatormetrics:
NetworkDensity:Connectionsinanetworkmadeinatimeframe.
ContentAdded:
VisitFrequency:
2. ForFBitwas7Friendsin10Days.
10. Knowingthetruecoreproductvalueallowsyoutodesigntheexperimentsnecessarysothatyou
canisolatecauseandeffect.ForFBtheydeterminedtherewasakeylinkbetweenfriendsina
giventimeandlikelihoodtoCHURN.ThentheycouldgetnewuserstotheirAhamoment
quickly.ButobviouslythisrequiresyoutoknowwhatthatAhamomentiswithcertainty.
1. Youcanonlyidentifybestpracticesforgrowthbyexperimentation.
11. Basicgrowthequation:TopoftheFunnel(A)xMagicMoment(B)=SustainableGrowth(C)
1. MostgrowthprofessionalsstartworkingonAfirst.ButifyoudontunderstandB/C,thenyoure
addingpeopletoaleakybucket.Topofthefunnelisaboutmechanismstodrivetraffic
+conversionstoproduct(SEM,SEO,PaidAcquisition).Ahamomentsarethecompelling
experiencesthatcreateaninitialemotionalresponsetothecustomersfirstexperience.
2. Anotherwaytothinkaboutthisis:
Acquisition:
Whatdopeoplewanttoaccomplish(Whatisthecoreproductvalue)?
Whatisthebestwaytogetpeopleexperiencingtheservicequickly?
Activation:
WhatistheAHAmoment?
Howdoyougetpeopletothispointasfastaspossible?
Engagement:
Howcanthebusinessdeliverasmuchcoreproductvaluetocustomersaspossible?
3. OnlyafteryougetthosethreepartsDOWNdoyoumoveontomakingvitalityaconcern.
4. AndyJohnelaborates:1.Howdoincreasetherateofacquisition?2.WhatcanIdotoactivateas
manyusersaspossibleinthefirstNdays.3.Whataretheleversforengagementandretention
andhowcanIpullthem?4.HowdoIbringchurnedusersbackintothesystemtoresurrect
them?

5. DaveMcCluresprocess:AARRR
Acquisition:where/whatchannelsdouserscomefrom?
Activation:what%ofusershaveahappyinitialexperience
Retention:dotheycomebackandrevisitovertime?
Referral:dotheylikeitenoughtotelltheirfriends?
Revenue:canyoumonetizeanyofthisbehavior?

12. RemovethefrictionthatimpededusersfromgettingtotheAHAmoment.Eliminateany
unnecessaryfrictioninthecustomeracquisitionprocess.WhenindoubtREMOVEstepsthata
customermusttaketogettoanAHAmoment.HowcanthecustomergetanAHAexperiencein
justseconds?
1. Firststepisunderstandingallthechannelsthatbringnewuserstoyourproduct.Whatarethe
conversionratesofeach?
Easiertobuildonastrengththatimproveonaweakness.
Easiertogetanactiveusertodomorethantogetaninactiveusertodoanything.
DesireFriction=Conversion.Creatingdesireishard.Removingfrictioniseasy.
10%Rule.Assumingyoucanincreasetheconversationrateby10%ineachchannelby10%,
howmanynewuserstoyougetfromeachflow?
13. Thinkaboutwhatthemagicmomentisforyourproduct,andthengetpeopleconnectedtoitas
fastaspossible.
1. Notlosingcustomersisanunderratedwaytogenerategrowthinabusiness.CHURNisthe
limitingfactoronthebusiness.Atsomescale,churnwillpreventthebusinessfromgrowing.
Thentomaintainrevenuefromthecustomerbaserequiresmoreandmorecashfromthatsuer
base.
14. Shorttermoptimizationneverworks.
1. Ifyouhaventdiscoveredcoreproductvalue,noamountofgrowthwillsaveyou.Hacksor
vitalitybeforeproductmarketfitisproblematic;thosecustomersaregoingtoleaveanyways.
15. GrowthisNOTaboutgeneratingextranormalorextraordinarybehaviorsinpeople.Itsabout
theelegantunderstandingofproductvalueandconsumerbehavior.
1. Itisfarbettertocreateaprocessbasedonadeepunderstandingofconsumerbehaviorthanto
relyonatrick.
2. Goodbookstounderstandconsumerbehaviorinclude:Influence,ThinkingFastand
Slow,Misbehaving.Understandconceptlikereciprocityandsocialproof
16. Retentionisthemostimportantthingforgrowth.Retentioncomesfromhavingagreatideaand
agreatproducttobackupthatidea,andagreatproduct/marketfit.Douserswhoinstallproduct
stayonitlongterm?

YouhavediscoveredProduct/MarketFit.WhataboutaMoat?,TrenGriffin

Moatisdifferencebetweenvaluecreationandcompetitiveadvantage.

Evenifabusinessdiscoverssolutionstothevaluehypothesisandthegrowthhypothesis,without
amoat,thelongtermprofitabilityofthebusinessisinjeopardybecauseyouwillnotsustainthe
businessgivenacompetitiveresponse.

YouneedtoSUSTAINreturnoninvestedcapital.Atbest,withomoat,thebusinessisprofitable
forawhile,butitovertaken(e.g.Groupon).

MichaelMauboussin:Companiesgeneratinghigheconomicreturnswillattractcompetitors
willingtotakealesser,albeitstillattractivereturn,whichwilldriveaggregateindustryreturnsto
theopportunitycostofcapital.

Similartoevolutioninnature.

Predictingthefutureofmoat(theyareneverstatic,alwaysincreasingordecreasing)isHARD:
factorsthatcreateamoatareconstantlyinflux.Theycanfallapart(e.g.Newspapersphysical
distributionbasedmoat).

Newinventions/innovationsDOESNOTequalhavingamoat.Itisabigmistaketoconfusea
moatshortagewithaninnovationshortage.MOSTinnovationsdonotproduceanyprofit,more
likelytodestroyprofitsandletvalueflowtocustomers.

Factorsthatcreatemoats:Qualitative
Factorsthatmeasuremoats:Quantitative.

Quantitativetest.LooktoMMarticledidthebusinesshaveanearnedreturnoncapitalthat
substantiallyexceededtheopportunitycostofcapital(discountrate)for35years.

Qualitative.Noformulas/recipes.NotSUPPOSEDtobeeasy.

OnionTheoryofRisk(fromAndyRachleff,founderofBenchmark):Thinkaboutacompanyon
dayonehaseveryconceivableriskpossible;,makealistoftherisks.

1.Foundingteamrisks(arethefoundersgoingtobeabletoworktogetherandbuildtheteam)2.
Productrisk(Canyoubuildtheproduct?)3.TechnicalRisk(Doyouneedsomefundamental
breakthroughintechnologytomakeyourproductwork?)4.Launchrisk(Willthelaunchgo
well?)5.MarketRisk(Doesthemarketwanttheproduct?)6.Revenuerisk.7.Salescostrisk
(Doyouselltheproductwithenoughrevenuetoactuallypayforthecostofsales?8.Viral
growthrisk(ifyouareaconsumerproduct).9.Competition.10.Timing.11.Financing.12.
Distribution13.Marketing

Eachriskmustberetiredatsomepointbythebusinesstomakeaprofit.Moatsarecriticalto
reducingcompetitionrisk.

EugeneKleiner:Riskupfront,outearly.Anotherwayofsayingthis:Reducethebiggest
risksfirstforthefewestdollars.

Haveastrongbiasforeliminatingthebiggestrisksquicklymuchmorerelevantwhenyouare
startingcompanieswithhightechnicalrisksandlowmarketrisks(e,g,Pharmaceuticals).

CreatingmoatsisanART.Thisiswhyentrepreneursarestylizedasartists.Particularlywhen
youseeindividualsbuildsuccessfulbusinessmultipletimes,itishardnottosaythatthisskill
luckaxistiltstowardsskill.

However,moatcreationinareallylargeandvaluablemarketisareallyrareevent.Mostventure
backedbusinessfail.

Factorsinvolvedincreatingmoats:
1. DemandSideEconomiesofScale.AKANetworkeffects.Productorservicebecomesmore
valuableasmorepeopleuseit.Mostmultisidedplatformshavestrongnetworkeffects.Most
valuablefactorsincetheycanincreasebusinessvalueNONLINEARLY.Thesetypesofmoats
arevastlymorescalablethanothertypesofmoatsthereturnstoaDSEScompanyexceedsthat
oflargeproducersthatarebasedonSSES.Noneismorevaluablethanthis.
2. SupplySideEconomiesofScale.Abusinessgeneratessupplysideeconomiesifperunitcosts
fallwithincreasingoutput.However,theseeconomiesstopatsomepoint,andgenerallytheyare
exhaustedwellbeforebusinessdominatestheentiremarket,e.g.GMneverhad100%MS.Rare
exception:StandardOil.Nevertheless,thiscancreateveryvaluablebusinesses.
3. Brands/Patents/OtherIPProtections:Astrongbrand==pricingpower.Patentsautomatically
createamoat.Opensourcehasmadethisstrategyproblematicforsoftwarecompanies.
4. Regulation:Sometimesbusinesshavecreatedcompetencewithregardtoregulationthatisso
highthatregulationservesasamoat.

Industryvs.Strategy/Management:

Ingeneral,whenamanagementbrilliancegoesheadtoheadwithbusinesswithbadeconomics,
thereputationofthebusinesscomesoutintact.Arrogantforacompanytobelievethatitcan
deliverthesamesortofproductthatitsrivalsdoanddobetterthancompetitorsoverthelong
run.Thatgenerallyleadstopricecompetition,whichinevitablydegradesto0profit.

Buffett:Thekeytoinvestingisnotassessinghowmuchanindustryisgoingtoaffectsociety,or
howmuchitwillgrow,butratherdeterminingthecompetitiveadvantageofanygivencompany
and,aboveall,thedurabilityofthatadvantage.Theproductsorservicesthathavewide,
sustainablemoatsaroundthemaretheonesthatdeliverrewardstoinvestors.

CrossingtheChasm:MarketingandSellingHighTechProductstoMainstream
Consumers,GeoffreyMoore

ConfessionsofaVentureCapitalist,RuthannQuindlen

CompetitiveStrategy,MichaelPorter

Chapter1.TheStructuralAnalysisofIndustries.

Fundamentalessence.Relatingacompanytoitsenvironment.
Keyaspectofenvironmentistheindustryorindustriesitcompetesin.Industrystructure
influencesthecompetitiverulesofthegame.

Competitioninanindustryisrootedintheunderlyingeconomicstructureandgoesbeyondthe
behaviorofcurrentcompetitors.Thereare5basiccompetitiveforces.Collectivestrengthof
theseforcesdeterminetheultimateprofitpotentialoftheindustry(profit=longtermreturnon
investedcapital).

Basicmapofcompetitioninanindustry.
Whatarethekeystructuralfeaturesofindustriesthatdeterminethestrengthofcompetitive
forcesandhenceinfluenceprofitability?

Goalofafirmvisaviscompetitivestrategyistofindapositionintheindustrywherethe
companycanbestdefenditselfagainstcompetitiveforcesORcaninfluencetheminitsfavor.
Industryworkingdefinition:Groupoffirmsproducingproductsthatareclosesubstitutesfor
eachother.

Competitioninanindustrycontinuallyworkstodrivedowntherateofreturnoninvestedcapital
tothecompetitivefloorrateofreturnorthatwhichwouldbeearnedinaperfectlycompetitive
market.
Whatsthefloor?Yieldongovernmentbondsadjustedupwardbyriskofcapital
loss.

Investorswonttoleratereturnsbelowfloorrateinlongruntheycanjustinvestinother
industriesifso.Ifthereexistsreturnshigherthanthefloorrate,itstimulatesinflowofcapital
intotheindustrybynewentryoradditionalinvestmentbyexistingplayerstheywantsomeof
therevenue,happytotakeasmall(butstilllarge).Profitgetscompetedtonothing.

Fiveforces:1.ThreatofNewEntrants2.ThreatofSubstitution3.BargainingPowerofBuyers4.
BargainingPowerofBuyers5.Rivalryamongexistingfirms.

Allofthoselistedabovearecompetitors'tothefirm.Youcompetewithyoursuppliers,notjust
existingfirms.Itscalledyourextendedrivalry.

All5componentstogetherdetermineintensityofcompetitionandprofitability.
Underlyingstructureofanindustryreflectedinthestrengthoftheforcesshouldbedistinguished
fromtheshortrunfactorsthatcanaffectcompetition/profitabilityintheshortrun.Focusofthis
analysisisstructuralanalysisIDingthebasicunderlyingcharacteristicsofandindustryrooted
initseconomicsandtechnologythatshapethearenainwhichcompetitivestrategymustbeset.

ThreatofEntry

Newentrantstoanindustrybringnewcapacity,thedesiretogainmarketshare,andsubstantial
resources.Pricescanbebiddown,incumbentscostscanbeinflated,reducingprofitability.

Donthavetocreateanewentitytohaveanewentrance.Companiesthatdiversifyingthrough
acquisitionintoanewindustryisanewentrant.

Threatofentrydependsonthebarrierstoentrythatarepresentcoupledwiththereactionfrom
existingcompetitorsthatanentrantcanexpect.Ifreactionissharpandbarrierstoentryarehigh,
threatofentryislow.

6majorsourcesofbarrierstoentry:
1. EconomiesofScale.Refertothedeclinesintheunitcostsofaproduct)oroperation/functions
thatgointoproducingaproduct)astheabsolutevolumeperperiodincreases.Thesedeterentry
byforcingtheentranttocomeinatlargescaleandriskstrongreactionfromexistingfirms,or
comeinatsmallscale,butatacostdisadvantage.Saleeconomiescanbepresentinnearlyevery
functionofabusiness,frommanufacturing,purchasing,researchanddevelopment,marketing,
servicenetwork,salesforceutilization,anddistribution.
1. Scaleeconomiesmayrelatetoanentirefunctionalarea,asinthecaseofasalesforce,ormay
stemfromparticularoperationsthatarepartofthefunctionalarea.E.g.economiesofscaleare
largeincolortubeproductionfortelevisionsets.
2. Economiesofscopeformultibusinessfirms.Firmscanreapeconomiessimilartothatofscaleif
theyareabletoshareoperationsorfunctionssubjecttoeconomiesofscalewithotherbusinesses
inthecompany,E,g,ifacompanymakeselectricmotorsthatgoin45differentproducts,they
thenhaveeconomiesinthemotormanufacturing.Thus,diversificationaroundcommon
operations//functionscanremovevolumeconstraintsanyentrantthenisforcedtobe
diversifiedfromthegetgoorbeatacostdisadvantage.
Forthisbarriertoentrytobesignificant,itiscrucialthatthesharedoperationbesubjectto
economiesofscalethatextendbeyondthesizeofonemarket.Otherwiseyouwillhaveillusory
costsavings;dependonlyonthepresenceofexcesscapacityinoperation.
3.

CompetitiveAdvantage,MichaelPorter

LetsTalkaboutProductManagement+AProductManagersJob,JoshElman(Partner,
GreylockVentures)

Job:Helpyourteam(company)shiptherightproducttouser.s

1.Helpyourteam:
A.Coordination.Theteamhastoplan,makedecisions,andworktogethereffectivelywitha
clearpurposeandfocus.
B.Communication.EveryoneneedstounderstandWHATishappening,WHEN,andWHY,as
thingschange.

DontthinkoftheproductmanagerasaCEOoftheproduct.Bestteamsoperateinaway
whereteamCOLLECTIVELYfeelsownershipovertheideaandeveryhasbeenabletosuggest
andpromoteideas.Bestproductmangerscoordinatedecisionsmakingbytakinginputsfromall
teammembers.

2.Company.
Youmustunderstandthecompanysoverallgoalsandobjectivesandhowyourteamfitsintothe
broadervisionofthecompany.Articulatehowthemicrolevelmetricsandgoalsbolsterthethe
companysoverallstrategy.
3.Ship.
Actuallydeliveringproductstoyourusersishowyouwillbejudged.Nothingelsemattersunless
yougetyourteamtoapointwhereyoucanshiptheproduct.Trickybalancebetweengettingit
rightandgettingittoconsumers.

4.TheRIGHTproduct.

5.Foryourusers.

HardestpartofbuildinganyproductisarticulatingyourCOREUSECASEwhoshouldusethe
productandwhy(similartoCOREPRODUCTVALUE).Bestproductmanagersadvocatefor
usersandrepresenttheuserinnearlyeveryconversationabouttheproduct.

YouhavetohaveaDEEPUNDERSTANDINGaboutyouruserswhataretheirproblems,
issues,andchallenges.

Productmanagersdont:1.signdeals(businessdevelopment)2.createmockups(design)3.
writecode(engineers)5.planPR(communications).

Productmanagerjobs:
Definethemarketandtheconsumer.
Definetheproblemandthevaluehypothesis
Identifycompetitors,incl.theirproductsandcapabilities
Defineproductrequirementsandroadmap.
Coordinatelaunchtiming,salesandmarketing.

Youneedto:
SETCADENCE:
Buildtheproductroadmapbybrainstormingmeetings(quarterly)
Articulatetheroadmapclearly.
Holdregularproductoperationsmeetings(weekly)
TakeCLEARmeetingnotes.
Brainstormeffectively
Everyonepitchesideas.
Q&Awherepeopledescribe/pitchideas.
Everyonevotefortop3.
Discussionofhow+WHYpeoplevoted.
Revote
Top3plans.
Manageproductoperations.
Sharecompanynewsrelevantfortheteam.
Learnings+analysisofrecentfeatures.
Checkinonnewdevelopments.
YourjobismainlytoDOCUMENTdecisions.Notesareprobablythebiggestthingyouneedto
do.
ACTSOLID(Analytics,Communications,Trust,SupportOps,Legal,International,Design).

Hiringtip:Howoftendocandidatesrefertothebiggervisionofthecompany.

Shipping>Perfection:

Helpingtheteamonlymattersifyoucanshiptheproduct.
Provideclearcriteriaforwhenaproductisreadytolaunch.
Makedifficulttradeoffdecisions.
Prioritizeruthlessly

NeedtheRIGHTideas.
Takefeedbackfromtesters+activeusers.
Listentocriticismfromnonusers.
Inputfromfounders.
Getideasfromanywhere.
YoumustMEASURERESULTS.
Theoryoftheimpactyouwanttohave.
IDmetricsthatdemonstratetheimpact.
Generatedataonwhatworksanddoesnt.

Youmustadvocatefortheuser:
Disruptionvs.Enablement,JoshNussbam(Partner,LightspeedVenturePartners)

Importantquestionsforinvestors:
Wheredidpastvaluecreationcomefrom?Whatwasthepathdependencethatledtowherewe
aretoday?
Whatschangedrecentlythatmakesthepathdependenceofyesteryearlessimportanttoday?
Couldbetechnologicaladvance,shiftinconsumerpreference,regulatoryarbitrage,etc.Doesan
opportunityexisthere?
Whatmoatsdotheincumbentshave,wheredidtheycomefrom,andhowhavetheydefended
thosemoatstodate?Aretherestructuralmisalignments,inefficiencies,fragmentation,or
consolidationthatcreateapotentialvulnerabilityinthemarketthatastartupcantakeadvantage
of?
Whataretheincentivesofthestakeholdersinvolvedandhowmighttheyreacttothestartups
marketpositioning.Willanegativereactionmatter?Ifpositive,howwillitleadtovaluecreation
inthefuture?
Allthisservestoanswerthequestion:canthetechnologycreatedefensible,venturebackable
businesseswiththehighestprobability.

Doyoudisruptorenable?

Disruption:strategyofservingapreviouslyunderservedmarket(usingtechnologytoprovidea
productorservicetoanendcustomerwhopreviouslycouldntorstruggledtoaccessitdueto
eitherthetypeofproductorserviceitis,orbycostsrelatedtothestructureofanindustry)or
targetinganoverservedsegmentbydeliveringabetterorcheaperproduct.
Youcan1.Createanewmarket,2.Servecustomersthatpreviouslywerentpartofthe
market,3.Aggregatedisparatepartsofthemarkettocreatebettereconomicsorabetter
experience,4.Siphonawaycustomersfromincumbentswithanalternativethatisbetterbecause
itsmoreefficient,cheaper,andservestheirneeds/wantsbetter.

Enablement:Insomemarketsthereareindustrydynamicsatplaythatmakeitimpossibleorvery
difficulttodisrupt.Enablementbasedcompaniesbuildproductstoimproveprocessesand
providetoolsthatexistingcompaniesareunabletobuildinhousebecauseitdoesntmakesense
tofinancially,ortheyidonthavetheabilityto.

TypesofDisruptors:
1. Marketplaces.Workbestwhentheycreatenewvaluebymatchingsupplyanddemandmore
efficientlybymakingpreviouslyunavailableordifficulttoattainorassessupplyeasily
accessible.
1. BestsuitedforhighlyfragmentedindustrieswheresupplyisaCOMMODITY.
MostcommonexampleisUber;customerjustwantstogetfromPointAtoB.ChooseUber
becauseitsthefastest,cheapest,highestquality.Basicallyacommodity.
2. Sincesupplyiscommoditized,frequencyofpurchaseisextremelyimportant.Switchingcostsare
quitelowinthesemarkets,youcanonlytakeasmallpercentageofthetransactionotherwise
youllgetintoapricewar.
marketplacecompanythereforehaslessroomtoplayaroundwithhighCAC.Usershaveto
thereforebekeptreducingchurnisCRITICAL.
3. CanalsoworkinindustrieswherethesupplyisntacommodityBUTthefragmentedsuppliers
dontbenefitfromeconomiesofscaleduetoindustrydynamics.Particularlyrelevantforhigh
touchservices.
E.g.Upcounsel(marketplaceforlegalservices).Startupsherebuildpreviouslynonexistent
economiesofscalebybuildingtechnologythatroutecustomerstoservicethatbestsuitestheir
needsaswellasbymakingtheprocessfrictionless.
Supplysideservesmorecustomerswhiledemandsideenjoysbettereconomics.
Usuallyahumaninvolvedwithprovidingtheservice.Thisleadstohigheraveragetransaction
sizesandtheopportunityforthestartuptoaddvaluebymakingtheserviceseamlessforall.
Purchasefrequencyisthereforelessimportant;therearedifferentiatorsforyourservice.
HOWEVER,doesntworkforallcomplextasks.Ifthereisahighdegreeoffragmentationin
thequalityofsupply,itshardtomakethemathwork.I.e.douserstrustyourmarketplaces
rulesforverification(relevantinmarketswherethereisahighvarianceinquality)enoughto
transactattherateyouneedtomaintainliquidityinthedemandsideofthemarket?
4. Thisisquiterare.Somemarketshavefragmentedsupply,butaggregatingthatsupplydoesnt
leadtoaneconomyofscale.Etc.Hardtofindamarketwhereallofthequalitiesexist.
5. Whenlookingatcoststructures+marginsofincumbents,itsimportanttodiscerntheirsizeand
scalewhendeterminingtheirreactiontoaanewentrant.
6. Workedexample:Uber.
Supply=Commodity.RiderswanttogettoPointBfromA.Thatsit.
Purchaseisveryfrequent.
TaskisNOTcomplex.
Humancomponentnecessary?Fornow,yes.Butnotspecializedsononeedforaworkforceof
humansinteractingwithcustomerstohelpthempurchase.
7. Didntworkexample:Homejoy.
Supplewasnotacommodity(kindof).Homecleaningisntacomplicatedtaskbutalsoisnota
commoditydifferentpreferences.Leadstodifferentiatedqualityofsupplythatshardtoscale.
Purchasefrequencyisdependentoncustomerspersonalpreference.
Complicatedtask?Notreally,buttherearepersonalpreferences.
Humancomponent?Yup.Butthesupplesideeconomyofscaleisnotnearlyaspowerfulwhen
thecleanerhastospendtwohoursatthecustomershome.
2. Aggregators.Iftheindustryisplaguedbyanabundanceofchoice(search/transactioncostsare
high),customerswillshoparoundandlookforguidanceoradviceinseekingoutthebest
productforthem.Aggregatorsaretwosidedmarketplacesinwhichtheaggregatoractsasan
intermediarybetweenbuyersandsellers,usingdatatoroutethebuyertothebestsellerfortheir
needs.Similartomarketplacesbecausetheymatchbuyersandseller,butmarketplacescontrol
thesupply,whileaggregatorspassthecustomerontotherightsuppliertofulfillthepurchase.
1. E.g.ZocDoc,Ebay,Facebook,Netflix.
2. Worksbestwhentheindustryeconomicsallowincumbentstowithstandastartupcommoditizing
themarketandthereforestartupscanacquirenewcustomersforthemandimprovethe
experiencewhileeveryoneenjoystheprofitofthenewdistributionchannel.
3. Alsomustbeenoughexistingcompaniestoprovideproductsthathaveclosetoanequalfooting.
Thereneedstobeenoughsupplyavailabletoavoidsupplierbargainingpower.
4. Products/Servicesneedtoconsistofenoughdifferentiation(unlikemarketplaces)where
customerneedsandpreferencesdomatter.Thesebusinessesusetechnologytoprovideguidance
andinformationtocommoditizesupplytoadegreethatthecustomercanmakeandinformed
purchasedecision.
FinelinebetweenmarketthatfitsthiscriteriaandoneinitcurrentproductsareVASTLY
differentandconfusingtoamendsuer,inwhichcasecommoditizationbecomesverydifficult,
andatrustedthirdpartyhumanadvisor.mightbepreferable.
5. Attractivemarketstoaggregatorsarethoseinwhichthereisasignificantbarriertoentryto
competedirectly,butwherebytechnologicaladvanceshavecreatedacatalystforanintermediary
toaggregateincumbents,metadata,andconsumerpreferences.
6. Shouldhavefragmentedsupplyandproductdifferentiation,butnottothepointwhere
consolidatingandcommoditizingthesupplyleadstomoreconfusionfortheconsumerto
navigate.
7. Alsohavetowatchoutforwhensupplyanditsmetadataiseasytoaccess.Sinceitseasierthane
vertostartacompany,thedefensibilityinstartingoneofthesecompaneisliesinconsumer
acquisition.
Masterstrokeforaggregatorscomesafterthereissignificantdemandsidegrowth.Aggregators
usuallythriveinindustrieswherethereissubstantialbarriertoentryforupstarts.These
companiesusedatatheyvecompiledonusersandleveragedemandsideeconomiesofscale
whendiscussingwithsupplierstocreatetheirownsupplywhiletheirsuppliersareforcedinto
commoditizationbecausetheaggregatorownstheconsumerandthereforethesesuppluersfust
tailortheproductorservicetothecompany'sspecifications.
BenThompsonsAggregationTheory:"Morebroadly,Isuspectmanyindustrieswillinthelong
runfacethissortofonetwopunch:thefirstaggregatorswillfocusonbetterconnectingthe
consumertothesupplythatexists,buttheirdominationwontbecompletebecausetheyare
competingwiththeirsuppliers.Later,though,willcomeVersion2.0aggregators,whichnotonly
captureconsumersbutalsocompletelymodularizesupplythatisoftenexclusivetotheir
platform.Forexample,Googleaggregatednewspapers,butFacebookultimatelywonthe
attentionwarbydevelopingitsownsupplyofcontent.Netflixaggregatedvideocontent,butits
reallongtermvalueisinthecreationofitsown;YouTubehasgoneinthatdirectionfromthe
beginning.Thedegreetowhichincumbentsfendthemoffwillbeafunctionofjusthowmuch
differentiationfortheendusertheyprovide.
Thisendgameiswhyfindingtheperfectmarkettobuildthesebusinessesanbeextremely
defensible(andthusprofitable).Bystartingoutinamarketwheretherearesignificantbarriersto
entryexistinbuildingafullstackmarketplace,aggregatorscanbackintothesamemodelover
time,takingadvantageofbetteruniteconomicstobecomethemarketskingmakeratamuch
greaterscalethantheproducts/servicestheyonceaggregated.
3. ManagedMarketplaces.Marketplacesthatdontjustconnectbuyersandsellers,buttakean
additionalpartsofthevaluechaintoofferabetterexperience.
1. E.g.Compound.Purchaseshighendhandbags,andthensellsthemonavarietyofchannels.
Theytakeontheadditionalvaluechainprocessofpurchasingthehandbagsupfronttomaintaina
liquidsupplyofatraditionallyilliquidgood.Anotherexample.OpenDoor,whichbuyshomes
directlyfromseller,certaintyofsale,inexchangeforwhatthecompanybelievestheproperty
couldbeworthontheopenmarket.
2. Unlocknewsupplyandreducethepainofsellingcertainitemsbyprovidinganaddedbenefitor
servicethatmakesthetransactionmoreseamless.ThisusuallyinvolvesmakinglifeonONEside
ofthemarketplaceeasierbecausethereisenoughmarginafterthesaletocoverthecostsandstill
addvaluetothatsideofthemarketplace.
4. TechEnabledMiddlemen.Startupsthattargetwaysofhelpingpeoplethatcouldtraditionally
onlybedoneonanagencymodel.
1. E.g.Compass,arealestatebrokeragethatgivesbrokersaccesstodataandtoolspreviously
unavailableatotherbrokeragestoclosedealsfaster,andprovideoverallbetterservice.
2. Whenacompanyhasaccesstoatypeofdatasetwithlotsofrelevantfeaturestotheir
businesses(letsthemiddlemanbemoreefficient),themiddlemencanbeempoweredwith
superpowers,improvingtheirefficiency.
3. Mustdeterminewhetherornotthereisadditionalunderlyingprofittobehadbyconsolidatinga
previouslyfragmentedmarket.Byaggregatingindividualagentsparticipatinginthemarkets,can
startupproduceaneconomyofscalethatmakesforbetterpricing,additionalnegotiatingpower,
orbetterallaroundvalueforasideofamarket?
Ifthisispossible,thecompanycanproducebettermarginsthantheindustrystandardandwill
havegreatopportunitybecausethereisenoughmarginandthecompetitiveadvantageincreases
asthecompanyscales.
Anotherthingtowatchoutfor:howlongdotransactionstaketoclose.Ifyoucantstreamline
theprocess,theymaynotbecomevaluableenoughtocustomers.
ThisisessentialtobothTEMandMMmodelsbecausesomehowyouhavetohaveawayof
augmentingtheexperience(MM))orempowerthemiddleman(TEM).Withoutasuperiordata
setorsourceofeconomiesofscale,youhavenosustainablecompetitiveadvantage.
4. Leveragingthesedatasetsworkbestinmarketswherepurchasefrequencyisverylowandthe
stakesarehigh,e.g.buyingahome.Thesepurchasestendtobecomplexandhappeninmarkets
thatarenttypicallyliquid.Generallythetransactionsarenotprocessesthatpeopleareusedtoor
comfortablewitthevaluecomesfromhavingahumanassistthecustomerprovidethemwitha
highdegreeofconfidencethattheyregettingthebestpossibledeal.
Hightransactionvalueensuresthatthereisenoughmargintowarranthavingamiddlemanand
paythecompanyfacilitatingthetransaction.
5. NewProducts.Insomeindustries,astartupsbestchanceforsuccessistocompetewith
incumbentsinamarketbycreatingtheirownproductduetoanewfoundadvantagesuchthatthe
resultingmarketdynamicpreventsestablishedplayersfromcompetingproperly.Thisshiftin
marketdynamicisoftenashiftinconsumerpreferences/behaviorortechnologicalprogressof
suchmagnitudethatforthefirsttimemakestheimpossible,possible.
1. GreatexampleisJapanesecarmakersdisruptingoldAmericanautomakers.
2. Dominoesareaptmetaphorsforcertainfactorsbreakingjusttherightwaytocreatenew
products.
3. Havetothinkaboutwhatyourmoatis:
Understandpreviousbarrierstoentryinthecategory.
Whyhavethesebarriersbeenlifted.
Doespricingpowerexist?

TypesofEnablement:
1. SAAS
2. API

HowtoBuildandEnduring,MultiBillionDollarBusiness+TakingtheWrongLesson
fromUber,SarahTavel(Partner,GreylockVentures)

ThemagicofUberisthatitusedmobiletocreatea10xbetterproductthantheincumbentand
didsoatalowerprice.TheANDiseverything.

Uberactuallyhadtoiterateacoupletimes(andstealapageoutofLyftsplaybook)when
launchingUberXasalowcostuberin2013.ThentheyrolledoutUberPool,whichwas40%
cheaperthanthat.

ThisisverypowerfulbecauseeachtimeUberwasabletoleveragethemarketplacedynamics
(verystrongnetworkeffects),assetlightbusinessmodel,andcheapcapitaltosubsidizeitsprice,
theiraddressablemarketgrew.

Sototheproblem.Newondemandstartupsdotwothingswrong1.Theyaddnewcosts2.
theydontfundamentallyrecastcoststructureslikeUberdid.Theuniteconomicsofthese
businessesdontmakemuchsense.

Tonsofbusinessesaredoingthis:Alibaba,Craigslist,AirBnB,etc.)Shouldntbetoomuchofa
surprisethat10x+cheaperissuchakillercombinationforconsumers.Alsohappenstobea
greatcatalystforwordofmouth.

1. Itsaboutthe10xproduct.Savingmoneyisthrowinggasonthefire.
1. ServiceshouldntLEADwithsavingmoney.Theofferingshouldbesocompellingthatitstands
byitselfintheconsumermind.
Uber,AirBnB,Amazon,allofferaproduct,thatevenindependentofpriceismucheasiertouse
andhasadistinctvaluehypothesis(withstrongmoats).Thepriceacceleratesbehaviorchange,
buttheproductiswhatkeepscustomers.
Ifhoweversavingmoneyisthefeature,itputshugedownwardpressureonthecompanysunit
economics.
2. Usetechnologytorecastincumbentcoststructures.
1. Technologieshavetorecasethecoststructureoftheincumbent.Createsastructuralcost
advantage,andifyouhaveeconomiesofscaleornetworkeffects,thatadvantagegrowsasyou
scale.
2. ECommerceexample:
Recastcoststructureofbrick/mortarretailersbycentralizingoperationsandbenefitingfrom
hugescalesonthesuppleside.
3. SharingEconomy.
Unlockslatentvalueinunderutilizedassets,isveryassetlight.
4. P2Pmarketplaces.
eliminatemiddleman,passsavingtoparticipantsinthemarketplace+reduceoperational
overhead.
5.

AggregationTheory,BenThompson(Stratechery,Consultant)

Thevaluechainforanygivenconsumermarketisdividedintothreeparts:1.Suppliers2.
Distributors3.Consumers/Users.Thebestwaytogainabnormalprofitsinthesemarketsisto
gainahorizontalmonopolyinoneofthethreeparts(e.g.adistributionmonopoly),orto
integratetwoofthepartssuchthatyouhaveacompetitiveadvantageindeliveringavertical
solution.
Preinternet,peopleaccomplishedthelatterviacontrollingdistribution.
E.g.newspapers.Theyweretheprimarymeansofdistributingcontenttoconsumersina
geographicregion,sothenewspapersintegratedintothesupplierlayerbycreatingcontentand
earnedoutsizedprofitsviaadvertising.
Existedinotherindustries:bookpublishers(distributioncapacityintegratedbackwards
tocontrolauthors),TV(broadcastdistributionintegratedbackwardswithcreating/purchasing
content),taxis(dispatchcapabilitiesintegratedwithmedallionstocontrolsupply).

Inalltheaboveexamples,thedistributioncontrolpowersintegratedbackwardsintosupply.Ina
worldwheretransactionsarecostly,owningthesupplierrelationshipprovidesmoreleverage.
BUT,internethasflippedthisdynamic.1.Distributionofdigitalgoodsisnowfree,neutralizing
theadvantageindistributionthatpreinternetcompaniesleveragedtointegratebackwards(how
areyougoingtocontrolpublishingwhenthecontentcreatorscangostraighttotheiraudience?)
2.TheInternethasmadetransactioncostsZERO,makingitviableforadistributortointegrate
forwardwithendusers/consumers.

Thishaschangedtheplaneofcompetition.Distributorscantcompetebasedonexclusive
supplierrelationships.Nowsupplierscanbecommoditizedandaggregatedatscale,leaving
consumers/usersaFIRSTORDERpriority.Themesimportantfactorinearningsustainable
competitiveadvantagethenistheUSEREXPERIENCE.
ThebestaggregatorshavethefollowingCROSSSIDEnetworkeffect:bestexperience>most
consumers>mostsuppliers(crosssidenetworkeffect)>enhancesuserexperience.

Soallthesupplierintegratedcompanieslosevalueinfavorofaggregatorswhoaggregate
modularizedsupplierswhichtheydontpayfortoconsumerswithwhomtheyhavean
EXCLUSIVErelationshipatscale.

Examples:
Google.Publishersusedtointegratepublishing+content/articles.Googlemodularized
thecontentbymakingthemdirectlyaccessibletousersviasearch.ThenGoogleintegrated
searchresultswithsearchandprofiledataaboutusersenablingittosellhighlyeffective
advertising.
FB(andAdNetworks):Publishersintegratedcontent+advertisements.FBmodularized
advertisementsbyallowingadvertiserstotargetcustomersdirectly,enhancedbyprofiledata.
Amazon.Bookpublishersintegratedediting,marketing,distribution.Amazon
modularizeddistributionviaecommerceandebooks,goingdirectlytoconsumer.Then
Amazonintegratedcustomerdataandpaymentinformation.
Netflix.Networksintegratedbroadcastavailabilityandcontentpurchases/creation.
Netflixmodularizedbroadcastavailability,makingtheentirelibraryavailableatanytimeto
users.Thentheyintegratedcontentpurchaseandcustomermanagement,creatingcycleof
increasedsubscriptiondemandincreasingcontentpurchasecapability.

Now,consideringFBandSnapchat,theyareSUPERstrongaggregatorsbecausetheirsuppliers
aretheirownUSERS.Thatsfuckingpowerful.

Newwaveareindustriesthatdonthaveobviousdigitalcomponents.AirBnBcommoditized
trust.Ubercommoditizedtrustanddispatch.

Keythingwiththeseaggregatorsithattheserviceshavestrongnetworkeffectsonthedemand,
supplyandcrosssideeffects.Theybecomebetterservicesthemoreconsumerstheyserveand
arecapableofservingeveryconsumer/useronEarth.

WhatClaytonChristensenGotWrong,BenThompson(Stratechery,Consultant)

ThereareTWOtheoriesofdisruption.
1. New Market Disruption. Incumbent firms ignore new technologies that dont
serve the needs of their users or fit within existing business models.
However, the new technology, which excels at different attributes, continues
to mature, it can eventually serve the rest of the market.
2. Low-end Disruption. This is his theory of the switch from vertically integrated
players to modularized suppliers.

Whats the flaw in #2? Consumers dont buy the products that Christensen
cites in his theory. His theory is drawn from B2B/enterprise products, where
buyers subscribe to all the assumption of Christensens Theory: 1. Rational 2.
Every attribute that matters can be MEASURED 3. Modular providers can
become good enough on all the measured attributes that matter to buyers.

This all fails in consumer markets, particularly those in internet businesses.


Couple of problems: 1. Consumers arent rational 2. Even if they are mostly
rational, not everything about products can be documented/measured and 3.
Modularized suppliers cannot compete when it comes to user experience
that is a direct result of vertical control.

E.g. IPhone has superior touch screen, bigger pixels, etc.

Additionally the traditional tradeoff between horizontal integration and


vertical integration taught in business school: "Two issues that should be
considered when deciding to vertically integrate [are] cost and control. The
cost aspect depends on the cost of market transactions between firms versus
the cost of administering the same activities internally within a single firm.
The second issue is the impact of asset control, which can impact barriers to
entry and which can assure cooperation of key value-adding players.only
considers DIRECT financial cost. There are however, other costs, particularly
in the design/experience of using products.

Netflix and the Conservation of Attractive Profits, Ben Thompson


(Stratechercy)

What is revolutionary about on-demand streaming in general and Netflix in


particular is that the service has commoditized time: Netflix at 9PM is no
different then on Tuesday, etc.

The Law of Conservation of Attractive Profits:

Netflix isnt really a network. They are a type of marketplace where


consumers can give their attention to creators. Netflix isnt that far off from
the other market-makers.
Netflix is: 1. Infinitely scalable network. 2. Commoditized a previous restraint
(time/broadcast availability) 3. Positioned itself to be the chief beneficiary of
an industry transformation.

So whatt this law. The Law of Conservation of Attractive Profits states: "In
the value chain there is a requisite juxtaposition of modular and
interdependent architectures, and of reciprocal processes of commoditization
and de-commoditization, commoditization, that exists in order to optimize
the performance of what is not good enough. The law states that when
modularity and commoditization cause attractive profits to disappear at one
stage in the value chain, the opportunity to earn attractive profits with
proprietary products will usually emerge at an adjacent stage. (Christensen
2003)

Broadly. Breaking up a formerly integrated system, commoditizing and


modularizing it, destroys incumbent value while simultaneously allowing a
new entrant to integrate a different part of the value chain and thus capture
new value.
The thing with Netflix, AirBnB, Uber, they all modularized the production or
delivery of their service which has allowed them to move closer to the
customer.

Heres Netflix: