It has never been easier to build a business online. By that same token, there has never been more competition. The best way to remain profitable long term is to invest in moats using the 7 Powers Framework.
It’s terrifying being a seller on Amazon. What if Big Bezos decides he wants to make an AmazonBasics version of your best seller? Or what if your supplier decides they want to start competing against you?
Affiliate marketers have to deal with people spying on and ripping off their campaigns. Facebook costs keep rising. Margins keep shrinking.
I learned a concept over a decade ago called the moat. Centuries ago, castles would protect themselves from enemies by building moats. These were deep ditches surrounding the castle, filled with water.
Warren Buffett refuses to invest in a company unless he feels they have enough strong moats. Moats are the competitive advantages that protect your profit margins despite competition.
This subject fascinates me because so much of the eCommerce world is based around private labeling. Everyone’s re-selling private labeled goods at a significant markup. What’s stopping someone else from coming in and copying you?
Supplement companies such as Bulletproof and Onnit are doing roughly $30 million a year in revenue. Anyone can easily start a supplement company by private labeling. Yet these companies are thriving in spite of competition because of the moats they’ve established.
As much as I understood the concept of moats, I’ve always wondered if there was a framework that breaks down what types of moats there are.
My research led me to a book called 7 Powers: The Foundations of Business Strategy by Hamilton Helmer.
This book is recommended by some super smart people such as Daniel Ek (founder of Spotify), Reed Hastings (founder of Netflix), and Peter Thiel (the first outside investor of Facebook).
This is a simple and straight to the point framework to help you understand business strategy. Successfully implementing these concepts will help you build a long-lasting and profitable company. Despite the increasing amount of competition.
Some Helpful Terminology
Before we begin, I want us all to be on the same page when it comes to definitions. We’ll be using these terms a lot.
Strategy: the study of the fundamental determinants of potential business value.
Power: the set of conditions creating the potential for persistent differential returns.
Each power needs to have a benefit for you while serving as a barrier to your competition.
Benefit: how the power improves cash flows, such as through lower costs or ability to charge higher prices. AKA the magnitude of power.
Barrier: the way that competitors are prevented from arbitraging the benefit of the power. AKA the duration of power.
I’m going to quickly define the 7 powers, and then we’ll go into them in more detail.
The 7 Powers
- Scale Economies: A business where per unit costs decline as volume increases.
- Network Economies: A business where the customer gains more value as the userbase increases.
- Counter Positioning: A business adopts a new, superior business model that incumbents cannot copy because it’ll cannibalize parts of their existing businesses.
- Switching Costs: A business where customers expect a greater loss than the value they gain from switching to an alternate.
- Branding: A business that enjoys a higher perceived value to an objectively identical offering due to historical information about them.
- Cornered Resource: A business that has preferential access to a coveted resource that independently enhances value.
- Process Power: A business whose organization and activity set enables lower costs and/or superior products that can only be matched by an extended commitment.
Power 1: Scale Economies
As the volume increases, the per-unit costs decrease.
We all understand this. The more widgets that you’re able to purchase from a supplier, the bigger the discount you’ll receive. Your local diner can’t get a discount on potatoes like McDonald’s can.
The author demonstrates scale economies through Netflix.
In the early days, Netflix negotiated deals with different content providers. They were able to get fantastic deals because the content providers didn’t understand the value of streaming.
Eventually, the content providers started to wisen up. Their streaming rights were worth more than they realized. So they kept increasing the cost of the streaming rights to their content. Some of the content would permanently become unavailable because Disney, Starz, and NBC would start their own services.
Netflix realized early on that the differentiator in the streaming wars would be original content.
In 2011, they spent $100m for two seasons of House of Cards. This is where Scale Economies come in.
Netflix had a first mover’s advantage which led them to acquiring a massive userbase. Their scale economies meant they could acquire original content at a much cheaper relative cost compared to a newcomer like Hulu.
D&D (D.B. Weiss & David Benioff) were the showrunners for the massively successful show Game of Thrones. After the series was over, they were looking for a new streaming service to develop movies and shows for.
This caused a bidding war among Disney, Apple, Amazon, Netflix, and others. In the end, Netflix won by paying $200 million for the rights. Even though the other companies had a larger war chest, it made more financial sense for Netflix to pay that much.
Scale economies are why some companies are willing to run at break-even or unprofitably for a few years. They know that once they achieve scale economies, they can lower their costs. To the point where they’re profitable, and their competition can’t keep up.
Power 2: Network Economies
Your customer’s experience improves as more people join.
Technology can be an initial advantage. However, it can over time become a commodity and easily replicated.
You can build an app like Tinder for around $50,000 USD. What you can’t copy are the users and the community.
How useful would a dating app be if there were no more new matches after the first day? How useful is a job board if no one’s actively posting jobs there?
The service becomes more useful the more people that join. Sometimes it can be a winner takes all situation. Because of that, these companies will raise massive amounts of money and focus on growth.
Some examples include Facebook, Linkedin, eBay, and Tinder.
Power 3: Counter Positioning
A business adopts a new, superior business model that incumbents cannot copy because it’ll cannibalize parts of their existing businesses.
A fear that small businesses have is if they achieve product / market fit, a bigger and more well-funded competitor can come in and copy their idea.
Counter positioning is when you have a business model that will harm them if they try to copy it.
Think about Kodak film cameras vs. digital cameras. It’s easy to say in hindsight, “Wow, how did Kodak not see that digital cameras were coming to destroy them?”
They did see it, but they couldn’t do anything about it. Their biggest cash cow was selling film rolls. Betting on and investing in digital cameras would be killing their existing business.
Next, digital cameras were a different industry. Developing technology wasn’t their strength.
It’s easy to see what the right move was in hindsight. If you were the CEO Kodak during that time, it’s easier to keep your job by doing what works.
Counter position isn’t the same as disruptive technology. McDonald’s is the biggest hamburger seller in the world. Shake Shack has taken a counter-position by selling gourmet hamburgers that cost twice as much.
McDonald’s can’t copy the same strategy without hurting their brand.
Whenever there is a leader in a market, realize that their strength is also a weakness. There’s always room for the “opposite.”
- High priced hedge funds: Vanguard index funds
- Cheap McDonald’s burgers: ShakeShack
- Instagram showing off how perfect your life is: TikTok where people can be goofy
Power 4: Switching Costs
The value loss expected by a customer that would be incurred from switching to an alternative supplier for additional purchases.
I’ve used depositphotos.com for years to supply photos for my blog posts. I decided to switch over instead to Pexels.com for my photos. I save $300 a month that way. There were no “consequences” for me switching.
Let’s look at a situation where I have high switching costs. I use Keap.com (the CRM formerly known as Infusionsoft) as my CRM for this blog – it’s how I email everyone on a weekly basis.
Don’t get the weekly email yet? Sign up here.
I chose to work with Keap because it was the best CRM provider when I signed up around 2015. Now, there are many more viable CRM alternatives out there I could try such as ConvertKit or Drip.
I’d love to test them out, but I can’t. The switching costs would be too high.
- I’ve invested so many years in learning how to use Keap.
- My automation contractor specializes only in Keap. I’d have to find someone else to replace them.
- I might run into some email deliverability issues.
- All the funnels that I’ve built are in Keap. It’ll take significant labor to re-build them on a different platform.
While I’m not thrilled with using Keap, the switching costs of it is too high for me to use a different product. I’m sticking with them for the foreseeable future.
Another example for affiliate marketers is the Voluum.com tracker. They were one of the first large trackers in the industry. There have since been countless competitors such as RedTrack, and Adsbridge.
However, many affiliate marketers chose to stay with Voluum because of Switching Costs.
- They invested the time to learn how to use the software.
- They don’t want to lose their historical data.
- And it might be a pain to switch the links in their active campaigns.
Right now I’m using WPEngine to host this blog. Several years ago, I was with another provider. It’d be a pain in the ass for me to switch server hosts. WPEngine offered to painlessly switch my service over as a free service.
Some companies add to the switching costs as part of their strategy.
I can’t ever get rid of my Gmail account. It’s because I have at least 50+ sites where I signed up using the “Sign in with Google” feature.
Me getting rid of my Gmail account means I have to go through the process of signing up to all these websites.
I’ve been using Apple Macbooks for the past decade. I have to admit, those Microsoft Surface laptops look damn sexy. But I’ve invested so many resources into the Apple ecosystem.
If you’re trying to get customers to try out your product, think about how you can make it easier for your customers to switch.
Power 5: Branding
The durable attribution of higher value to an objectively identical offering that arises from historic information about the seller.
Branding is such an overused phrase. Just because you have a cute logo and packaging doesn’t mean you’ve built a brand.
What defines a brand?
There are two parts to branding.
1. Affective Valence: Associating with the brand gives the customer good feelings. It could have been built from nostalgia or associations with positive moments in their lives.
I have positive emotions with brands such as Disney, Apple, Ben & Jerry’s, and Adidas. I’m willing to pay more money because those brands make me happy.
2. Reducing Uncertainty: You take a risk every time you buy a product. Brands offer peace of mind that the product works as intended.
I don’t mind buying generic versions of food. I can’t tell the difference most of the time between generic and name-brand food.
There are some categories where people don’t want to take risks.
Diamond Ring. A diamond at Tiffany’s can cost 3 times more than an equivalent diamond. People are willing to spend that because they know Tiffany’s has a certain standard of quality. They don’t want to take the risk with their local jewelry store.
Baby Products. Most parents don’t want to take any risks with their children. I’m willing to pay more money for products by Graco or Fisher-Price because these are the brands I grew up with. I have no interest in getting a stroller seat from AliExpress.
The book, 7 Powers, limited branding to affective valence, and reduced uncertainty. I’m going to add a third aspect of branding based on my experience.
Signaling means you’re trying to broadcast to people a characteristic of you.
If I want people to think that I’m a selfless, caring person, I can record and upload a video of myself volunteering at a homeless shelter. If I want people to think I’m staying fit, I’ll post a photo of me exercising at the gym.
Social media has increased the amount of signaling by everyone. There’s this pressure to appear special. There’s a pressure to signal to everyone how well that we’re doing in life.
This is where certain brands come in. By buying certain brands, we’re signaling what the brand represents.
This is why some women do an awkward pose to show off that they have “red bottoms.” (Christian Louboutin is known for having their shoes be the color red on the bottom. The average pair costs around $600.)
This is why some men do an awkward pose in front of a supercar in their Facebook profile picture. They’re trying to signal to others that they have money.
That’s the power of the brand. Some brands have developed such a positive reputation that people will buy them simply to “signal” the characteristics.
However, the power of branding has decreased in the past decade. It’s because part of branding is to reduce the uncertainty for the customer.
A big mistake people make is they think brands take a long time to develop. A few years ago I needed to buy rechargeable batteries.
Who are the top names in batteries? Duracell and Energizer. They’ve built their brands over decades.
Yet I went with Anker who was only 5 years old at the time. Why did I go with them?
The first is influencers. I saw a few reviews on YouTube, and most of the tech reviewers preferred Anker’s battery.
And second, reviews. I compared the reviews on Amazon. Anker’s reviews were far superior to that of Duracell and Energizers.
Brands are still important, but consumers have alternative ways to help them select quality.
Power 6: Cornered Resource
A business that has preferential access to a coveted resource that independently enhances value.
In every industry, there are certain resources that give advantages if you can obtain them.
- DeBeers has exclusive rights to so many diamond mines in the world.
- Nintendo has developed so many iconic video game characters such as Mario, Pokemon, and Link.
- You’re a meth dealer in the Southwest, and you’re the exclusive seller of Heisenberg’s blue sky.
If you’ve developed certain technology, you can get a patent so that other people can’t get access to it.
I mentioned earlier that Netflix signed D&D to develop a show. They signed them to a ten-year deal.
Power 7: Process Powers
Sometimes a company’s processes are so valuable, that it lowers the costs of the product or enhances the experience. And it’s not easily replicated.
The author uses the example of Toyota who are known for their Toyota Production System. What’s interesting is Toyota had a partnership with General Motors at one point.
Toyota gave General Motors 100% access to learning their systems. But General Motors could not replicate it under any circumstances.
Another example is Pixar.
Reading the book Creativity, Inc. gave me insight into some of the secret sauce of how Pixar built their movies. In fact, it was one of the reasons that Disney bought Pixar. The talent and their process powers would go on to lead a revival of Disney Animation.
And finally, a modern example is the social app Tik Tok. Everyone assumes that TikTok is an app for Gen Z to dance and be goofy. What most people don’t realize is how advanced Tik Tok’s algorithm is. So much of traditional social media feeds are based who you follow.
TikTok’s algorithm is able to predict what you’re interested in based on a few behaviors. Right now Instagram’s trying to lure audiences away with their feature called “Reels.” But TikTok has created a Process Power with their “For You” algorithm that keeps their audience coming back.
Affiliate Marketing and the 7 Powers
Let’s do an exercise.
I introduced you to the 7 Powers. Which of these powers would apply to running affiliate marketing campaigns?
Take a few minutes and do this exercise, rather than scrolling down for the answers.
First, let’s eliminate some of the powers that don’t apply. There’s no network effect, or counter position, branding, or switching costs in affiliate marketing.
1. Scaling Economy:
What advantages does a super affiliate have by sending more volume?
On smaller traffic sources, more volume means you can negotiate discounts and flat fees for traffic. I’ve had situations where I bought out a publisher’s entire month of impressions. On bigger traffic sources like Facebook, volume means you’re feeding data to the pixel.
Furthermore, scaling gets you access to information. Every affiliate asks their affiliate manager at a network, “What’s hot?” Trust me, there’s going to be a world of difference between a guy generating $10k revenue a day vs. a guy that’s generating $100 a day.
After that, Scaling Economies can lead to Cornered Resources. If you can generate a massive amount of traffic, then you can get an offer exclusive.
2. Cornered Resource:
When I reflect on affiliate marketing, cornering resources is most of the advantage super affiliates have.
- Signing an exclusive media buying deal on a hot property.
- Getting the exclusive offer.
- Working with the advertiser on getting a unique offer page designed, that converts higher.
Designing a great landing page isn’t a moat.
Writing great headlines and angles aren’t moat.
Why? Because they can easily be replicated by your competition.
3. Process Power:
Finally, we land at process power.
How does one affiliate get a campaign to profitability versus someone else?
How do they optimize the campaign?
What’s their formula to creating winning video ads?
All of these contribute to process power.
Process power is going to matter less over time with media buying. We’re seeing it right now with Facebook. You can set up the right pixel, feed it enough data, and Facebook will optimize the campaign for you.
In a few years, there will be A.I. Copywriting tools that can outperform your average marketer.
I challenge you to think about what can’t be replaced.
I’m grateful to be living in this era.
We’d all be forced to climb the corporate ladder if we were born several decades earlier.
Instead, we’re in one of the greatest entrepreneurial eras of all time. You don’t need permission from anyone to make money off your music. You don’t to understand coding to set up your own eCommerce stores.
However, lower friction means more competition.
It has never been easier for us to copy each other.
When you find a business model that works, start thinking in terms of strategy and power. Capital allocation is one of the most important decisions you make.
You don’t need to pay yourself $200k a a year to upgrade your lifestyle. Live on less. Invest the difference into creating moats for your business.
If you’re making money, then expect the wolves to come. Invest in your defense.