PowerPoint

20 slides

CHAPTER TWELVE USING ADVANTAGE

Two equally skillful chess players sit waiting for the game to begin—which one has the advantage? Two identical armies meet on a featureless plain—which one has the advantage? The answers to these questions is “neither,” because advantage is rooted in differences—in the asymmetries among rivals. In real rivalry, there are an uncountable number of asymmetries. It is the leader’s job to identify which asymmetries are critical—which can be turned into important advantages.

WRESTLING THE GORILLA

In 2000 I was working with a start-up company that had developed a new microporous material where the size of the pores adjusted with temperature. The hope was that clothing incorporating this material would shed rain, like Gore-Tex, but would also be warmer in really cold conditions and cooler when it became hot. As a start-up, this had been the company’s only activity and the team was justly proud of their accomplishment. They were excited about the possibility of taking their patented idea and developing a line of textiles and outdoor wear. They had already picked a brand name and were negotiating with designers. At the venture-capital firm that had backed the start-up, Susan had been their strongest supporter and she knew the most about both the team and its technology. However, when the start-up team met with Susan to work out third-round financing, or even an initial public offering of stock, she was not enthusiastic. “I think it would be smarter,” she said, “to take our samples and work out license arrangements. Or even to sell the company outright to a major textile manufacturer.” The start-up team fought back. The CEO led the charge, arguing, “We have shown what we can do. This is a real opportunity to build a great company.” “You have done a fantastic job,” Susan replied. “You have created a wonderful new technology. No one can deny your skills at development—they are world class. But building a textile company, or a clothing company, is a completely different game.” The air in the room was taut with frustration. Susan might be right, but they wanted to move forward. Hadn’t they proved themselves? “Look,” Susan said, “it’s like this. You have won an Olympic gold medal in the 1,500-meter run. You have a good chance at winning the 10,000-meter run and I might back you at that. But you want to switch from running to wrestling gorillas. That’s not a good idea and I can’t back you at it.” Susan’s powerful image helped sway the team. They wanted to move ahead, but they certainly didn’t want to wrestle the gorilla. No one has an advantage at everything. Teams, organizations, and even nations have advantages in certain kinds of rivalry under particular conditions. The secret to using advantage is understanding this particularity. You must press where you have advantages and side-step situations in which you do not. You must exploit your rivals’ weaknesses and avoid leading with your own. After 9/11 the United States formulated an objective of destroying the Afghanistan-based al Qaeda leadership and the Taliban government that had protected them. In military conflict, the United States has enormous resources and skills that enable it to quickly deliver stupendous amounts of force. The United States had a clear strength and used it to kill al Qaeda operatives and drive the Taliban from power. Top-level leaders failed, however, to press this advantage and allowed Osama bin Laden to escape from his mountain hideout in Tora Bora into northwest Pakistan. 1 Nine years after 9/11, Osama bin Laden remains uncaught and the United States is involved in a continuing low-intensity war in Afghanistan against the Taliban. The present strategy of the United medieval warlord-based society where loyalty and power is local. After years of U.S. support, the Afghan central government remains corrupt and ineffective outside of Kabul. Thus, the Taliban’s terror tactics against the population are brutally effective because any protection against the Taliban can only be temporary and geographically limited. Even more seriously, the Taliban is not an army, it has no uniform, and everyone in Afghanistan is both armed and probably related to someone in the Taliban. All of these obstacles can be overcome with time and resources. But both ordinary citizens and the Taliban know that the United States will withdraw. It will withdraw for political reasons and because staying in Afghanistan is stupendously expensive. The U.S. military, carefully designed to inflict crushing high-intensity force, spends $1 million per year to put each soldier in Afghanistan. You don’t want to have been a tool of the United States when these forces are drawn down and the Taliban return to power. In Afghanistan, the United States is “wrestling the gorilla” because it has allowed itself to be drawn into a conflict in support of an almost nonexistent ally and where advantage lies with the side with the most patience and with the least sensitivity to casualties and collateral damage. In this situation, the Taliban has the advantage and is using it.

COMPETITIVE ADVANTAGE IN BUSINESS

The term “competitive advantage” became a term of art in business strategy with Michael Porter’s 1984 insightful book of that title. Indeed, Warren Buffett has said that he evaluates a company by looking for “sustainable competitive advantage.” The basic definition of competitive advantage is straightforward. If your business can produce at a lower cost than can competitors, or if it can deliver more perceived value than can competitors, or a mix of the two, then you have a competitive advantage. Subtlety arrives when you realize that costs vary with product and application and that buyers differ in their locations, knowledge, tastes, and other characteristics. Thus, most advantages will extend only so far. For instance, Whole Foods has an advantage over Albertsons supermarkets only for certain products and only among grocery shoppers with good incomes who place a high value on organic and natural foods. Defining “sustainability” is trickier. For an advantage to be sustained, your competitors must not be able to duplicate it. Or, more precisely, they must not be able to duplicate the resources underlying it. For that you must possess what I term an “isolating mechanism,” such as a patent giving its holder the legally enforceable right to monopolize the use of a technology for a * dramatic economies of scale, and tacit knowledge and skill gained through experience. As an example, Apple’s iPhone business is protected by the Apple and iPhone brand names, by the company’s reputation, by the complementary iTunes service, and by the network effects of its customer group, especially with respect to iPhone applications. Each of these resources has been crafted by Apple executives and put in place as part of a program for building a sustained competitive advantage. These resources are scarce in that competitors find it difficult, if not impossible, to create comparable resources at a reasonable cost. Claims in advertising or sales pitches that a particular IT system or product or training program will provide a competitive advantage are misusing the term since an “advantage” on sale to all comers is a contradiction in terms.

“INTERESTING” ADVANTAGES

Stewart Resnick, the chairman of privately held Roll International Corporation, and his wife, Lynda, are serial entrepreneurs. Not only have they established several very successful companies, they have also used their wealth to support medical research, education, and the arts. Being able to create successful strategies, not just once but over and over again, is a rare skill. And it is clear that their skills are not rooted in any one industry—they have been able to succeed in alarm services, flower delivery, collectibles, agribusiness, and bottled water. As I drive to Roll’s headquarters in West Los Angeles, I review what I know about the Resnicks. Stewart’s father had owned a bar in New Jersey, and Stewart’s first business was a janitorial service based on a friend’s floor scrubber. The business grew, paying his way through law school at UCLA. He sold it in 1969 for about $2.5 million and invested in an alarm services firm. Lynda’s first business was an advertising agency, and when Stewart sold the alarm services firm, they worked together to acquire Teleflora in 1979. For Teleflora, Stewart and Lynda created the concept of flowers arranged in keepsake containers, an approach that dramatically increased profits for them and their florists. In 1985, they bought the Franklin Mint, a producer of collectors’ coins. Lynda spearheaded the expansion into pop-culture keepsakes, precision model cars, and a host of other items. (The Resnicks sold the Franklin Mint in 2006.) During the 1980s, the Resnicks began to invest in agribusiness: citrus orchards, pistachio and almond orchards, and pomegranates. Over time, these businesses have become their biggest profit makers. Today, Roll is the largest citrus grower in California and the largest nut grower in the world. During the 2000s, Roll began marketing pure pomegranate juice and juice products under the Today, Roll International is one of the two hundred largest private companies in America. Roll’s headquarters is an oasis of art and sculpture in an ordinary West Los Angeles office district. Stewart is casual, soft-spoken, and self-confident. His grasp of the details of each of Roll’s businesses is unusual for the chairman of a firm of Roll’s size and complexity. Stewart tells me that Teleflora had been competing on price when he acquired the business. “We changed to a service model,” he says, explaining that Teleflora provides florists with the largest member network, an Internet-based IT system, keepsake products to hold and include with flowers, Web hosting services, credit card processing services, and point-of-sale technologies. “There is more competition now than ever,” he says, “but Teleflora is a much more successful business than it was when we bought it. Then it was one-tenth the size of FTD; now it is twice as large.” I ask him if there is a common lesson that can be taken from businesses as disparate as Teleflora and Fiji Water. Stewart opens his hands palms up and tilts his head to the side, a gesture meaning “How can I explain?” After a pause, he says, “By providing more value you avoid being a commodity. The bottled water field is crowded, but Lynda saw something unique in this product—water from a deep aquifer in Fiji that has been naturally filtered for several hundred years. Water that fell to earth before the industrial age, before pollution and chemicals. It is a unique proposition that the original owners had not exploited.” I understand about avoiding being a commodity. Yet, Roll has become the largest citrus grower in California and the largest almond and pistachio grower in the world. I ask, “Aren’t these agricultural products, by definition, commodities?” Stewart says that he began to buy agricultural land in 1978 as a passive hedge against inflation. The breakthrough came when he realized that these businesses were actually quite “interesting.” “Interesting?” I ask. If human ears could perk up, mine would. After thinking for a moment, Stewart says, “To me, a business is ‘interesting’ when I can see ways to increase its value. The typical nut farmer can’t control his own destiny. He simply accepts what the trees yield and the market’s prices. “A small nut farmer can’t afford the investments needed to develop the market or do research on yields or do efficient processing. But we had a large holding. We were large enough to earn back the costs of research on yields and quality. And I realized that if we could stimulate the demand for almonds and pistachios, then there would be a real benefit. Of course, all California nut farmers would benefit from the increased demand, but we were the only grower with the size to make the investment worthwhile. And it has worked. Consumption keeps growing and exports are up. Our ‘Wonderful’ brand commands a price provide only a temporary benefit to Roll. Wouldn’t the advantage dissipate once other growers increased their production to match the higher demand? “Things don’t happen with lightning speed in agriculture,” Stewart explains. “It takes seven to ten years for newly planted trees to mature. That gave us time to invest in planting, branding, processing, and merchandising. Then, as demand grew, we aggressively built nut-processing capacity. The scale economies in processing make it hard for smaller farmers to build their own processing facilities. And unless you can do processing, packaging, marketing, branding, and distribution, it may not pay to buy more land and plant new trees.” I could see that Stewart’s approach to the nut business was a complex coordinated maneuver over a decade of time. His original large-scale holdings enabled him to capture the lion’s share of benefits from investments in research, market development, advertising, and promotion. The seven-to-ten-year lag in competitive response provided both the financing and a window of opportunity to build large-scale nut-processing facilities. The economies of scale in processing have so far prevented smaller competitors from achieving equivalent costs. It must have taken iron nerve to wait years for the strategy to work. “You are still looking five to ten years ahead?” I query. “It is one of the big benefits of being a private company. When I first bought these lands from major oil companies, they were looking ahead one quarter or one year. They wanted to get the assets ‘off their books’ to make their financial ratios look better. We can do more with these businesses because we don’t suffer the crazy pressures that are put on a public company.”

Some Advantages Are More “Interesting” Than Others

When another person speaks you hear both less and more than they mean. Less because none of us can express the full extent of our understanding, and more because what another says is constantly mixing and interacting with your own knowledge and puzzlements. When Stewart Resnick explained what made a business “interesting” to him, I made an unexpected connection to aspects of the concept of competitive advantage that I had been puzzling over for some time. I felt something click into place in my mind. To explain, I have to go back to 2002 when my UCLA colleague Steven Lippman and I created a thought experiment about competitive advantage. Our thought experiment * concerned an imaginary “silver machine” left behind by a passing UFO. It could produce $10 million per year in raw silver at no cost—it used no inputs of energy, materials, or labor. There were no taxes and the constant interest rate was 10 percent. The original finder of the silver silver business? The silver machine problem became an underground puzzle in the strategy field. The silver machine was obviously a low-cost producer—zero cost is about as low as it goes. The conundrum was that this advantage did not make the new owner any wealthier. Yes, the machine paid out $10 million per year, but that was just an ordinary 10 percent return on what had been paid to buy it. Its competitive advantage seemed to have evaporated because of the change in ownership. Yet the machine continued to produce silver at zero cost. 3 It took some time, but I can unravel the puzzle. The silver machine does have a competitive advantage in the silver business. 4 The conundrum disappears when you carefully distinguish between competitive advantage and financial gain—many have assumed that they are the same thing, but they are not. But it was Stewart Resnick who helped me see another even more important fact about the silver machine—that its advantage, though real, wasn’t interesting . The silver machine’s advantage gives it value, but the advantage isn’t interesting because there is no way for an owner to engineer an increase in its value. The machine cannot be made more efficient. Pure silver cannot be differentiated. One small producer cannot pump up the global demand for silver. You can no more increase the value of the silver machine than you can, by yourself, engineer an increase in the value of a Treasury bond. Therefore, owning this advantage is no more interesting than owning a bond. For Stewart Resnick, and now for me, a competitive advantage is interesting when one has insights into ways to increase its value. That means there must be things you can do, on your own, to increase its value. To see an example of a major competitive advantage that is, presently, not increasing in value, look at eBay. It should be obvious that eBay has a considerable competitive advantage in the global person-to-person auction business. eBay invented this business and remains by far the worldwide dominant firm in it. More specifically, eBay’s competitive advantage lies in its unrivaled ability to offer the least expensive, most effective solution to just about anyone who wishes to buy or sell a personal item online. Its broad user base, easy-to-use software, the PayPal payment system, and its methods of rating sellers all give it a considerable advantage over any competing platform. Over the years, eBay has been very profitable. During the year ending in December 2009, the company had an operating cash flow of $2.9 billion, an after-tax sales margin of 26 percent, and a healthy after-tax return on assets of 13 percent. Yet, despite its competitive advantage, the company’s market value had been stagnant or declining for more than seven years. By operating, eBay definitely provides a service whose cost of provision is well below the value placed on it by customers, and does this so efficiently that others can not horn in on its core business. Nonetheless, it has not been are no ways (by definition) to alter the silver machine’s advantage, there are a myriad of ways to change eBay’s services, its efficiency, and the uses to which its resources and skills are put. So, eBay’s advantage is potentially interesting. It will become truly interesting when someone gains special insights into unexploited ways to expand the value of eBay’s already considerable competitive advantages.

VALUE-CREATING CHANGES

Many strategy experts have equated competitive advantage with high profitability. The example of eBay (and of the imaginary silver machine) shows that this is not necessarily so. Despite all the emphasis on “competitive advantage” in the world of business strategy, you cannot expect to make money—to get wealthier—by simply having, owning, buying, or selling a competitive advantage. The truth is that the connection between competitive advantage and wealth is dynamic. That is, wealth increases when competitive advantage increases or when the demand for the resources underlying it increases . In particular, increasing value requires a strategy for progress on at least one of four different fronts: deepening advantages, broadening the extent of advantages, creating higher demand for advantaged products or services, or strengthening the isolating mechanisms that block easy replication and imitation by competitors.

Deepening Advantage

Start by defining advantage in terms of surplus—the gap between buyer value and cost. Deepening an advantage means widening this gap by either increasing value to buyers, reducing costs, or both. * It would be foolish to attempt to summarize the vast variety of methods and approaches that can be used to make improvements in cost and/or value. It is more useful to highlight the two main reasons this process stalls. First, management may mistakenly believe that improvement is a “natural” process or that it can be accomplished by pressure or incentives alone. As Frank Gilbreth pointed out in 1909, bricklayers had been laying bricks for thousands of years with essentially no improvement in tools and technique. By carefully the supply pallets of bricks and mortar to chest height, hundreds or thousands of separate lifting movements per day by each bricklayer were avoided. By using a movable scaffold, skilled masons did not have to waste time carrying bricks up ladders. By making sure that mortar was the right consistency, masons could set and level a brick with a simple press of the hand instead of the time-honored multiple taps with a trowel. Gilbreth’s lesson, still fresh today, is that incentives alone are not enough. One must reexamine each aspect of product and process, casting aside the comfortable assumption that everyone knows what they are doing. Today, this approach to information flows and business processes is sometimes called “reengineering” or “business-process transformation.” Whatever it is called, the underlying principle is that improvements come from reexamining the details of how work is done, not just from cost controls or incentives. The same issues that arise in improving work processes also arise in the improvement of products, except that observing buyers is more difficult than examining one’s own systems. Companies that excel at product development and improvement carefully study the attitudes, decisions, and feelings of buyers. They develop a special empathy for customers and anticipate problems before they occur. The second reason firms may fail to engage in a process of improvement occurs when isolating mechanisms surrounding important methods are weak. Companies in such situations sensibly hope to catch a free ride on the improvements of others. To benefit from investments in improvement, the improvements must either be protected or embedded in a business that is sufficiently special that its methods are of little use to rivals.

Broadening the Extent of Advantage

Extending an existing competitive advantage brings it into new fields and new competitions. For example, cell phone banking is a growing phenomenon outside of the United States, especially in the less developed countries. eBay holds substantial skills in payment systems embedded in its PayPal business. If eBay could build on these to create a competitive advantage in cell phone payment systems, it would be extending a competitive advantage. Extending a competitive advantage requires looking away from products, buyers, and competitors and looking instead at the special skills and resources that underlie a competitive advantage. In other words, “Build on your strengths.” The idea that some corporate resources can be put to good use in other products or markets is possibly the most basic in corporate strategy. 6 Its truth is undeniable yet it is also the source of great mischief. Bemused by the idea that their company’s competitive strength lies in vaporous generalities such as “transportation,” “branded consumer products,” or “management,” companies may at chemistry and chemical production led DuPont to manufacture cellulose, synthetic rubber, and paints. The work in synthetics led to new skills in polymer chemistry, which, in turn, led to Lucite and Teflon in 1935. Further developments in polymers led to nylon, Mylar, Dacron, Lycra, and more. Similar patterns of accumulating and extending technological resources can be found in General Electric, IBM, 3M, and many pharmaceutical and electronics companies. Extensions based on proprietary know-how benefit from the fact that knowledge is not “used up” when it is applied; it may even be enhanced. By contrast, extensions based on customer beliefs, such as brand names, relationships, and reputation, may be diluted or damaged by careless extension. Although great value can sometimes be created by extending these resources, a failure in the new arena can rebound to damage the core. A good example of the care management must take in extending its brands and reputation is that of the Walt Disney Company. It has long enjoyed a substantial competitive advantage in the entertainment industry because of its ability and reputation in family-friendly fare. To appreciate the magnitude of this advantage, note that no other film company is able to pull viewers to its movies by its brand name alone. Many kids go to (or are taken to) the newest Disney film without much regard to its content. By contrast, no one goes to a movie because it is a Sony Pictures Studios product or because it was made by Paramount. Those brands have some power in financial circles and in distribution channels, but none with the consumer. A brand’s value comes from guaranteeing certain characteristics of the product. But those characteristics are not easy to define. What, exactly, is a “Disney” film? How far can the brand be stretched without losing value? Mark Zoradi is president of the Walt Disney Motion Pictures Group (formerly Buena Vista Motion Pictures Group), which markets and distributes motion pictures under the Walt Disney, Touchstone, and Miramax imprints. It also oversees the operations of the Disney and Pixar animation studios. In late 2008, Mark and I were discussing the Disney brand and strategies for extending it. He told me this: The most valuable thing we have is the Disney brand. Several years back, Dick Cook [then chairman of Walt Disney Studios] got us thinking hard about how to build on that strength without diluting it. Some people think a Disney movie has to be suitable for very young children. But they forget that Walt made 20,000 Leagues Under the Sea , a film that was probably much too scary for very young kids. We looked at the whole list of the most successful films in history and discovered that we would have been proud to release a surprising number under the Disney name—films like E.T., for people to get angry and red in the face, but no cursing. No uncomfortable sexual situations . We want romance but we will leave making dirty movies to others. No gratuitous violence . We are all in favor of swashbuckling adventure but there will be no beheadings or spurting blood. It is this broader view that let us release Pirates of the Caribbean, National Treasure , and Prince Narnia under the Disney brand. Mark Zoradi’s three guidelines are intended to help the company extend the Disney brand into the increasingly successful action-adventure genre without damaging the brand’s value in its more traditional sector.

Creating Higher Demand

A competitive advantage becomes more valuable when the number of buyers grows and/or when the quantity demanded by each buyer increases. Technically, it is the scarce resources underlying the advantage that increase in value. Thus, more buyers for small airplanes will increase the value of Embraer’s (Brazil) brand name and its specialized skills in design and production. Note that higher demand will increase long-term profits only if a business already possesses scarce resources that create a stable competitive advantage. Because so many strategy theorists have mistakenly equated value-creating strategy with “having” a sustainable competitive advantage, they have largely ignored the process of engineering increases in demand. Engineering higher demand for the services of scarce resources is actually the most basic of business stratagems. Stewart and Lynda Resnick’s POM Wonderful pomegranate business is an example of acting creatively to generate more demand. In 1987, they bought 18,000 acres of nut orchards from Prudential Life Insurance. Among the almond and pistachio trees were 120 acres of pomegranate bushes. “I first wanted to replant this acreage with nut trees, but we decided to keep the bushes,” Stewart recalled. “Our company reports split results by crop and, after a few years, I noticed that we were consistently making more money per acre from the pomegranates than from the nuts.” In the 1990s, pomegranates were a very minor crop in the United States, and Americans were largely unfamiliar with them. The fruit had its ancient origins in the Middle East, and many associated it with life-giving properties. In 1998, the Resnicks began to fund research on the properties of pomegranates. The researchers reported that the juice contained even more antioxidants than red wine. Further study suggested that the juice might lower blood pressure and that its concentration of flavonoids might help prevent prostate cancer. Since 1998, the Resnicks have increasing the national demand for pomegranates. Like their previous success in nuts, this would create value if they owned a substantial fraction of pomegranate production and if new competitive production did not swiftly appear. To implement this strategy, the Resnicks began to buy more acreage. By 1998, they had six thousand acres committed to the future production of pomegranates—a sixfold increase in U.S. productive capacity. The company also began to study ways of packaging and marketing pomegranate juice. The standard industry approach was to dilute an expensive strong-flavored juice with much larger quantities of blander white grape, apple, and pear juices. That was how Ocean Spray sold its cranberry juice. Lynda Resnick suggested a different concept. Their main pomegranate offering would be 100 percent pure with no fillers. It would deliver 100 percent of the health benefits. It would not be marketed as a soft drink or kids’ sugar kick. Rather, it would be a new category—a fresh, refrigerated antioxidant juice, distributed beside fresh produce. The brand name would be POM with the “O” shaped like a heart. The Resnicks decided to bet on Lynda’s concept. POM’s president Matt Tupper recently recalled that the massive plantings, cresting in 2000–2001, created the threat of a “red tide” of unsold pomegranate juice if the strategy of dramatically increasing demand didn’t work. “It was daunting,” he said. “We had to go all out. Lynda worked tirelessly to shape the concept, the package, and the marketing approach. She wrote, gave interviews, and introduced POM to every mover and shaker in her huge network of contacts. It worked . Demand surged. By 2004 we were the dominant producer in a new hot category of product. And, even better, it’s good for you.”

Strengthening Isolating Mechanisms

An isolating mechanism inhibits competitors from duplicating your product or the resources underlying your competitive advantage. If you can create new isolating mechanisms, or strengthen existing ones, you can increase the value of the business. This increased value will flow from lessened imitative competition and a consequent slower erosion of your resource values. The most obvious approach to strengthening isolating mechanisms is working on stronger patents, brand-name protections, and copyrights. When a new product is developed, its protection may be strengthened by stretching an already powerful brand name to cover it. When an isolating mechanism is based on the collective know-how of groups, it may be strengthened by reducing turnover. When protections are unclear, legislation or courtroom verdicts may clarify and strengthen certain positions. An example of collective action to strengthen property rights is the history of the U.S. petroleum industry. As soon as oil was first courts decided, moved and flowed like a wild beast—no one could really tell where a particular drop of oil had come from. Applying the age-old Anglo-Saxon “rule of capture,” oil legally belonged to whoever pumped it out of the ground. Because oil reservoirs extend beyond property boundaries, most wells are drilled into what amounts to being a large common reservoir. Since the rule-of-capture said that the oil belonged to whoever pumped it, each successful driller had to pump as fast as possible. If a well was not pumped, others would empty the reservoir anyway. This created the forests of oil rigs and fantastic rates of development in early U.S. oil fields where overpumping was the rule of the day. For example, soon after the great East Texas field was discovered in 1930, there were forty-four separate wells pumping on one square city block in the town of Kilgore. Within eighteen months, the price of oil had fallen from one dollar to 13 cents per barrel, the field’s pressure had collapsed, and water was seeping into the reservoir. Many members of the industry wanted some way of stopping the “arms race,” but courts threw out plans to control production as illegal price fixing. In late 1931, the governor of Texas declared martial law in the East Texas field and used the National Guard to halt production. Eventually, over decades, oil producers, state governments, and the federal government struggled to work out the present rules for controlling oil field production and the sharing of revenue among property owners. The task was complicated because not all oil producers had the same interests or information. In particular, larger holdings had better information about the ultimate reserves in the field. 7 Nevertheless, the obstacles were overcome. In this case, it took cooperative action to alter the legal isolating mechanisms protecting each driller’s discoveries. Another broad approach to strengthening isolating mechanisms is to have a moving target for imitators. In a static setting, rivals will sooner or later figure out how to duplicate much of your proprietary know-how and other specialized resources. However, if you can continually improve, or simply alter, your methods and products, rivals will have a much harder time with imitation. Consider, for example, Microsoft’s Windows operating system. Were this to remain stable for a long period of time, there is little doubt that clever programmers around the world could, over time, create a functionally equivalent substitute. However, by continually changing the program—even if the changes are not improvements—Microsoft makes it very costly to engineer a continuing series of functional equivalents. Windows is a moving target. Along the same lines, continuing streams of innovations in methods and products are more difficult to imitate when they are, themselves, based on streams of proprietary knowledge. For example, a company that innovates by using scientific knowledge will have, in general, weaker isolating mechanisms than one that internal operations.

* A “network effect” increases the value of a product as the number of buyers or users gets larger. It is like an economy of scale, but instead of reducing the producer’s cost, it increases the buyer’s willingness to pay. We see very strong network effects in businesses like Amazon and Facebook.

* A thought experiment tests ideas for logical consistency and logical implications.

* When looking at costs, include the buyer’s costs of searching for the product, evaluating it, traveling to buy it or waiting for it to arrive, switching to it, installing it, and learning how to consume it.