Defensive strategy of the firm

Combined with an offensive strategy to increase a firm’s competi­ tive advantage, an explicit defensive strategy can raise the sustainability of whatever competitive advantages a firm possesses. The ideal of defen­ sive strategy is usually deterrence— preventing a challenger from initi­ ating 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 possi­ bilities.

The important steps  in deterrence can be summarized as follows:

  1. Thoroughly understand existing 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? W here do these stem   from   in the value chain? Is access to channels difficult? W hat underlies this difficulty? W hat  are the value activities that  lead   to differentiation? How sustainable are the sources of the firm’s cost position and differen­ tiation (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 challeng­ ers 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 m ount the wrong defensive strategy.

  1. Anticipate the likely A firm must anticipate  the most likely challengers, whether they be potential entrants or competi­tors attempting to reposition themselves. Knowing who the likely chal­ lengers 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 m otor  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 independents.

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 competi­ tor by another  firm   will alter the   com petitor’s goals,   and   may create a would-be challenger. In beer, for example, M iller’s acquisition   by Philip Morris was a precursor of an aggressive challenge of Anheuser- Busch.

Who are the most likely potential entrants? Determining  the exist­ ing competitors that are most likely to reposition themselves is not easy, but anticipating likely potential entrants is often even more diffi­ cult.   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 m ajor food companies such as Consolidated  Foods  and  H. J. Heinz have acquired regional companies in order to take them national. For­ eign 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 busi­ nesses that represent a path for diversification into an industry,  de­ scribed 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 K odak’s  chemical and optical expertise, and of M atsushita’s office automation strategy.

The m ajor 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.8

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

  1. Forecast likely avenues o f attack. The third  step in formulating a   strategy   for   deterrence  is forecasting   the   likely   avenues   of 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 ques­ tion, “ 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 differ­ entiation 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, strate­ gies, 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   Instrum ents’  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 exam­ ple, Daimler Benz acquired Freightliner (number six in the industry), Volvo acquired the truck operations of W hite M otor (number seven), and Renault formed a coalition with Mack.

  1. Choose defensive tactics to block the likely avenues o f attack. Effective deterrence requires that a firm block the challenger’s likely avenues of 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 challengers. It is particularly important that defensive tactics reflect the actual goals of likely chal­ lengers and that they be noticed.
  1. Manage the firm ‘s image as a tough 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 sent.   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.
  1. Set realistic profit 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 investments. 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 respond­ ing to attacks  effectively and in   a   timely   way   is an   im portant  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 em­ ployed 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 im portant 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 im portant to holding the challenger’s expec­ tations 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 o f 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 suppli­ ers, 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 indus­ try, 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 fo r 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 chal­ lenger’s goals and timetable must also be assessed, because good re­ sponse 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 competi­ tors. Moreover, the response to less threatening  competitors  sends signals to more threatening  ones. A t 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 m ust 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 price- cutting 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 some­ times 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  SpecialProducts. Price cutting  can some­ times 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 m arket 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 re­ sources
  • 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 posi­ tioned 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 pro­ cesses 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.

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