Defensive strategy of the firm

Combined with an offensive strategy to increase a firm’s competitive advantage, an explicit defensive strategy can raise the sustainability of whatever competitive advantages a firm possesses. The ideal of defensive strategy is usually deterrence—preventing a challenger from initiating a move in the first place or deflecting it to become less threatening. The other type of defensive strategy, response, is one in which the firm reacts to challenges as they occur. Response seeks to lower the challenger’s objectives for a move once begun, or lead the challenger to rescind it altogether. In both deterrence and response, the principle is to alter a challenger’s assessment of the attractiveness of a move.

1. Deterrence

The cost of deterrence is often less than the cost of fighting battles once a challenge has begun. A firm cannot deter challengers, however, unless it understands the nature of the threat. A maxim of defense in military strategy is that it is extremely costly to defend an entire perimeter against attack from any direction where the challenger may employ any weapon. The same principle applies in competitive strategy. A firm must determine which competitors and potential competitors are most dangerous, and the ways in which they might choose to behave. Only then can the appropriate defensive tactics be marshaled. Scenarios (Chapter 13) can be a useful device for examining the possibilities.

The important steps in deterrence can be summarized as follows:

1. Thoroughly understand existing barriers. A firm must have a clear understanding of what entry and mobility barriers it currently possesses, their specific sources, and how they might change. Is the firm protected by economies of scale? Where do these stem from in the value chain? Is access to channels difficult? What underlies this difficulty? What are the value activities that lead to differentiation? How sustainable are the sources of the firm’s cost position and differentiation (Chapters 3 and 4)?

The height of existing barriers shapes the extent of the threat to a firm’s position. If barriers are falling, for example, they must be rebuilt or replaced if the firm is to preserve profitability. The specific barriers present will also determine the types of strategies that challengers will employ, and the areas in which defensive tactics might prove most effective. A firm protected by high barriers to channel access, for example, is more likely to face competitors’ attempts to create new channels than invasions of the existing ones. Conversely, a firm without scale or other sustainable cost barriers may be vulnerable to small, low- overhead competitors that are satisfied with what for the firm would be a poor return on investment. Challengers will usually try to find ways to sidestep existing barriers or somehow nullify them (see Chapter 15).

A firm must have precise knowledge of the specific sources of each barrier if it is to exploit them effectively. In residential roofing products, for example, a firm must recognize that economies of scale are driven primarily by regional scale due to high transport costs, the economics of production and sales force utilization, and regional differences in product mix. If a roofing products firm is satisfied in attributing its barriers only to scale but does not understand the specific sources of its scale barriers, it may mount the wrong defensive strategy.

2. Anticipate the likely challengers. A firm must anticipate the most likely challengers, whether they be potential entrants or competitors attempting to reposition themselves. Knowing who the likely challengers are is essential to focus and target defensive investments. The height of barriers and the impact of retaliation are also relative to who the likely challengers are, and not absolute. In motor oil, for example, the likely potential entrants facing Castrol, Quaker State, and other competitors are the oil majors. Given the resources of the majors, barriers such as capital and scale become less important than they would be if likely entrants were

There are three questions to answer in anticipating likely challengers:

Which existing competitors are not satisfied? The most likely challengers will be existing competitors that are not satisfied with their current position. Competitors that consistently fail to meet their goals will be prone to attempt to reposition themselves. An assessment of competitors’ assumptions, strategies, and capabilities should illuminate whether they are likely to reposition themselves in a way that threatens the firm. Good competitors (Chapter 6) pose a less serious threat of repositioning than bad competitors. Often the acquisition of a competitor by another firm will alter the competitor’s goals, and may create a would-be challenger. In beer, for example, Miller’s acquisition by Philip Morris was a precursor of an aggressive challenge of AnheuserBusch.

Who are the most likely potential entrants? Determining the existing competitors that are most likely to reposition themselves is not easy, but anticipating likely potential entrants is often even more difficult. A way to identify potential entrants is to isolate those firms for which entry into the industry would represent a logical extension of their existing activities. The most common potential entrants tend to fall into the following categories:

• • Regional competitors in other regions.
  • Foreign firms not now operating in a country.
  • Firms for which the industry would be backward or forward integration.
  • Firms that can achieve tangible interrelationships, intangible interrelationships, or create blocking positions by entering the industry (see Chapter 9).

Regional firms often enter other regions or go national. This has been a popular strategy recently in the food industry. A number of major food companies such as Consolidated Foods and H. J. Heinz have acquired regional companies in order to take them national. Foreign entry into a country is also common as industries globalize—a contemporary example is the attack on Upjohn in the U.S. antiarthritic drug market by Boots Company, headquartered in Britain.

There are many forms of tangible interrelationships among businesses that represent a path for diversification into an industry, described in Chapter 9. The potential interrelationships leading to an industry should be traced to identify logical entrants. For example, entry into copiers was a logical extension of Kodak’s chemical and optical expertise, and of Matsushita’s office automation strategy.

The major challenge in identifying potential entrants is to avoid being trapped by conventional wisdom. Many companies overlook serious potential competitors such as foreign firms or related diversifiers by focusing too closely on traditional sources of new competitors such as regional firms or spinoffs. The list of most likely potential entrants may also shift as an industry evolves. ¹⁰³

Are there substitute competitors? In some industries, substitutes may be the most dangerous competitors, and thus should be the appropriate focal point for defensive strategy. Chapter 8 describes how to identify substitutes, and how threatening substitutes can be deterred.

3. Forecast likely avenues of The third step in formulating a strategy for deterrence is forecasting the likely avenues of attack. A firm must determine the best ways in which its position might be attacked so that it can focus its defensive investments on the most vulnerable areas. Every management team should ask itself the question, “Given what I know, how would I attack this firm if I were a competitor?”

The likely avenues of attack will be a function of the barriers to entry or mobility that are present, and how they might be changing. In the mustard industry, for example, Grey Poupon has increased advertising spending dramatically and attacked French’s with a differentiation strategy. This was much more logical than a head-on price battle given French’s scale-related advantages. The same sort of logic would suggest that SCM’s portable typewriters were vulnerable to private labeling by Brother combined with new electronics technology, given SCM’s channel and brand loyalty. U.S. farm equipment firms were more vulnerable in small tractors than in large tractors, where their U.S. base gave them volume advantages over Japanese firms.

The likely avenue of attack will also reflect the assumptions, strategies, and capabilities of likely challengers. Miller Beer stressed heavy advertising and market segmentation in the beer industry. This was not surprising given the intangible interrelationships present involving its parent, Philip Morris. Texas Instruments’ ill-fated price cutting in personal computers was similarly predictable, given its traditional posture in semiconductors. Acquisition of second-tier competitors is a common way for potential entrants to challenge a firm, and this possibility must always be considered. In the truck business, for example, Daimler Benz acquired Freightliner (number six in the industry), Volvo acquired the truck operations of White Motor (number seven), and Renault formed a coalition with Mack.

4. Choose defensive tactics to block the likely avenues of attack. Effective deterrence requires that a firm block the challenger’s likely avenues of attack. This requires choosing defensive tactics that raise structural barriers or increase expected retaliation that will be most cost-effective from those described. The appropriate mix of defensive tactics will vary from firm to firm, and must meet the tests outlined above. If a firm is most vulnerable to private labeling, for example, it may have to invest in a special private label model and signal its willingness to price-compete. In addition, the defensive tactics chosen must be targeted against the most likely It is particularly important that defensive tactics reflect the actual goals of likely challengers and that they be noticed.

5. Manage the firm’s image as a tough defender. In addition to investing in defense, a firm must clearly communicate its intentions to defend. A firm is continuously sending signals about its commitment to defend and must carefully manage the image it projects. Every public statement and every action in the marketplace must be weighed to determine the signals that will be Ideally, a firm can achieve the image that Procter & Gamble (P&G) has. A poll of almost any group of managers, in and out of consumer goods, will show over- whelmingly that P&G is viewed as totally committed to defending share in its business. The fact that P&G has this image is not an accident, but the result of statements and actions over a long period of time.

6. Set realistic profit expectations. No defensive strategy can be effective unless a firm has realistic profit expectations. A firm’s profit expectations must reflect the barriers it possesses and those that can be created through defensive Often reducing profitability today will allow the firm to earn superior profits in the future.

2. Response

If deterrence fails, a firm must decide how to react to a challenger once an attack is under way. Deterrence cannot and should not try to reduce the chance of attack to zero. Doing so is usually too expensive and every possible challenge can rarely be anticipated. Hence responding to attacks effectively and in a timely way is an important part of defensive strategy.

Effective response is based on shifting a challenger’s expectations. The whole arsenal of defensive tactics I have described can be employed to accomplish this, matched to the goals, assumptions, and capabilities of the particular challenger. For example, General Foods’ Maxwell House has mounted a tough and effective defense against P&G, and no doubt caused P&G to reconsider its targets in the coffee industry. Aggressive pricing, advertising, and fighting brands have been employed to hold position and demonstrate General Foods’ commitment. The vigor of the defense has meant that P&G is believed to be earning little return on its investment in the coffee business.

A number of important principles should guide response:

Respond in Some Way as Early as Possible. A firm must respond in some way to an attack as early as possible, because a challenger’s exit barriers and commitment will grow as it meets its early targets and makes incremental investments. While a firm is often not in a position right away to completely counter an attack, making some immediate response is still important to holding the challenger’s expectations in check. Even an inadequate holding action, such as increased advertising, may be necessary to keep a competitor from meeting its initial targets and thereby gaining the confidence necessary to increase its capital investment and raise its goals.

Invest in Early Discovery of Actual Moves.  Given the advantages of responding early in the entry or repositioning process, the firm can gain substantial advantages in detecting actual moves of challengers very early. This can be facilitated through activities such as:

• Regular contact with raw material suppliers, equipment suppliers, and engineering firms to learn of orders or interest
• Close contact with advertising media to detect purchases of advertising space
• Monitoring of attendance at trade shows
• Regular contact with the most adventurous buyers in the industry, who might be approached first by a new competitor or most prone to be seeking alternative sources
• Monitoring of technical conferences, schools, and other places when technical people might be recruited

Base the Response on the Reasons for the Attack. A firm must attempt to understand why a challenger is attacking, what its goals are, and what long-term strategy it has adopted. An attack based on desperation should be responded to differently than one emanating from parent company pressure on a business unit for growth. A challenger’s goals and timetable must also be assessed, because good response requires that they be disrupted and ultimately modified. A good response also recognizes how one move by a challenger might fit into a longer term strategy.

Deflect Challengers in Addition to Trying to Stop Them. Part of the purpose of response is to make a move less threatening even if it cannot be stopped. It is often easier to get a challenger to focus or redirect its strategy than to withdraw it. A firm must identify ways in which a challenger’s goals could be partially or completely met in less threatening ways and respond accordingly.

Take Every Challenger Seriously Enough. There is no such thing as a challenge that can be ignored. Every challenger must be analyzed for its motivations and capabilities. Even weak challengers have the potential of disrupting industry structure or damaging good competitors. Moreover, the response to less threatening competitors sends signals to more threatening ones. At the same time, however, a firm must avoid the tendency to overreact to a challenger. Response is costly, and must be directed at real and not imagined threats.

View Response as a Way to Gain Position. Response can often be used to gain position rather than just to stop a competitor. A battle between strong competitors often hurts weaker competitors more than the strong competitors hurt each other, as has been the case in soft drinks and beer. Moreover, an attack by a competitor in one segment may open that competitor to vulnerabilities in another segment that can be exploited.

3. Response to Price Cutting

Price cutting is among the most difficult forms of attack to counter, due to its rapid effect on profitability and the risk of an irreversible downward price spiral. Thus a firm must be particularly careful in how it responds to price cutting. Some additional issues may be useful to consider in responding to a price cut in addition to those discussed above:

Reasons for Competitor Price Cutting. A competitor may be price-cutting out of necessity to raise cash in the short term, or as part of a long-term campaign to increase share. It might also be pricecutting because it does not understand its costs and thinks it is pricing to achieve a fair return. Worse yet, the competitor may be price-cutting because it enjoys significantly lower costs. The correct response to price cutting will be very different depending on the reason underlying it. Therefore, the reason must be diagnosed as rapidly and accurately as possible.

Willingness To Do Battle. Price cutting by a competitor often rests on the assumption that a firm will not react aggressively, but will maintain a price umbrella in the hope of preserving profits. Early and vigorous response is thus often necessary if price cutting is to be contained. The response need not always be a corresponding price cut, but it must be something besides hoping the price cutter will go away. A firm must convince a price cutter that mixed motives will not paralyze it.

Localized Response. Often the response to price cutting can and should be localized to particularly vulnerable buyers, or to product varieties where differentiation is lowest, and not involve across-the- board actions. Localizing the response reduces its cost.

Cross Parry. Price cutting may be contained or eliminated if the firm immediately attacks (with price and other moves) the price cutter’s key buyers or product lines. Similarly, price cutting can sometimes be stopped if blocking positions in other industries are employed to respond. The principle is to demonstrate that the price cutter has more to lose from initiating a price war than it is likely to gain.

Cut Price in Other Ways. Sometimes prices can be effectively reduced to respond to a price cutter through providing free service, discounting ancillary equipment, or other means that are easier to reverse than a price cut itself. Also, indirect price cuts may be more susceptible to localization, and less easy for competitors to match. Failing indirect price cuts, rebates or other special discounts may be less difficult to reverse later than reductions in list prices.

Create or Employ “Special” Products. Price cutting can sometimes be met more effectively with fighting brands or stripped-down products (e.g. no free service), than by lowering the price of the primary product line. The buyer can be offered a low price on special products, but reminded that they are inferior to the firm’s normal offering.

4. Defense or Disinvest

In many industries, defensive investments yield a high return. However, a firm should optimize rather than maximize its investment in defense. In some industries, defensive investment is not appropriate at all, or is only appropriate as a temporary delaying action. This is true where a firm’s position is not ultimately sustainable. In such industries, the best defensive strategy is to “take the money and run.” This means that the firm generates as much cash as possible, knowing that entry or repositioning will ultimately erode its position. Part of such a strategy may sometimes be to encourage the entry of competitors to boost the growth rate of the market while harvesting takes place.

The conditions that suggest that disinvestment is preferable to investing in defense are as follows:

• low barriers, or falling barriers as the industry evolves
• little opportunity to create barriers
• potential entrants and existing competitors with superior resources
• competitors with low return-on-investment targets or other characteristics of a bad competitor

5. Pitfalls in Defense

There are many pitfalls in defending position. Even strongly positioned leaders are regularly attacked successfully because they make errors in defensive strategy. The single biggest pitfall in defense is a narrow concern with short- term profitability, which conflicts with the reality that defense requires investment. Internal decision-making processes in many firms are biased against defensive investments. They reward short-term profitability, and fail to reward the reduction of risk that defensive strategy seeks. The benefits of a successful defensive strategy are often hard to measure, since a successful defense means that nothing happens.

The second largest pitfall in defensive strategy is complacency. Firms often do not examine their environment for potential challengers, or seriously consider the possibility that challenge will occur. As a result, it is striking how often firms fail to make simple and inexpensive defensive moves. Moreover, firms often actually invite competitors into their industry by earning unsustainable margins or by ignoring buyer needs. A number of the other pitfalls in defensive strategy will become apparent when I discuss the principles of gaining competitive position in the next chapter.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.