Force and Direction

This fourth (and final) blog post on “Hypercompetitive Rivalries” by Richard D’Aveni addresses competition against competitors with deep pockets as detailed in D’Aveni’s Chapter 4 (“How Firms Outmaneuver Competitors with Deep Pockets”).[1]  After the previous three escalation ladders have been ascended, firms have only one option which is competing with the extra resources of the company.  Companies with extra resources or deep pockets can withstand price wars and economic losses for longer timeframes, reduce risk with multiple locations, use several strategies simultaneously, recruit the best talent, monitor competitors more effectively, influence government, and have a wider margin of error.  However, competing with deep pockets is not sustainable.  Smaller companies may gain their own deep pockets, and companies with deep pockets in other industries may decide to compete in that industry.  D’Aveni outlines five dynamic strategic interactions to compete with deep pockets:

1)      Drive ‘Em Out – Firms with deep pockets may act more aggressively to drive out competition.  Once driven out, the firm must erect barriers of entry; otherwise, new entrants will continue to try and penetrate the market.

2)      Smaller Competitors Use Courts/Congress to Derail Deep-Pocketed Firm – Small competitors may file lawsuits claiming antitrust or predatory pricing or may apply for government subsidies.  They can also launch a public relations campaign against the company.

3)      Large Firm Thwarts Antitrust Suit – Sometimes lawsuits work but sometimes they are baseless.  Large firms have more resources to fight a lawsuit, and they can operate in another country where those laws aren’t applicable.  Governments may also support the large company, especially if that company operates in an area that affects national security.

4)      Small Firms Neutralize the Advantage of the Deep Pocket – Small companies can develop their own deep pockets through mergers and acquisitions or can form alliances and joint ventures with the large firm or with other firms.  They can focus on a niche market as described in the other escalation ladders and do it so well that the large firm can’t compete effectively against them.

5)      The Rise of a Countervailing Power – When a large company has little competition, it has power over consumers and suppliers.  Those consumers and suppliers can try to gain power and put pressure on the large company by forming consortia or merging.

The bottom line is that deep pockets aren’t sustainable.  Companies must find temporary competitive advantages using all four ladders of escalation in order to compete in this new hypercompetitive world.

This third blog post on “Hypercompetitive Rivalries” by Richard D’Aveni addresses entry barriers and how to tackle them in D’Aveni’s Chapter 3 (“How Firms Outmaneuver Competitors that have Built Strongholds Using Entry Barriers”).[i]  Limiting the number of competitors in a market has several benefits.  Companies have more power over buyers if there is a limit on choices and more power over suppliers if there are a limited number of companies buying particular supplies.  Limited competition also leads to tacit cooperation where all competitors cooperate with each other in their pricing schemes.  For example, if a company lowers its prices, then its competitor will follow suit and lower.  Therefore, the two companies tacitly cooperate by leaving their prices the same (most of the time!)

There are many entry barriers that competitors can erect to discourage new entrants from entering a market: economies of scale, strong brand image, investments in capital equipment and research, switching costs (i.e. making it difficult or costly for consumers to switch to other products), government protections, strong distribution channel, access to raw materials, favorable location, and development of know-how as described in my second blog post on this book.  Though these entry barriers can seem daunting to a potential entrant, entry barriers fall over time, and there are ways around entry barriers.  For example, new entrants are typically smaller so they are more nimble and flexible than incumbent competitors.  This can allow them to exploit competitive advantages quickly.  They can add their own varieties to existing products which give buyers for choices.  They can create their own distribution channels, ask the government for assistance and protections, or make complementary products to the incumbents’.  Acquisitions and alliances can offer synergies and resources to compete more effectively.

The following eight dynamic strategic interactions detail the escalating steps of building barriers and tearing them down:

1)      Building Barriers to Create a Stronghold – Companies develop the barriers listed above.

2)      Launching Forays into a Competitor’s Stronghold – D’Aveni outlines several critical success factors for attempting to enter a stronghold:

• Attack incumbent’s weaknesses first or find a blind spot in its strategy
• Concentrate on a single point of entry or find a niche that’s smallest enough to dominate
• Avoid or delay retaliation of the incumbent by launching when an incumbent can’t or won’t respond
• Withdraw quickly if incumbent retaliates and make sure to protect your home base once it is established

3)      Incumbent’s Short-Run Counterresponses to a Guerilla Attack on its Home Turf – Most incumbents don’t react to forays into their strongholds because they either don’t see the entry as a threat or retaliation is too costly.  However, an incumbent can use its entry barriers and advantages to crush competition, erect new barriers, or change the rules of the game.

4)      Incumbent’s Delayed Reaction – Many incumbents will eventually react – even though that reaction may be delayed.  They will generally try non-price retaliation first but usually have to move to price retaliation.

5)      Overcoming the Barriers – Entrants will use the methods described in the introduction of this blog to overcome barriers.  If they have a successful entry, other entrants will enter, and the incumbent will need to use long-term retaliation methods as described in #6 below to stifle competition from new entrants.

6)      Long-Run Counterresponses to the Attack – Incumbents may strengthen barriers, address their own weakness which allowed for the breach in barriers, or exploit a weakness in the entrant.

7)      Slow Learners and the Incumbent’s Reactions to Entrants Who Don’t Get the Message – Entrant may not react to retaliation because it doesn’t want to look weak or the retaliation wasn’t costly enough for the entrant.  At this point, the incumbent may take a much more aggressive position using stronger techniques to eliminate or reduce competition.

8)      Unstable Standoffs – Companies may directly attack each other’s strongholds, but many factors can break this standoff, including entrant by a third competitor, gains in cost, quality, timing, and know-how as described in my previous blog posts on this topic, and several other situations.

An interesting example of the steps in this chapter is Alice.com which is an e-commerce business that sells consumer goods online at similar prices to Target and Walmart but offers free shipping.  It uses a centralized warehouse and deals directly with manufacturers of the products.[ii]  Only time will tell whether Target or Walmart will directly retaliate against Alice.  Netflix is another example of a new entrant who found an online niche (which avoided initial retaliation) to successfully compete against Blockbuster.  Now Netflix (as the incumbent) competes against new entrant, Redbox.  If you have other examples, please feel free to leave a comment with them.

This second blog post on “Hypercompetitive Rivalries” by Richard D’Aveni describes timing, know-how, and the escalation ladder outlined in Chapter 2 (“How Firms Outmaneuver Competitors with Timing and Know-How”).[1]  Timing relates to the positions of first mover or second mover in a market.  There are advantages and disadvantages to both, and in many cases, being a close second mover is better than being a first mover.  Know-how relates to the knowledge and capabilities that a company develops that allow it to create new products and services.  The following six dynamic strategic interactions detail the escalating steps using these advantages of timing and know-how:

1)      Capturing First Mover Advantages – First movers have the advantage of time to develop economies of scale, reputation, brand loyalty, distribution and supplier networks, advertising space, and know-how in their functional skills of R&D, marketing, manufacturing, and other areas.

2)      Imitation and Improvement by Followers – D’Aveni gives several examples from a study that demonstrate how a close second mover can benefit over a first mover:

• “60 percent of patented successful innovations were imitated within 4 years”[2]
• “imitator’s development costs were 35 percent less than the innovator’s”[3]
• 65 percent of unpatented innovations were copied in a year or less[4]

However, timing is still important for a second mover.  If the second mover enters too soon, it still has the same costs and risks of the first mover.  If it enters too late, it could be too costly to ramp up and compete with the first mover.  D’Aveni then outlines seven strategies for followers: imitating exactly, adding options, removing options (thus lowering the price), creating a different product with the same use, changing the use of the product, branding, or creating compatible products.

3)      Creating Impediments to Imitation – First movers may construct barriers to entry with low or bundled pricing, economies of scale, patents or secrets, contracts with suppliers and distributors (locking out potential entrants), or switching costs (by making it difficult for consumers to switch to other products).

4)      Overcoming the Impediments – Second movers can take several actions to overcome the barriers in #3 above: enter at low price, reverse engineer first mover’s product, improve product, find new distribution and suppliers, integrate vertically, create joint ventures, license product, and use advertising and discounting.

5)      Transformation or Leapfrogging – Companies at this point can develop new capabilities to improve upon products and services, thus competing directly with competitors (i.e. transformation).  Or companies can use new capabilities to create a new product or focus on a new customer base (i.e. leapfrogging).

6)      Downstream Vertical Integration – Companies can provide services along with products or offer higher quality or more product variety.

Just as Chapter 1’s dynamic strategic interactions created an escalation ladder of competition.  These interactions do as well.  To avoid perfect competition, competitors race up these ladders to find temporary competitive advantages.  Steps may be skipped or rearranged, and if a company leapfrogs to a new product, then the cycle starts over.

We see these interactions in the most competitive industries today.  Look at Apple, Google, and Microsoft in the tablet market.  Apple released its first version of the iPad in April of 2012[5] and has released two new versions since then.  Google and Microsoft have followed suit with their Nexus 7 and Surface tablets, respectively.[6]  Red Bull has been the leader in energy drinks,[7] but Monster, Rockstar, and others are constantly introducing new flavors and trying to topple Red Bull’s market leadership.  There are many, many more examples, so feel free to “leave a comment” below!

For my last strategy class at Indiana University, we read the book, “Hypercompetitive Rivalries”, by Richard D’Aveni.  The first four chapters describe ladders of escalation of competition and the dynamic strategic interactions that occur at each step.  The fifth chapter describes hypercompetition in more detail while the sixth chapter outlines a New 7-S model for developing competitive strategy.  It was a pleasure to read, and I find myself looking at industries, companies, and competition through the lens of this book.

The first four chapters were my favorites and since they have some meaty information in them, I’ll break this blog post into four separate posts.  Below are my takeaway points and applications for Chapter 1 – “How Firms Outmaneuver Competitors with Cost-Quality Advantages”.[1]

The chapter begins by discussing Michael Porter’s traditional view of cost and quality by reviewing the strategies of Cost Leadership, Differentiation, and Focus.  Unfortunately, these strategies don’t consider what the competition is doing.  They also are more focused on the company’s present state as opposed to what the future holds.

In order to present his ideas appropriately, D’Aveni takes a moment in the chapter to discuss the definition of quality, how it changes over time, and how it is perceived differently by individuals.  Then D’Aveni moves into outlines of seven dynamic strategic interactions that occur in regards to cost and quality.

1)      Price Wars – If there is no differentiation in quality, then the only determinant is cost.  Therefore, price wars can occur, and since no one wins in price wars, competition quickly attempts to escalate to the second dynamic strategic interaction – Quality and Price Positioning

2)      Quality and Price Positioning – In this step, companies attempt to develop within-segment and between-segment positioning based on quality and cost.  For example, Mercedes and Cadillac fight for price and quality in their differentiated position while Stanza and Yugo fought for price and quality in their differentiated position.  Those segments also can compete against each other as one takes a cost leadership role and the other takes a differentiation role.

3)      The Middle Path – Some companies try to take the middle path by being between cost leadership and differentiation but this path is unstable due to the fourth dynamic strategic interaction – Cover All Niches

4)      Cover All Niches – Companies attempt to eliminate the Middle Path by offering a complete line of products.  But this method is difficult because the company’s capabilities for being a cost leader or differentiator are different and can be conflicting.

5)      Outflanking and Niching – Even if a full line of products is possible, there is still room for entry into niches.  But companies must beware… small niche competitors can flex and stretch into other segments, stealing away market share.

6)      The Move Toward Ultimate Value – Then the market moves into the ultimate value, aka perfect competition where companies try to provide high quality with low cost.  But in perfect competition, there are no profits and thus no winners.

7)      Escaping from the Ultimate Value Marketplace by Restarting the Cycle – Since no one wins in perfect competition, companies must restart the cycle.  They can do this by shifting competition to cost leadership or differentiation again, redefining perceived quality, switching from products to service, masscustomizing, extending product lines, or moving into a completely new industry or niche.

In order to escape perfect competition, companies attempt to move up the stages in this escalation ladder faster than competitors.  They may also restart the escalation ladder by redefining quality or moving competition into another arena that I’ll discuss in my next blog post.

In the course, we discussed the Old Rip Van Winkle Distillery who makes high-end aged bourbon that takes around 25 years to make.[2]  Its long lead time and limited supply allow the company to differentiate itself from other bourbon manufacturers and charge more for its high quality and exclusivity.  Thus it has successfully found a niche for those willing to buy – and wait for – high quality aged bourbon.

In addition to this company, I can think of so many examples where these stages occur.  Just look at the cereal aisle or chip aisle in the grocery store.  Every company is trying to differentiate themselves with varieties of flavors, packaging, and ingredients to avoid perfect competition.  Occasionally, Pepsi and Coke will enter into a price war and then quickly use marketing or new product extensions to differentiate themselves again.  Toyota has a full line of products offering the Yaris at $14,000[3] to the Lexus LFA at $375,000[4] which squeezes out the middle path discussed in stage 3.  They also have used niching and product extensions with their Scion, Daihatsu, and Hino Motors brands.[5]  Fashion lines range from Gucci and Armani on the differentiated segment to clothing lines sold at Walmart on the cost leadership segment.  Evidence of cost and quality competition is all around us, and D’Aveni has successfully outlined the stages in this competitive arena.

I recently finished reading “The Innovator’s Solution” by Clayton Christensen and Michael Raynor, and I enjoyed it very much.  It contains valuable information and advice for managers attempting to navigate the difficult line between sustaining the core business and innovating products and services that create new growth and profits.  Many lessons from the book have been learned, but the following points truly resonated with me.

Chapter 5 – Paraphrase: If products aren’t good enough, integration is the competitive advantage.  If products are more than good enough, modularity is used to compete on speed, responsiveness, and convenience.[1]

In the year 2000, I started my first internet retail business and added a few more in subsequent years, each serving a niche market.  When I first started them, we had to be fully integrated as e-commerce was fairly new.  We created and managed the websites including the secure ordering algorithms, databases for customer information and product information, and website content.  We setup our own phone system to handle calls and took our own photographs of the products for the sites.  We purchased inventory that we held in our own warehouse and packed products up for shipment every day.  Although I no longer have these businesses, I see how internet retail has changed over the years.  Companies have specialized in website templates that provide secure orderings for customers.  Other companies specialize in the database systems for storing inventory and customer information.  Other companies supply phone support for businesses, and others specialize in website optimization to help with marketing products.  UPS and Amazon offer pack-and-ship services for retail businesses so companies no longer have to manage inventory and shipping services.  Companies have also popped up to handle payroll, taxes, and state-required workforce rights postings.  In a few short years, internet retail has gone from highly integrated to highly modular as e-commerce has become more than good enough.

Ch. 6 – page 162 – “ Competitiveness is far more about doing what customers value than doing what you think you’re good at.”[2]

Many companies focus so much on their core competencies that they fail to see where the market is headed, what customers really want, and how they can successfully compete.

Ch. 7 – page 187 – “An opportunity that excites a small organization simply isn’t large enough to be interesting to a very large one.”[3]

This point was the one that my small internet retail businesses were based upon.  I sold niche products with a small following that the larger companies weren’t interested in pursuing.  The amount of incremental revenue for the larger companies was not beneficial for them to pursue, whereas, it was for me.  As my businesses grew, I found that the same action occurred to me as it was no longer beneficial for me to continue pursuing certain markets.

Ch. 8 – page 217 – “a company’s strategy is what comes out of the resource allocation process, not what goes into it.”[4]

This point was a bit painful to read because it represented a poor decision that I made with one of my online businesses.  Cross-Stitches.com sold prefinished cross-stitch products online and did so successfully for several years.  Then I started buying cross-stitch patterns and cross-stitch books to sell, thinking that they would complement the prefinished products.  Unfortunately, it was a poor decision that had not been fully analyzed.  There were dozens more competitors in the cross-stitch pattern market, so my spur-of-the-moment action caused that market to be more competitive and induced pattern retailers to enter into the prefinished market.  Worse than that, my resources were tied up in inventory of books and patterns, so I didn’t have the resources to use for other parts of the business.  To this day, I’m still convinced that the decision to sell books and patterns was the beginning of my company’s downfall.

Chapter 9 – page 236 – “patient for growth but impatient for profit” [5] and page 258 – “Ventures that are allowed to defer profitability typically never get there.”[6]

As discussed previously, I had several e-commerce businesses in the early 2000s.  At the time, I believed that it was important to grow and grow as fast as possible like other internet businesses were trying to do at the time.  I took no salary and put all revenues back into the business to expand our warehouse space, start more e-commerce businesses, purchase more inventory, and pay for more marketing.  I was spending and spending and spending every dime that came in so we could get bigger and bigger.  I completely ignored profits thinking that they would come someday.

Cross-Stitches.com was the main site that had financed the other businesses and financed our rapid growth.  It was a healthy business with growing sales and gross profit margins of 40%.  Then in May 2007, our main supplier started its own e-commerce site with aggressive marketing and advertising.  Sales plummeted.  Cross-Stitches.com was no longer in a position to support the other businesses which were still in the nascent stages of development.  I had pushed for growth and not profitability in the subsequent businesses, so I was in the exact same spot as described in Chapter 9 of the book:

“The dilemma of investing for growth is that the character of a firm’s money is good for growth only when the firm is growing healthily.  Core businesses that are still growing provide cover for new-growth businesses.” …  “It is when growth slows – when senior executives see that the sustaining-innovation pipeline is inadequate to meet investor expectations – that investing to grow becomes hard.  The character of the firm’s money changes when new things must get very big very fast, and it won’t allow innovators to do what is needed to grow.”[7]

The new businesses couldn’t survive without assistance from the core business, and the core business couldn’t fund itself.  I had to make a very difficult decision to close all of them.

Conclusion

This book is very well-written and contains valuable nuggets of information for any manager.  I highly recommend it.