Competition Demystified
Competition Demystified

Competition Demystified

The process by which high returns are eroded is straightforward. In the case of automobiles, it began in the years after World War II, when Cadillac (with Lincoln in the United States) and Mercedes-Benz dominated their local markets and made exceptional profits. (Location 402)

This process—in which prices remain stable, while sales fall and fixed costs per unit sold rise—differs from that which operates in a price-driven (commodity) market, but the ultimate effect on profitability is the same. (Location 412)

If no forces interfere with the process of entry by competitors, profitability will be driven to levels at which efficient firms earn no more than a “normal” return on their invested capital. It is barriers to entry, not differentiation by itself, that creates strategic opportunities. (Location 423)

Barriers to entry lie at the heart of strategy. The first task in our simplified approach to strategic thinking is to understand what barriers are and how they arise. (Location 452)

Strategy, on the other hand, is concerned with structural barriers to entry. (Location 457)

Competitive advantages may be due to superior production technology and/or privileged access to resources (supply advantages). They may be due to customer preference (demand advantages), or they may be combinations of economies of scale with some level of customer preference (the interaction of supply-and-demand advantages, which we discuss in chapter (Location 486)

Innovations that are common to all confer competitive advantages on none. (Location 534)

If cost advantages rooted in proprietary technology are relatively rare and short-lived, those based on lower input costs are rarer still. (Location 536)

Access to cheap capital or deep pockets is another largely illusory advantage. (Location 542)

History is full of companies driven out of business by more efficient competitors—steel producers, appliance manufacturers, small-scale retailers, and nationwide chain stores. (Location 545)

In the absence of government support, the notion of “cheap” capital is an economic fallacy. “Cheap” capital that is due to government support is best thought of as just another competitive advantage based on a government subsidy. (Location 555)

These advantages, though, tend to be limited both in the markets to which they apply and in the extent to which they can prevent competitive entry. (Location 558)

The competitive advantages we have described so far are uncomplicated. An incumbent firm may defeat entrants either because it has sustainably lower costs or, thanks to customer captivity, it enjoys higher demand than the entrants. (Location 648)

advantage. In fact, the truly durable competitive advantages arise from the interaction of supply-and-demand advantages, from the linkage of economies of scale with customer captivity. (Location 651)

The competitive advantage of economies of scale depend not on the absolute size of the dominant firm but on the size difference between it and its rivals, that is, on market share. (Location 654)

The cost structure that underlies these economies of scale usually combines a significant level of fixed cost and a constant level of incremental variable costs. (Location 658)

But something in addition to this cost structure is necessary for economies of scale to serve as a competitive advantage. If an entrant has equal access to customers as the incumbents have, it will be able to reach the incumbents’ scale. (Location 663)

This holds true for differentiated markets, like kitchen appliances, as well as commodity markets. All competitors who operate effectively should achieve comparable scale and therefore comparable average cost. For economies of scale to serve as a competitive advantage, then, they need to be coupled with some degree of incumbent customer captivity. (Location 666)

Still, if an incumbent diligently defends its market share, the odds are clearly in its favor. This is why it is important that incumbents clearly understand the nature of their competitive advantages and make sure that their strategies adequately defend them. Think (Location 679)

The best strategy for an incumbent with economies of scale is to match the moves of an aggressive competitor, price cut for price cut, new product for new product, niche by niche. (Location 696)

Computer manufacturers are accustomed to dealing with Intel and are comfortable with the level of quality, supply stability, and service support they have received from it. (Location 703)

Economies of scale in distribution and advertising also perpetuate and amplify customer captivity across generations of consumers. (Location 715)

Because of the edge it gives incumbents in both winning new generations of customers and developing new generations of technology, the combination of economies of scale and customer captivity produces the most (Location 718)

sustainable competitive advantages. (Location 719)

First, in order to persist, competitive advantages based on economies of scale must be defended. (Location 721)

If a rival introduces attractive new product features, the leader must adopt them quickly. (Location 723)

Second, the company has to understand that pure size is not the same thing as economies of scale, which arise when the dominant firm in a market can spread the fixed costs of being in that market across a greater number of units than its rivals. It is the share of the relevant market, rather than size per se, that creates economies of scale. (Location 731)

The relevant market is the area—geographic or otherwise—in which the fixed costs stay fixed. (Location 733)

Network economies of scale are similar. Customers gain by being part of densely populated networks, but the benefits and the economies of scale extend only as far as the reach of the networks. (Location 742)

Third, growth of a market is generally the enemy of competitive advantages based on economies of scale, not the friend. The strength of this advantage is directly related to the importance of fixed costs. As a market grows, fixed costs, by definition, remain constant. Variable costs, on the other hand, increase at least as fast as the market itself. The inevitable result is that fixed costs decline as a proportion of total cost. (Location 752)

on economies of scale are found in local and niche markets, where either geographical or product spaces are limited and fixed costs remain proportionately substantial. (Location 770)

A firm in an industry with no competitive advantages basically should forget visionary strategic dreams and concentrate on running itself as effectively as it can. (Location 779)

Operational effectiveness can make one company much more profitable than its rivals even in an industry with no competitive advantages, where everyone has basically equal access to customers, resources, technology, and scale of production. (Location 782)

In competitive situations where a company enjoys advantages related to proprietary technologies and customer captivity, its strategy should be to both exploit and reinforce them where they can. (Location 785)

To reinforce its competitive advantages, a company first has to identify their sources and then to intensify the economic forces at work. If the source is cost advantages stemming from proprietary technologies, the company wants to improve them continually and to produce a successive wave of patentable innovations to preserve and extend existing advantages. The practice here is again a matter of organizational effectiveness, including making sure that investments in research and development are productive. (Location 794)

If the source is customer captivity, the company wants to encourage habit formation in new customers, increase switching costs, and make the search for alternatives more complicated and difficult. (Location 797)

Amplifying switching costs is usually a matter of extending and deepening the range of services offered. Microsoft has regularly added features to its basic Windows operating system, making the task of switching to other systems and mastering their intricacies more onerous. As banks move beyond simple check processing and ATM withdrawals to automatic bill payment, preestablished access to lines of credit, direct salary deposit, and other routine functions, customers become more reluctant to leave for another bank, even if it offers superior terms on some products. (Location 808)

The same tactic of providing more integration of multiple features raises search costs. Comparison shopping is more difficult if the alternatives are equally complicated but not exactly comparable. (Location 812)

First, as we have mentioned, they tend to be far longer lived than the two other types, and therefore more valuable. (Location 820)

Second, advantages based on economies of scale are vulnerable to gradual erosion and thus need to be defended vigorously. (Location 827)

Once a competitor increases the size of its operations, it shrinks the unit cost gap between it and the leader. (Location 827)

These advantages can be destroyed, but they can also be created. In a market with significant fixed costs but currently served by many small competitors, an individual firm has an opportunity to acquire a dominant share. If there is also a degree of customer captivity, that dominant share will be defensible. (Location 830)

In pursuit of these opportunities, it is important to remember that size and rapid growth of the target market are liabilities for incumbents, not assets. (Location 838)

The appropriate strategy for both incumbents and entrants is to identify niche markets, understanding that not all niches are equally attractive. (Location 841)

Production and product features that require capital expenditures, like building centralized facilities to provide automated processing, will also make life more difficult for smaller competitors. (Location 847)

Ill-conceived growth plans, in contrast, can do just the opposite. Grow or die corporate imperatives too often lead to grow and die results. The fates of Kmart, Kodak, RCA, Westinghouse, CBS, the original Bank of America, and AT&T, all once lustrous corporate names, are evidence of the perils of unfocused growth strategies. Instead of defending the markets in which they were dominant and profitable, they spent copiously (Location 850)

Competitive advantages are invariably market-specific. They do not travel to meet the aspirations of growth-obsessed CEOs. (Location 855)

As a first rule of thumb, if you can’t count the top firms in an industry on the fingers of one hand, the chances are good that there are no barriers to entry. The rapid change in market share in table 4.2 confirms the rule. As a second rule of thumb, if over a five-to eight-year period, the average absolute share change exceeds 5 percentage points, there are no barriers to entry; if the share change is 2 percentage points or less, the barriers are formidable. (Location 1068)

incumbent firm can do is prepare in a general way to resist the incursion. The outsider must decide between entering the market and staying out. Though there are a range of possible entry moves, from tentative and measured to a full-frontal assault, to keep things simple we will treat the decision as binary, a choice between either enter or don’t enter. (Location 3213)

It needs to consider the two basic alternatives; either accepting the entrant, however grudgingly, or attacking it. Both alternatives have costs, and a rational decision compares them carefully. (Location 3219)

The first is avoiding head-to-head competition, just as in the prisoner’s dilemma. (Location 3293)

It can choose a niche strategy if the incumbent has adopted a high-volume, mass-market one. (Location 3295)

Second, the entrant should proceed quietly, taking one small step at a time. A brash public announcement that it plans to capture a major portion of the incumbent’s business, with openly proclaimed goals for market share, is almost certainly going to trigger an aggressive reaction. (Location 3298)

the entrant should let the incumbents know that it is moving into only one market, not all the ones the incumbents dominate, (Location 3308)

In formulating strategy, there is a natural progression of perspectives from unrestrained competition through a mix of competition and cooperation to a more purely cooperative viewpoint. We have followed that progression in this book. We began with an analysis of competitive advantages. Then we considered companies as economic agents concerned only with their own capabilities, which they seek to exploit without regard to how others might react to whatever they do. We noted that there were two situations in which this type of competition takes place. (Location 3969)

The other situation is one with an elephant surrounded by ants—Wal-Mart in its stronghold, Intel and Microsoft on the desktop. There are barriers to entry, and the companies that benefit from competitive advantages do very well, especially if they know how to exploit those advantages. But their success does not entail any measure of cooperation with their smaller rivals. What these two situations share is a model of competition among agents that is unmediated by any recognition of common interests. (Location 3974)

Until now, we have concentrated on the capacities of firms (competitive advantage) and on their actions (competitive strategies). (Location 4005)

The cash flows themselves are based on estimates of future sales, profit margins, tax rates, capital investment requirements, and the cost of capital. (Location 4701)

equity). Many of these variables, especially market share, margins, overhead expenses, and capital requirements, will depend on the intensity of future competition. But it is difficult to forecast precisely how competition will affect each of them. Moreover, competitive conditions do not influence these variables independently; the intensity of competition affects many of them simultaneously. (Location 4704)

The first important judgment is whether the product market in which the company operates will be economically viable going forward. In the case of Ford, the question is whether the global automotive industry is likely to exist for the foreseeable future. (Location 4790)

Finally, for a viable industry, intangibles like customer relationships, organizational development, workforce acquisition and training, and product portfolios will have positive reproduction costs.* (Location 4806)

Calculating the reproduction value of the assets of a firm in a viable business, just like establishing the liquidation value, does not require projections into the future. The necessary information is all currently available. Also, in working down the balance sheet, the estimates of value move from the most certain (cash and marketable securities) to the least certain (the intangibles). These distinctions are important; a valuation in which intangibles like brand equity are a significant part of the whole is less trustworthy than one in which cash, receivables, and general-purpose PPE represent most of the total value. Finally, assets further down the balance sheet require more industry expertise to calculate their reproduction values. But this expertise is no greater than what is necessary to make any informed investment decision in the industry in question. (Location 4813)

Second, what are euphemistically called “nonrecurring items” have to be incorporated into the calculation. In an ideal world, these charges would be infrequent, equally divided between positive and negative changes, and would not affect long-term sustainable earnings. But in the practice of some companies, the charges are frequent, they are overwhelmingly negative, and they cram into single years losses that have been incurred over many prior years and may be incurred in future years. (Location 4844)

The difference between the asset value and the EPV is precisely the value of the current level of competitive advantages. (Location 4908)

Only growth in the presence of existing competitive advantages creates value. (Location 4957)

The same method for valuation applies to investment projects on a scale smaller than entire companies. (Location 4987)

Without competitive advantages, investments will generally return the cost of capital, meaning they will not add any value for the existing owners. (Location 4994)

On the other hand, investments made under the protective umbrella of a well-established competitive advantage will almost always be worth doing, either to exploit opportunities or to secure the existing franchise. We discuss this issue more completely in the following chapter on corporate development. (Location 4997)

The strategic framework we have developed in this book, especially the view that the most important determinant of strategy is whether an incumbent firm benefits from competitive advantages, applies directly to issues of corporate development. (Location 5010)

Venture capital investing is a second area in which strategic considerations ought to play an important role. (Location 5187)

example of how enthusiastic venture investors can saturate an attractive market with new entrants, almost all of whom lose money. According to conventional wisdom, success in venture capital investments depends upon two factors: the quality of the business plan and the capabilities of the venture team itself.* (Location 5192)

Proprietary technologies, the venture investors hope, will be developed as the venture progresses. But when they start out, almost by definition, no firms have access to such technologies. (Location 5196)

So, while a well-conceived venture business plan should look to the ultimate creation of competitive advantages, that vision is not itself a competitive advantage. (Location 5200)

Venture sponsors are ultimately in the knowledge business. They have to create and maintain information collection networks. They bring together knowledge of technologies, markets, people, and other essential resources and try to combine these ingredients to produce a well-functioning entrepreneurial organization. (Location 5216)

First, extensions of current operations are more likely to address well-established markets than newly developing ones. Entering established markets is actually more difficult than moving into new ones. Barriers to entry are much more likely to exist in already functioning markets. (Location 5222)

The fact is that companies with sustainable competitive advantages are the exception, not the rule. (Location 5317)

It is true that many firms may have the potential to enjoy competitive advantages in some markets. A company that chooses its niche market wisely, works assiduously to develop customer captivity, and organizes its operations to achieve economies of scale may be able to emerge from the pack and become the dominant firm in a market, now protected by barriers to entry. (Location 5319)

The traditional discussion of productivity growth ascribes it to increases in potential output that arise from capital investment, a more educated workforce, and advances in technology. (Location 5338)

There is an alternative perspective, one that has received far less attention. According to this view, most firms operate well within the “productivity frontier,” which represents the limits of the possible given the availability of capital, the quality of the existing labor force, and the state of current technology. (Location 5342)

From this perspective, operating efficiency is at least as important as structural economic conditions in accounting for a firm’s performance relative to its peers.* The evidence strongly favors this second view. (Location 5346)

These differences are as common among simple, low-capital-intensive, low-tech operations as they are among sophisticated, capital-intensive, high-tech firms. (Location 5367)

Disparities in productivity across national economies mirror these intercompany differences and cannot be accounted for by divergences in either technology (which is globally available), capital investment, or labor force quality. (Location 5372)

Differences in productivity across firms and plants are surprisingly large and persistent, and these differences are due predominantly to differences in management performance. (Location 5411)

productivity improvement projects at the firm level have enormous returns on the capital necessary to fund them. (Location 5451)

The technologies employed tend to be seasoned, trailing edge rather than leading edge. (Location 5455)

(For a number of companies, the true software “killer-app” has been a fully integrated, enterprise resource planning package; difficulties with implementing it effectively put some firms out of business.) (Location 5457)

Companies with outstanding performance have tended to be narrowly focused on particular industries or even subsegments of industries. (Location 5471)

But Welch did reinstitute the policy of each GE business being either first or second in a market, or else getting out. (Location 5482)

matter. Pursuit of unrealistic strategic goals guarantees poor business outcomes. Warren Buffett has observed that when management with a good reputation meets an industry with a bad reputation, most often it is the reputation of the industry that survives. (Location 5489)

An obsession with strategy at the expense of the pursuit of operational excellence is equally damaging. (Location 5492)

The first is to identify the competitive universe in which the company operates, and to locate its position regarding competitive advantages and barriers to entry. (Location 5495)

If the company does enjoy competitive advantages, the second goal is to recognize and manage effectively competitive interactions with other firms on whom the company’s performance critically depends. (Location 5496)

The third goal, which applies to all companies whether or not they benefit from competitive advantages, is to develop a clear, simple, and accurate vision of where the company should be headed. (Location 5497)

A third measure, and the one we normally prefer when all the data are available, is return on invested capital (ROIC), which counts the returns both to shareholders and to lenders. (Location 5510)

ROIC solves that problem by treating both debt and equity as invested capital. (Location 5513)