Let’s Talk About Power

Most business conversations focus on performance, not power.  This makes sense from a customer-centric perspective, as performance is what customers are buying from us.  Moreover, our financial performance serves as an indirect measure of our overall customer success, and that is, financial metrics are core to the Performance Zone.

A focus on performance does not serve, however, when you are discussing future investment, strategy, or market cap valuation.  In these contexts, it is important to focus on power.  Power, not performance, is what drives investment decisions and market cap valuation.  The primary reason for this is that making an investment entitles one to a share of the future returns from the invested entity.  Power is a predictor of those returns.  The more you have, the better the bet.  Performance, by contrast, is a trailing indicator.  It does not predict—instead, it validates prior predictions. 

The reasons why investment analysts focus so intensely on performance are

a) it is the only source of data available,

b) it demonstrates whether or not management’s prior predictions have held up, and therefore

c) it establishes a level of credibility one should assign to their current predictions. 

The higher that credibility is, the more probable the forecast, the lower the discount for risk, the higher the market cap.  Net net, if you want to manage for shareholder value, you need to be very clear about what your power consists of, where it comes from, where it can be increased, and where it is liable to deteriorate. 

A good framework to use here is the Hierarchy of Powers:

The model is hierarchical in that the most impactful predictor of a company’s future performance is category power, followed by company power, and so on, down to execution power.  In the short term, one can overcome power deficits at the top by overperforming at the bottom, but in the long term, one cannot.  That is why, during strategy discussions, it is critical that you work through this model from the top to the bottom, with 90% of your time spent on just the top three.

Category power is the driver that separates growth stocks from value stocks.  Categories grow during the front end of any technology adoption life cycle due to net new budget coming into the sector. The greater the anticipated TAM (total available market), the bigger the pie to share.   Rising tides float all boats.  Conversely, a declining category creates pull in the opposite direction, dragging down the valuations of companies even though they may still be performing admirably.

Category power is the primary factor that drives portfolio management decision-making.  You can evaluate your current category power using the growth vs materiality matrix below, where materiality is measured as a percent of current total enterprise revenue, growth is measured relative to the current overall portfolio rate, and each line of business’s contribution is visualized by the size of the circle representing it:

This is a variation on BCG’s famous matrix, where materiality is substituted for market share.  It generates the same set of rising stars, cash cows, lazy dogs, and question marks.  The advantage of using materiality is that it better represents what the line of business means to the enterprise as a whole.

Company power is a function of market share within category.  Ecosystems self-organize around market share leaders, bringing extra business and higher margins to the leaders, forcing the rest of the players to compete on price and opportunity.  We call this the gorilla game.  Market share leaders emerge during the tornado phase of the technology adoption life cycle, where one company gets a sufficient lead to attract a greater number of partners to flesh out its platform, be that at the infrastructure or application level.  This advantage locks in business relationships that persist for the remainder of the category maturity life cycle, only coming into question when the once-disruptive category itself becomes subject to disruption.  Prior to that, the sustainable competitive advantage of such relationships is nothing short of extraordinary.  Jack Welch was famous for saying you need to be number one or number two in a category, otherwise don’t play.  But, of course, categories are made up of many more than their top two or three vendors, so what are the rest supposed to do?  (Hint: see next bullet.)

Market power is a local version of company power that organizes around a customer segment with industry-specific needs that are underserved by the vendor category leaders.  Vendors who step up to serving those needs in full become the de facto standard for that segment, or what we like to call the “gorilla in the niche.”  That is how Macintosh overcame the IBM PC in the graphics community, how Sun beat out the DEC workstation in the CAD community, and how Veeva has kept Salesforce at bay in the pharmaceutical market.  Local ecosystems form around these vendors, creating economic moats that protect them from the big guys appropriating their marketplace. 

Winning niche market leadership is like winning primaries in a presidential election.  They are stepping stones to building a bigger future.  The great thing about market power is that, regardless of how far back in the pack your enterprise finds itself, it can always provide a path to restoring your fortunes, provided you are able to think small enough.  That is, market power is a function of fish-to-pond ratio, meaning you have to target a market segment in which a company your current size can expect to be the big fish in that pond, assuming you execute. 

Execution in this context means delivering a whole product that is clearly superior to what anyone else can offer, largely because it deals so directly and completely with the idiosyncratic needs of the target market niche.  Once you are established as the big fish there, you can expect to expand and grow into the niches adjacent to your home base.  Conversely, if you venture too far beyond these adjacencies, into markets where you are not the ecosystem leader, you are likely to fall prey to category leaders.  In sum, if you don’t think small enough, if you find yourself fighting on their turf, competing for the same RFPs that they are, you are likely to win no more than the scraps from their table.

Final thought.  As the tag line at the bottom of the Hierarchy of Powers model states, power predicts performance, and performance validates power.  Another way to describe the relationship is that power enables successful performance, and performance funds investments in power.  If management focuses solely on enterprise performance and fails to hold itself accountable to maintaining or increasing enterprise power, it is effectively liquidating its franchise, albeit in a slow and almost invisible way.  To make matters worse, it is being compensated handsomely to do so because it is so good at making the quarterly numbers.  Managing for shareholder value is not about making the numbers.  It is about maintaining a franchise that has the power to do so.

That’s what I think.  What do you think?