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The importance of your firm “getting horizontal”

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February 23, 2011

Do you know what your firm’s key competitive advantage is? You know, your area of specialty; the thing that you do better than any other firm in the world?

I recently sat down with technology and investing legend Andy Kessler to ask him what up-and-coming business leaders like us need to do in order to maximize our firms’ successes.  Andy’s insightful reply – with a healthy sprinkling of humor--is a great rule we should all keep in mind when thinking strategically about our core competency and area of focus.

Brett Owens: In your career, Andy, as a hedge-fund manager, investor and entrepreneur, you found a series of rules to live and do business by that, if followed, would greatly increase your chance of business success.  One of these was inspired by an old buddy of yours, is that correct?

Andy Kessler: My old college roommate, Franz, would put the TV on and then pass out. Right before he passed out, he said, "When in doubt, get horizontal." I would say, "I want whatever he's having."

So many companies are vertical. They do everything from soup to nuts. IBM used to do everything. Even on their mainframes, they still pretty much do. They design the chips. They wrap plastic around them. They wrote the operating system. They wrote the applications. They have the sales force and service organization. They did everything. Innovation couldn't find a way into this vertical organization because it was slowed down by the slowest link. If it took an operating system five years, then who needed the next set of chips?

The modern style and the one that I think you can maximize profits and have longevity [with] is you just pick a horizontal slice. If you can find a protected horizontal slice, then you've got a huge opportunity. Intel owned the microprocessor space. They ended up with 90 percent of the market selling microprocessors into PCs. They didn't sell PCs. They started making boards to make it easier for PC companies. But it was Compaq, IBM, Dell and all these other guys who would wrap the plastic around it.

The Internet went horizontal. Instead of just AT&T handling everything, there were companies like Cisco that would do the routers and other companies that would provide the fiber optic cables and companies like Yahoo! or Google doing the application layer above that. So you didn't have to do the whole thing.

When I look at investment opportunities, private and public, I go, ‘Is this a horizontal or is this company trying to do the whole thing from soup to nuts?’ Because being horizontal, I think, is absolutely the way to go.

Brett: It seems like that's increasingly the way to go as specialization takes over.

Let's talk about the guy you sat next to on a plane - perfect horizontal play in your mind and he was trying to take it vertical instead.  What was his product and specific strategy?

Andy: I still haven't seen it in the marketplace. In the book I tell a story of, as I'm writing this whole chapter on getting horizontal and all the great examples, I am sitting next to a guy on a plane who starts telling me about his company on the East Coast somewhere that has this compound that can always have, I think, a negative charge. What they figured out how to do is apply it to sunscreen. They can use this compound and it'll be negatively charged, so they can have it in your soap or your shampoo. Think about your soap. You take a shower in the morning, you use the soap, and for the next day, because of this negative charge on these SPF compounds, it sticks to your skin. So instead of the oily crap in suntan lotion that we slop on and we feel slimy all day, this is just sitting there with a charge. Sure enough, you have sunscreen protection, which is a great way to hold off skin cancer and all these great things.

I said, ‘Oh, that's great. I can imagine Ivory soap with their compound inside and Irish Spring and whatever all the other soaps are.’ The guy goes, ‘No, no, no. We're building a factory. We're going to build our own soap.’ I just sat there and I go, ‘You're crazy because you're going to have to fight for shelf space against companies that have been selling soap for almost 100 years. They own the retail space and they own the branding. You're going to have to spend hundreds of millions to get your branding when you can just leverage off of someone else's brand.’ This was a couple years ago. I don't know what happened to that company. On the other hand, I went to a store and looked for a sunscreen soap. They don't exist.

I think if he had gone horizontal, it would be tough work to weasel your way in to some of these bigger companies. But if you can become a sub-brand underneath a big one because you do one thing really well and are horizontal, I think it's a much higher chance of success.

Brett: Sure and let them do the marketing, manufacturing and the sales end for you.

Andy: Yeah. I'll give you one other example, and we can move on to another one. Google Android. This ties into another rule that I call Zero Marginal Cost, which I'll just touch on briefly. They developed a viable operating system for smartphones. At first, they made the Google Nexus One or whatever it was. I think it was just a sample phone. They sold it off of their website. Instead, what they ended up doing was just giving it away. You want to do a smartphone? Here's the operating system. It doesn't cost us anything. It costs on a marginal basis. We have all the engineers that develop it and keep it up. If you sell one copy or 10 million copies, because we gave it to you for free, it doesn't cost us any more.

Of course the way that Google makes up for that is they're giving something away at a horizontal layer below them either upstream or downstream. You have to figure that out. They're going to make money by having that operating system direct more search queries to the horizontal layer on the Internet that they do own, which is search. Sometimes you can give something away if you own one of the horizontal layers or slivers upstream or downstream from what you give away. I think that's a perfect example and a great example.

Andy Kessler is a former hedge fund manager and author of the new book, Eat People: And Other Unapologetic Rules for Game-Changing Entrepreneurs

Brett Owens is chief executive and co-founder of Chrometa, a Sacramento, Calif.-based provider of time-tracking software that records activity in real time. Previously marketed to the legal community, Chrometa is branching out to accounting prospects. Gains include the ability to discover previously undocumented billable time, saving time on billing reconciliation and improving personal productivity. Brett can be reached at 916-254-0260 and brett@chrometa.com.

Comments (1)
Andy is right! If big companies or industry practitioners would be horizontal, future competition with new and budding companies would be lessened and they are able to sustain the profits coming in.
Posted by rick23 | Thursday, February 24 2011 at 7:40AM ET
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