Defensibility: Power
Part 3: "Execution power” is becoming more important than classical “structural power”
This is the third in a series of posts dedicated to understanding defensibility in technology-driven markets.
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In the first stage of a new market, companies must build something people want: a product that doesn’t suck. Without that, customers will be scarce and that’s certain death.
After achieving product-market fit, companies will attempt to grow as quickly as possible. On this path, others will compete as copycats or parallel innovators. Either way, customers will have multiple alternatives to choose from.
Zooming out to how cash flows through the stack as a whole, every company aims to keep as much value as possible for themselves. A physical part buyer will evaluate multiple manufacturers, a manufacturer will look at multiple robot vendors, a robot vendor will look at multiple model vendors, and so forth.
This is capitalism; competitive pressures force all players to become better and more efficient. This is good. As is sometimes said: the cure for high prices is high prices. Fat margins sing a siren-song for new entrants unless something stops them.
In this darwinian struggle, who wins? Value accrues to those with power: the ability to tilt build vs. buy decisions in their favor. In order to have durable cash flows over time—the definition of a great business—a business needs power.
Power must provide the holder a tangible benefit (e.g. lower cost, ability to charge higher prices) while preventing competitors from replicating the advantage.
Product-market fit is not power. If multiple companies delight customers via interchangeable products with similar production costs, then profits will erode.
Product-market fit is delighting customers, but power is beating competitors.
If an advantage is universally available, there is no resultant power. Viewed through the lens of the stack, power only accrues to better products if:
the advantage stems from something we control and
we can somehow exclude others from accessing the same advantage.
Misunderstanding power in the stack is perilous: IBM, when sourcing an operating system for their PC, may have seen Microsoft’s DOS as merely one component of many. It was not. Microsoft gained power because application developers customized their capital investments (software) for the OS, not the hardware. The growth of IBM-compatible PCs commoditized the hardware layer while the real money was made at the OS layer. Microsoft had power.
Structural power is the classic defensibility playbook.
Hamilton Helmer’s 7 Powers is perhaps the most well understood framework on defensibility. It’s a worthwhile read on the major categories of structural power that I’ll summarize here:
Branding—Disney, Nike, IBM, Apple: premium pricing through perceived superior quality.
Process Power—Apple, NVIDIA, TSMC: some sort of alchemy in a company’s operations that yield lower costs or better products that sell at higher prices.
Economies of Scale—AWS, Walmart, TSMC, Uber: size-driven advantages in costs or better products.
Network Effects—Facebook, Instagram, X, Windows, ChatGPT: value grows with user base, often due to more people to communicate with or datasets that make superior products.
Switching Costs—Salesforce, NetSuite, Airline loyalty programs: high barriers to changing providers. In organizations, lock-in is often due to data, integration, or process inertia.
Counter Positioning—Apple (vs. Facebook) in Privacy, OpenAI (vs. Google) with no ads in ChatGPT: business models that cannibalize competitors.
Cornered Resource—Qualcomm patent portfolio, DeBeers mines: exclusive assets that increase value or reduce costs.
These structural powers are clearly observable company attributes, making them “intellectually satisfying”. They make excellent case studies because they’re so obvious when present.
With startups, there are several things to remember when pursuing structural power:
Structural power is predictable based on the market. Launching a social network? Network effect. Building an enterprise workflow tool? Switching costs. Consumer packaged goods? Brand. Real-world logistics? Economies of Scale …and so on.
Power must actually influence customer decisions, or it’s a “power mirage”. If customers can ignore power with impunity, then it’s not real power: it’s a misleading slide on a fundraising deck. Consider an example from a prior letter:
"…while the concept of a “network effect” is intellectually satisfying, we can restate the hypothesis as: “Customers will be happier with our product if we had more customers and less happy if we had fewer customers.” In some cases it might be true (e.g. communication tools or proprietary AI models that depend on lots of training data), but in many cases a product’s value is more or less the same regardless of the number of customers. In this latter case, there’s clearly no network effect”
Structural power takes time to build—it’s a “step 2” after initial success once a company has the ability focus on something other than survival. Investors often fall into the trap of over-emphasizing structural power when evaluating pre-seed and seed companies because it’s so satisfying when the question of defensibility comes up at a partner meeting.
If this is a complete description of defensibility, why do companies with no obvious structural power sometimes win decisively? Why did Stripe beat other payment processors? Why does SpaceX continually beat everyone? At the early stage and in rapidly evolving markets, a different type of power exerts itself.
Execution power is the subtle secret behind many successful companies.
While structural power gets the most mindshare, execution power is the true cause of many successful startups. Founders and experienced investors have seen execution power firsthand, yet many investors overlook companies that don’t (yet) have some form of intellectually satisfying structural power.
Structural power is readily observable from a snapshot while execution power can only be seen in motion. Execution power is dynamic power—the ability to move with the world—not something that can be easily evaluated at any point in time, making for ambiguous case studies.
I’ve observed three types of execution power create durable advantages: Speed, Taste, and Rainmaking.
Speed is the ability to ship products and incorporate feedback faster than others. It gives startups an edge over slow-moving incumbents. Execution speed is especially important in dynamic—and therefore immature—markets. If the battleground changes frequently, companies that can adapt the fastest tend to win. In AI, where advancements occur every day, we’re going to get smoked if we can’t incorporate them immediately.
“One of the biggest advantages that start ups have is execution speed and you have to have this relentless operating rhythm.”
- Sam Altman
Taste is the ability to make correct decisions amidst uncertainty. It manifests in exceptional product design (e.g., Stripe’s payment APIs, Airbnb’s early investment in great photography, the iPhone), technical decisions (e.g., SpaceX’s bet on reusability, Tesla’s focus on factory automation, OpenAI’s investment in infrastructure that enabled their research team to move faster than others), as well as picking talent (e.g., the "PayPal mafia” and the many other subsequent startup mafias).
Rainmaking is the ability to conjure revenue out of thin air. Some people are just very good at creating buzz (e.g., Marc Benioff’s “No Software” protest outside a Siebel Systems conference) or getting high-profile organizations to buy (e.g., Palantir’s early customers were some of the most demanding on the planet). Marketing is a “wholesale” (one-to-many) approach to getting customers, so skill there scales quite well. Sales is a “retail” (one-to-one) approach, so it tends to work best for big deals.
How does execution power scale?
Execution power is clearly valuable for startups, but what happens as they grow? Most organizations calcify over time, becoming less effective as they scale. This phenomenon serves as “dose-response” evidence for execution power: potent when present and an inactive ingredient when diluted.
Some companies that avoid “execution power dilution” are able to maintain defensibility at massive scale, creating the most effective technology organizations on the planet. SpaceX, Tesla, and OpenAI are great examples of what happens when companies retain speed at scale.
The recent debate over “founder mode”—where leaders eschew traditional delegation structures and become intimately involved in the details of individual contributor work—is a symptom of the struggle to preserve execution power at scale.
Here’s a typical lifecycle of execution power dilution: at a startup, everyone is an individual contributor (IC); they are directly responsible for getting things done. Execution power present in even a single person can make the team as a whole exceptionally effective. As a result, the startup becomes successful.
Scaling using traditional organizational design, founders hire multiple levels of management to wrangle increasingly large numbers of ICs. The organization that used to be optimized around IC effectiveness starts caring more about predictability, praying at the alter of “on time, on budget” (variability is the enemy of manager promotions). Exceptional work is hard to predict so it stops being expected. Calcification achieved.
Organizations can avoid execution power dilution by optimizing IC effectiveness: helping those directly responsible for output be as productive as possible. In these organizations, successful managers do not seek to minimize variability, but instead embrace it in order to achieve unpredictably excellent results by amplifying execution power in their teams. Stay up all night. Move unreasonably quickly. Agonize over design so you can be proud of the end result. Close deals that other’s couldn’t imagine possible.
Rarely can one create an IC-optimized organization going the traditional delegation route because there is just so much business culture that aims to eliminate variability. It takes a founder (or other similarly empowered individual) to continually blow up the forces that constrain great IC work and the type of high-variability management that enables it. Ever wonder why many leaders who run organizations with execution power are criticized for their extreme levels of micro-management at both IC and managerial levels. It’s not a coincidence, it’s causality.
If done right, “founder mode” leads to trillion dollar outcomes. Some might attribute Apple’s success to structural powers: brand, economies of scale, and iMessage network effects. I believe Apple’s true power lies in the execution power of taste: their ability to ship world-class products.
“If you’re an Apple user and somebody offers you $10,000, but the only proviso is they’ll take away your iPhone and you’ll never be able to buy another, you’re not going to take it. If they tell you if you buy another Ford car, they’ll give you $10,000 not to do that, you’ll take the $10,000 and you’ll buy a Chevy instead.”
- Warren Buffett
That’s power.
AI’s age of infinite leverage amplifies execution power.
Execution power thrives on the intensity of a single founder or a small, dedicated team. As technology advances, it amplifies execution power by granting increasing amounts of leverage.
“Expressiveness” is the unifying concept behind technology leverage: the ratio of output complexity to input specificity. A pre-industrial weaver’s work for few seconds might express a single stitch. Quite low. A software engineer’s work the same amount of time might express how an icon appears on billions of screens. Pretty high.
Software, while powerful, still has limited expressiveness because a program’s behavior must be explicitly coded. AI is on a whole different level: it is extremely expressive because models can make a massive number of conclusions from just a small input prompt in order to express a complex output. In the near future, an individual’s simple prompt might generate millions of lines of production code. AI has the potential to create “infinite leverage.”
AI does not automatically grant execution power to all. Companies will become more efficient, but in order to have execution power a company must be exceptional—better than everyone else. Let’s remember: power only exists when we have something others don’t.
With infinite leverage, a small team with execution power will be able to accomplish great feats without the risk of power dilution that comes with too large of an organization. We may soon witness multi-billion dollar companies run by only a handful of employees.
Perhaps even more exciting, what will a large team with execution power be able to achieve if they can successfully empower their ICs to operate with infinite leverage at massive scale?
As AI continues to amplify execution power, it will become the most important strategy for defensibility in the future.
Defensibility
A series of posts dedicated to answer the question: Where will value accrue in AI?
"Execution power” is becoming more important than classical “structural power”.
Market revolutions occur when “critical" technology makes a new stack “viable”.
When multiple stacks become viable in rapid succession, companies must “AND” or “OR”.
Power within the AI stack—hardware, hosting, models, and infrastructure.
Power in AI applications—big tech, switching costs, network effects, and the $100 trillion of global GDP up for grabs