Dynamic Strategy - Market context and competitive games
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lecture_outline_-_session_5.docxCorporate Strategy in a Global Economy
Session 5: Market Context and Competitive Games
In the last three sessions, we discussed a major tension in the content of business-level strategy, i.e. whether to emphasize the role of resources or of the markets. Now, we consider a related tension in the industry context of strategy – how much choice a firm has in shaping its context, vs. how much does it need to comply to the rules of the competitive game. We also consider a related tension in the process of strategy – how much can this process be determined and directed vs. left to emerge based on chance.
The choice or design school of strategy calls for a strategist to find the best alignment between the resources and the markets, i.e. internal and external conditions of a firm. The first step in this process is identify the Key Success Factors or KSFs – the factors in a firm’s market environment that influence a firm’s ability to survive and grow, and evaluate if the firm’s capabilities give it a position of strength or of weakness on those factors. According to Grant (2013), KSFs may be identified by considering two key competitive criteria: serving the customers and surviving the competitors. In other words, identify how to win the customer preference in a market? And what is critical to survive the competition in a market? Then, evaluate if these factors will be strength or weakness for the firm, and accordingly develop a strategy that builds on the strengths, and compensates for the weaknesses.
Five forces and Value Net are useful frameworks for identifying opportunities and threats or challenges within an industry. In addition, STEP analysis can be used identify opportunities and threats in the broader environment. STEP analysis entails an assessment of socio-cultural, technological, economic and political forces that are likely to shape the opportunities and challenges for a firm. An extended version of the STEP analysis is STEEP, which includes ecological as the fifth force. In a STEEP analysis, one considers for each force the trends that are most strongly shaping presently and/or are likely to shape in future the firm’s survival and growth. Then, one identifies whether those trends and changes are opportunities or threats for the firm, given its goals and strategies.
The compliance or structuralist school of strategy calls for a strategist to understand the structure of the marketplace, and then to craft strategies that are required to win in that marketplace. Market structures influence strategies in two ways – first direct influence on competitive gaming behavior, and second, influence on the strengths and weaknesses of competing firms, and in turn on the competitive moves and counter-moves of each firm.
There are two typologies of market structures – one based on the niche density (i.e. the number of competitors), and the other based on carrying capacity (i.e. the industry lifecycle). In economic theory, four major types of traditional markets are identified based on the number of competitors: (1) Monopoly (single firm), (2) Oligopoly (a few firms), (3) Monopolistic competition or niche markets (many firms), and (4) Perfect competition (numerous firms). Another important structural characteristic is the industry lifecycle. Similarly, in strategy literature, four types of markets are identified based on the industry lifecycle: nascent markets, hyper-competition, dominant firm, and fragmented market. Each of these market structures offers differing constraints, opportunities and incentives to the firms. Therefore, each market structure encourages distinctive types of competitive gaming behaviors.
Let’s review the competitive behaviors under market structures based on number of competitors.
Monopoly refers to a market structure with only one firm. The monopoly firm is largely free to decide its own price, output, and other product and service features. Monopolists are known to engage in a range of tactics, or games, to impede the entry and success of other entrants: “predatory pricing”, “essential facility denial”, “vaporware”. In the Internet era, new types of monopolies – referred to as creative monopolies – have emerged, who are actually helping to cut the monopoly power of suppliers, and transfer value back to the consumers (for example, Amazon).
Oligopoly comprises of a few large firms that perceive one another as mutually inter-dependent. There exists an intense rivalry along several dimensions, such as price, quality, brand image, and market share. Success requires firms to consider the effects of their actions on the competitors’ behavior. It is best for a firm to strike a balance between industry level cooperation (to avoid profit eroding warfare) and firm level competition (to avoid giving up potential revenues and profits). New evidence suggests that most oligopolistic markets tend to become ineffective because of collusive tendencies, and ripe for creative destruction by new firms.
Niche markets consist of market segments within the larger marketplace that emphasize a particular need, or geographic, demographic or product segment but that differ along some key dimensions from other market segments in the marketplace. Firms have two options for value differentiation in niche markets: vertical (alternative price-quality tradeoffs) and horizontal (alternative similarly priced qualities for different target groups).
Perfect competition is characterized by the lack of significant fixed costs or investments, and running business largely on variable costs. The firms tightly monitor their variable costs, and compete on efficiency. Though basic economic theory considers perfect competition to be the ideal state for social welfare, it does not provide effective conditions for the growth of the firms or the industry. It often invites fly-by-night players to make a fast, extra buck by free riding on the public goods and social infrastructure. A key insight is when the access to infrastructure, technology and knowledge is based on the pay per use model, more firms are likely to enter the market with limited risks of huge losses if they fail. Such pay per use model thus can engender several creative endeavors and promote innovation and growth.
Let’s review the competitive behaviors under market structures based on industry lifecycle.
Nascent competition markets are usually spurred by technological innovation, newly emerging customer needs, and economic and sociological shifts. A distinguishing characteristic of the nascent competition market is the lack of any “rules of the game”, and a competitive race among the firms. The success requires winning the competitive race on several fronts: improving the functionality of the technology, forging advantageous relationships with channel partners, acquiring a core group of loyal customers, accessing patient venture capitalists and entrepreneurial human capital, and moving fast to develop a network of players who commit to the use of firm’s technology as the reliable, cost-effective and dominant one.
Hyper-competitive market is turbulent and fast changing where the rules of game are continually shifting, spurred by the processes of globalization and information economy. The firms therefore seek to distribute up-front investment requirements, either across a network of firms or over time. A firm competing on the edge of hyper-competition thrives on the “guerilla advantage”.
Dominant firm structure comprises of a single large firm at the core, and several smaller firms at the periphery of the market. The dominant firm generally enjoys a competitive advantage based on the lower costs deriving from early entry and “learning-by-doing”, large economies of scale, and proprietary technology; the smaller firms focus on niches that are not profitable or attractive for the dominant firm, due to factors such as smaller scale, idiosyncratic resources and knowledge bases, and customized services of the smaller firms in their target markets. A special form of the dominant firm is the vertical dominance, where a dominant firm forms captive vertical relationships with vendors and distributors.
Fragmented structure is one where no firm has a significant market share to strongly influence market outcomes. While the products tend to be expensive and not very well developed, the success depends on keeping the costs low using a “bare bones” approach with low overheads, minimum wage employees, and tight cost control. A fragmented structure often arises when the government breaks-up a monopoly, or deregulates entry into an erstwhile monopoly market. There are three major approaches for consolidating a fragmented market: mergers and acquisition involving fragmented firms, codification of the effective practices and franchising to replicate those practices, and verticalization involving the use of information technology to coordinate the entire supply chain.
As noted earlier, KSFs differ across different market structures, and firms vary in terms of whether these KSFs represent strengths or weaknesses for them. In order to protect and reinforce their strengths, and compensate their weaknesses, firms engage in competitive games – i.e. competitive moves and counter-moves. These competitive games act to balance the role of choice (also referred to as agency) and compliance (also referred to as structure).
Competitive moves may be either defensive or offensive. Market leaders and followers who are seeking to maintain their positions tend to engage in defensive moves. These include (a) covering all bases, (b) establish footholds, and (c) prepare for disrupting self. First, firms may fill all gaps in the market by introducing a full product line that contains several variants of the products. The leading ready-to-eat cereal companies offer numerous variants of their products, leaving few holes for other companies to enter and fill. When firms choose to follow a strategy of cover-most-bases, they may combine that with a strategy to fortify the market base. In other words, they may lower the motivation of a rival to attack by reducing the profit expectations, through barriers such as capacity expansion, continuous improvement, and signaling of commitment. Second, firms may establish foothold - a small position within a market in which they do not yet compete. The footholds deter attacks from rivals, and give capability to expand if desired. Footholds may be geographical or technological. Swedish furniture firm IKEA relies on geographical footholds. When entering a new country, it opens only one store and uses that as a showcase to establish IKEA’s brand. Only then, it opens more stores. Third, firms may prepare themselves for disruption by forming partnerships with new entrants who have disruptive technologies, or by introducing fighter brands to ward off low quality low cost rivals, or by expanding into other markets where their major rivals are present or where new rivals might emerge in order to preempt attacks from those rivals.
Market followers who are seeking to grow and contest share from their rivals tend to engage in offensive moves. These include (a) flanking, (b) guerilla, and (c) judo. First, flanking involves identifying new target segments, or segments that are not well served by the rivals because they do not see them as important enough or profitable enough. This allows the firms to build their capabilities, and then rapidly scale up before the rivals are able to respond. Second, guerrilla involves surrounding the rivals with several brands, each targeting a very small market segment that the rivals find unattractive to serve. Guerilla strategy forces the rivals into making a choice between spreading their attention and resources too thin, and agreeing to share their key resources with the firm. Finally, Judo strategy is based on the principle of leverage – i.e. finding ways to turn the strength and strategy of a rival against the rival. Rivals tend to have emotional and other commitments to the areas related to their strengths, and may be slow or at loss to respond when these strengths are targeted. For instance, Drypers, a disposable diaper maker, declared that the P&G’s Pampers coupons could use be applied to Drypers diapers as well, neutralizing P&G’s strength of coupon distribution system.
Competitive countermoves are responses to competitive moves. Research indicates that a firm’s response to competitive moves of rivals is a function of three factors - awareness, motivation, and capability. Together, this is referred to as the A-M-C framework.
· Awareness: Firms often watch out for the moves by their rivals, just as a police patrol walking the beat.
· Motivation: Firms are motivated to retaliate most when their rivals make a competitive move, just as a kid who cries “he hit me first”.
· Capability: Firms must have resources and gameplan in order to respond.
In general, competitive games tend to be rule-based, in which specific “rules of engagement” based on the market structure influence the awareness, motivation and capability of the firms. There are three major rules of engagement: first, the timeframe for and speed with which the rivals respond to one another’s moves; second fair play, i.e. an equal opportunity for all firms to participate successfully in the competitive game; and third, expected payoffs, i.e. how the firms expect to win or lose from a competitive move or countermove. When the response timeframe is shorter, more imitative and repetitive behaviors are likely, as compared to when the firms have time to respond. When there is fair play, greater awareness building information sharing and capability sharing cooperative motivation is likely. When expected payoffs are win/ lose, then the firms are likely to show greater awareness, motivation and capability in an effort to mitigate losses.
Finally, let’s discuss the role of chance in the process of strategy – how much can the strategy process be guided and planned, vs. be let to emerge and unfold on its own. The chance factor influences the context of competitive business strategies in two ways: the scope of dynamism, and the scale of disruption. Globalization is associated with both increasing complexity (chance factors influencing more variables concurrently) and increasing radicality or uncertainty (more frequent, rapid, and unexpected surprises). This requires that the strategies must be adaptable to the crisis events.
Scenario analysis is a useful tool for discovering fundamental forces that shape future chance events, and to prepare the firm for potentially complex and uncertain chance events. In the late 1960s, Shell oil adopted scenario analysis for strategic planning. At the time, the supply for oil was believed to be plentiful, as there were sufficient known oil reserves and the major oil companies could increase the number of wells to drill to meet any increase in demand. However, Shell’s leaders were not comfortable with this understanding of the environment, and wanted to consider potentially unexpected developments. They asked their planners to construct six scenarios about the future, of which one was labeled crisis scenario. In the crisis scenario, the producing governments would refuse to increase oil production beyond the levels necessary for their own cash needs. The scenario was built by recognizing already increasing efforts of the governments in the Middle East to exercise their sovereignty, even though the big oil multinational companies were still dominant. When the oil crisis actually struck in 1973, Shell recognized how scenario analysis had helped it think deeper and stretch its mental models beyond the traditional wisdom, and thus prepared it to respond and compete effectively in the radically new environment.
The case on the wine industry discusses key actors in the market – grape growers, cooperatives, wine brokers, and wine merchants. These actors form many clusters around the world. Old World wine producers found themselves constrained by embedded wine-making traditions, restrictive industry regulations, and complex national and European Community legislation. This provided an opportunity for New World wine companies to challenge the more established Old World producers by introducing innovations at every stage of the value chain. The New World wine producers enjoy less expensive land, are willing to experiment unconstrained by tradition, bringing innovations in growing, winemaking, packaging and marketing, and are able to control the entire value chain and to react rapidly to shifts in demand. As illustrated by the case of Chinese firms, they also face some challenges - competition with increasing number of foreign wines (due to WTO entry), lack of wine industry standards and regulations, lack of Chinese wine drinking culture, and relative homogeneity of Chinese wine. Grace Vineyard of China has succeeded by focusing on domestic market where population is getting wealthier and more health-conscious, focusing on quality wine for upper middle class, and establishing wine shops to perform wine education for consumers.
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