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Theory

• 2 keys to succeeding as a capitalist enterprise:

o   Increasing returns to scale

o   A “grip” on multiple sections of the value chain

• Examples:

o   McDonald’s: real estate and franchise

o   General Motors: brands and assembling cars

o   Publishing house: editing manuscripts and distributing print copies

• Industry value chain is a world of platforms, not pipelines. Many moving parts.

• It’s raw resources (top) and job to be done (bottom). The value chain is the transformation of raw resources to meet the customers’ needs.

• Goods are top-down (extract resources —> transform —> sell —> ship, etc)

• Services are bottom-up (originates with a customer)

• Industry value chain is in the perpetual state of imbalance.

o   Many moving parts struggling to get a higher proportion of the total value in the chain.

o   Some links feature increasing returns to scale, and some – diminished.

• Examples:

o   Selling cars – diminished (very hard to scale up a dealership)

o   Manufacturing cars – increased (better productivity)

• Conclusion: large companies have increasing returns to scale, smaller companies – not.

o   Can’t defend their share of the value-add and live with diminishing margins.

Grip

• As far as I understand it, it’s domination of 2+ links in the value chain.

• The reason for the need is that another leader may emerge in the lower/upper link in the chain and squeeze the margins.

o   Can’t capture the entire value added

o   Need to have the highest increasing returns, otherwise you’ll be outcompeted.

• Need to have 2+ legs to stand on (see above)

o   Example: Netflix. Distribution of others’ content doesn’t offer the highest returns; producing own content at least lets control the margin of it.

• Defensibility

o   You don’t OWN your users the way you own a factory. Users’ interests shift.

o   Assets are more sustainable than users. Assets may also mean IP.

• Controlling ONE strategic point in the value chain is cool, but controlling TWO is better.

Risks

• No chance for self-inflicting wounds (Uber 2016, departure of Travis Kalanick)

• Context shift (Facebook and Trump’s posts – alienation of a bunch of users)

4 Paths to get to solid grip

1. Vertical integration. Fingers in all pies. Ex: Ford Motors. Top-down.

2. Vertical integration out of gradual growth for the purpose of securing resources. Ex: Standard Oil. Bottom-up.

3. Strong brand + Cheap cost of capital. Ex: Berkshire Hathaway.

4. Exclusive use of resources. McDonald’s. Logic: buying land and using it as collateral for loans for growth; also forcing franchisees to build on this land —> getting higher margins.

Conclusion: the grip on 2+ links is more important than the highest margins in 1 link. Examples:

• Netflix (see above)

• Aviasales and Travelpayouts (huge exposure and independent distribution).

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