The unique structural environment of the fragmented industry offers a number of characteristic strategic traps. Some common traps, which should serve as red flags in the analysis of strategic al–ternatives in any particular fragmented industry, are as follows:
Seeking Dominance. The underlying structure of a frag-mented industry makes seeking dominance futile unless that struc-ture can be fundamentally changed. Barring this, a company trying to gain a dominant share of a fragmented industry is usually doomed to failure. The underlying economic causes of fragmentation usually insure that the firm exposes itself to inefficiencies, loss of product differentiation, and whims of suppliers and customers as it increases its share. Trying to be all things to all people generally maximizes vulnerability to the competitive forces in a fragmented industry, al–though it may be an extremely successful strategy in other industries in which there are cost advantages to volume production and other economies.
An example of a company that learned this lesson the hard way was Prelude Corporation, which had the stated goal of being the “General Motors of the lobster industry.”4 It built a large fleet of expensive, high-technology lobster boats; established in-house main-tenance and docking facilities; and vertically integrated into trucking and restaurants. Unfortunately, the economics were such that its vessels had no significant advantage in catching lobsters over other fishermen, and its high overhead structure and heavy fixed costs maximized the company’s vulnerability to the inherent fluctuations of the catch in the industry. The high fixed costs also led to under-cutting on price by small fishermen who did not measure their busi-nesses against corporate ROI targets but seemed satisfied with a much lower return. The result was a financial crisis and eventual ces-sation of operations. Nothing in the Prelude strategy addressed the causes of fragmentation in its industry, and hence its strategy of dominance was futile.
Lack of Strategic Discipline. Extreme strategic discipline is nearly always required for effective competition in fragmented in-dustries. Unless the cause of fragmentation can be overcome, the competitive structure of fragmented industries generally requires focus or specialization on some tight strategic concept like those ar-ticulated in the previous section. Implementing these may well re-quire the courage to turn away some business, as well as to go against the conventional wisdom of how things are done in the busi-ness generally. An undisciplined or opportunistic strategy may work in the short run, but it usually maximizes the exposure of the firm to the intense competitive forces common in fragmented industries in the longer run.
Over centralization. The essence of competition in many frag-mented industries is personal service, local contacts, close control of operations, ability to react to fluctuations or style changes, and so on. A centralized organizational structure is counterproductive in most cases, because it slows response time, lowers the incentives of those at the local level, and can drive away skilled individuals neces-sary to perform many personal services. Whereas centralized control is often useful and even essential in managing a multiunit enterprise in a fragmented industry, centralized structure can be a disaster.
Similarly, the economic structure of fragmented industries is of-ten such that a centralized production or marketing organization is subject to no economies of scale, or even diseconomies. Thus cen-tralization in these areas weakens rather than strengthens the firm.
Assumption that Competitors Have the Same Overhead and Ob-jectives. The peculiar nature of fragmented industries often means that there are many small, privately held firms. Also, owner-manag-ers may have noneconomic reasons for being in the business. Under these circumstances, the assumption that these competitors will have an overhead structure or objectives of a corporation is a serious er-ror. They often work out of homes, use family labor, and avoid reg-ulatory costs and the need to offer employee benefits. Even though such competitors may be “inefficient,” it does not mean that their costs are high relative to those of a corporation in the same business. Similarly, such competitors may be satisfied with much different (and lower) levels of profitability than a corporation, and they may be much more interested in keeping up volume and providing work for their employees than profitability per se. Thus their reactions to price changes and to other industry events may be a lot different than the “normal” company.
Overreactions to New Products. In a fragmented industry the large number of competitors almost always insures that the buyer will exercise a great deal of power and be able to play one competitor against the other. In such a setting, products early in their life can often appear as salvations to an otherwise intense competitive situa-tion. With rapidly growing demand and buyers generally unfamiliar with the new product, price competition may be modest and buyers may be clamoring for education and service from the firm. This is such a welcomed relief in the fragmented industry that firms make major investments in gearing up to respond. At the first signs of ma–turity, however, the fragmented structure catches up with demand and the margins that were there to support these investments disap-pear. Thus there is a risk of overreacting to new products in ways that will raise costs and overhead and put the firm at a competitive disadvantage in the price competition that is a fact of life in many fragmented industries. Although coping with new products is a diffi-cult problem in all industries, it seems especially difficult in frag-mented businesses.
Source: Porter Michael E. (1998), Competitive Strategy_ Techniques for Analyzing Industries and Competitors, Free Press; Illustrated edition.