Finding Power

People think strategy is about profit, but really, it’s about power. Profit is just the prize.

And if you want to understand the nature of power in business — where it comes from, how to create it, how to sustain it — probably the best place to start is Clay Christensen’s “Law of Conservation of Modularity,” a massively underrated idea from his second book, The Innovator’s Solution.

It’s pretty obscure compared to Christensen’s other hit theories, like “disruptive innovation” and “jobs to be done.” I think this is because the theory can be somewhat abstract and technical, making it hard to understand. (Don’t worry — in this article I do my best to make it engaging and intuitive! 😅)

Another reason the idea is obscure is it suffers from branding issues. Confusingly, it was originally called “The Law of Conservation of Attractive Profits” and some people still refer to it by that name.

But, despite all the challenges, this is not an idea you want to overlook. In my view, it’s actually the most powerful theory in Christensen’s entire oeuvre. I love it because it gives us a unique lens we can use to answer the most important question in strategy: why are some companies so much more powerful than others?

So let’s dive in :) 🔮

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Every industry — the entire economy, in fact — is essentially a chain of interlocking activities that work together to transform raw resources into completed products. These “value chains” have evolved to serve the most common needs that arise in our lives.

For example, here are two value chains, built on two different consumer needs: refreshment and entertainment.

(JTBD = “job to be done,” which is Christensonian parlance for “need”.)

Of course, all these activities aren’t being performed solely to serve consumer needs. At every step in the process, businesses are trying to make as much money as possible. But they will not all succeed. Some positions in the value chain are destined to generate unimaginable wealth for the businesses that occupy them, while other positions are doomed to subsistence profitability.

This is a fact that we often take for granted. But really, stop to think about it: why do some companies make so much more money than others? 

In my previous posts covering Michael Porter’s work, I covered the Five Forces framework, which is a good tool to measure how powerful a company is. The basic idea is that there are five forces that act on every company to limit power and profits. But it doesn’t explain why some companies experience so much more force than others. Obviously this is important information to know when you’re crafting a business’s strategy.

Lucky for us, it’s the exact question Clay Christensen aimed to answer with his “Theory of Conservation of Modularity.”

The key to predicting where power will sit in any value chain, Christensen realized, is to identify where you can improve the thing that’s most painfully lacking in the user experience. In other words: focus on what is not yet good enough. Make it better, and customers will love you, giving you power. Back away from the frontier of what’s possible, or perform activities in the value chain that don’t alleviate this pain, and soon enough your power will vanish.

“Uhhhh… that’s obvious!” You might say. “Build a great product that solves a real problem, and you’ll have a great business.” And it’s true — but it’s nowhere near the whole truth. We need to dig deeper to make it useful.

Here’s the thing: In order to improve what’s not good enough in the user experience, you need to have control over the layers of the value chain where the problems are. And, critically, you need to maintain that position, or find a new one if/when the problems move somewhere else.

For example, imagine that smartphones had terrible battery life, but the screens were more than good enough. You might think the screen-maker deserves attractive profits because they did a great job and solved a problem for consumers — but no! The opposite happens! In this world, it would suck to be a screen-maker. The screens are good enough, so nobody cares about any of their product improvements. When the most important problem in a value chain moves away from you, so does your power.

This point is so important it’s worth repeating: When the most important problem in a value chain moves away from you, so does your power.

So, what does this mean for our smartphone value chain, where the battery sucks but the screens are great? In this world, the phone maker would have the power to buy screens from any reasonable provider without their customers noticing the difference — which makes screens a pure commodity. Competition becomes solely based on price, and the phone maker gets to dictate all the terms and influence the screen design to help them solve whatever problem they are focused on, like improving battery life.

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The phone maker’s power to dictate the terms to the screen makers is really important. In order to optimize battery life, the phone maker will need a lot of control over all the subcomponents inside the phone. And the phone maker that is able to get that control — and wield it well — will tend to sell the most phones. Because they’ll have solved the most important problem (battery life) the most effectively.

Clay Christensen would call the phone in this example an “integrated system,” and the screen a “commoditized module.” The distinction between integrated and modular can be somewhat confusing at first, but it’s actually pretty simple.

An integrated system has a lot of interdependencies. That means there are a lot of things inside that depend on each other, and if you try to separate them you run into problems. It’s like when you say someone is “really integrated into the community” it means they have a lot of relationships where they depend on others, and others depend on them.

A modular system, on the other hand, is made of clusters with lots of interior complexity, but relatively simple public interfaces. It’s like at a big company, where you have smaller teams with lots of internal integration, but externally they act as modules, with simple flows of inputs and outputs. Another example is our brains, which have “modules” full of dense networks of neurons, and relatively sparse connections between the modules.

What does the distinction between integration and modularity have to do with solving product problems? Well, improving any system is an act of integrating. You manipulate the connections between various components to make them work better together.

For example, the phone maker might come up with creative ways to improve battery life by dimming the screen in low-light situations. In order to do that, you need to integrate a light sensor, the operating system, and the screen’s backlight. If you don’t have control over all those layers, you can’t implement this optimization.

In any value chain, some companies own the important integrations, and others have to conform to what those integrators need. The way this works is simple: natural selection.

Imagine two value chains with two different architectures. 

The first has a company that controls all the important layers needed to solve the most important problem. (For example, a smartphone maker that has sufficient control over the internals of the screen and CPU to optimize battery life.) 

The second has a bunch of powerful module creators and a relatively weak integrator. (For example, a smartphone assembler that uses off-the-shelf components and doesn’t have enough control over them to fix the battery life problem.)

The value chain that will win is, obviously, the one that has a powerful integrator solving the problems that matter most to consumers. The other value chain might still exist to serve consumers that have different priorities (e.g. linux in the 90s), but it’ll be much smaller and weaker overall than the value chain whose architecture is better adapted to serve the mainstream market’s job-to-be-done.