Defensive strategy aims to influence a challenger’s calculation of the expected return from entry or repositioning, causing the challenger to conclude that the move is unattractive or to opt for a strategy that is less threatening. To do this, a defender invests in defensive tactics. Most defensive tactics are costly and reduce short-term profitability in order to raise the longer-term sustainability of a firm’s position. However, most firms cannot eliminate the threat of attack completely, except at prohibitive costs. Hence a defender should invest to reduce the threat of attack to an acceptable level, balancing the risk of attack against the cost of defense.
Three types of defensive tactics underlie any defensive strategy:
- raising structural barriers
- increasing expected retaliation
- lowering the inducement for attack
Structural barriers to entry/mobility are sources of disadvantage for a challenger relative to the firm (see Chapter 1). The presence of structural barriers worsens the challenger’s expected profit from a move. For example, General Foods’ Maxwell House Coffee brand enjoys scale economies in marketing that will force a challenger to bear higher than proportional marketing costs relative to General Foods until it reaches proximity in market share. These higher costs will reduce the challenger’s projected profit from entry below that of General Foods, and therefore reduce the likelihood of a challenge.
The second type of defensive tactic is those that increase the threat of retaliation perceived by challengers. Expected retaliation by the firm will lower a challenger’s revenues or raise its costs, and thus erode the challenger’s expected profitability. Raising structural barriers and increasing expected retaliation both seek to worsen a challenger’s position vis-a-vis cost drivers or drivers of uniqueness, thereby eroding its relative position.
A third type of defensive tactic involves lowering the inducement for challengers to attack. While raising barriers and expected retaliation is aimed at reducing a challenger’s expected profit, lowering the inducement requires that a firm accept lower profits. If a firm reduces prices or takes profits in an interrelated business unit instead of in the industry, for example, a challenger will see less to gain if an attack is successful.
All three types of tactics can be employed both before a challenge has occurred and once it has begun. Once a challenge has begun, however, a firm must consider not only its position toward the challenger but also how its behavior toward the challenger might discourage or encourage others. Investments in defensive tactics cannot and should not be measured against conventional short-term profitability targets. This ignores their purpose. Actions that deter challengers deliberately reduce short-term profitability to ensure long- term profitability.
1. Raising Structural Barriers
Chapter 1 summarized the types of structural barriers to entry/ mobility that may be present in an industry. Every type of barrier can be influenced by a defender. In some industries, the levels of spending on advertising, sales force, plant capacity, and other activities that is necessary for doing business (ignoring defensive considerations) creates high barriers as a by-product. If the barriers naturally created by ongoing activities are very high, a firm is in the happy position of not having to make further defensive investments in barriers. How- ever, in the long run it may be profitable to invest in building barriers even higher than natural barriers.
While offensive moves to enhance competitive advantage in the value chain can raise structural barriers, I concentrate here on defensive moves to raise barriers. Defensive tactics that raise structural barriers are actions that block logical avenues of attack for challengers. Some of the most important are the following:
Fill Product or Positioning Gaps. Barriers are increased when a firm fills gaps in its product line or preempts alternative marketing themes that a challenger might logically employ. Such moves force a challenger to take the defender head-on instead of being able to gain an unopposed beachhead, or command premium prices that can be used to offset higher costs. Filling gaps can take a number of forms:
- Broadening the product line to close off possible product niches. Seiko acquired the Pulsar watch brand to block attacks at the low end by Citizen and Timex.
- Introducing brands that match the product characteristics or brand positionings the challenger has or could use. These blocking or fighting brands raise barriers without undermining the position of the principal brand.
- Foreclosing alternative marketing themes by using such themes on secondary product lines or in secondary marketing campaigns.
- Defensive low pricing of product varieties adjacent to competitors’ lines in order to discourage competitor line extensions (Chapter 7).
- Encouraging good competitors (Chapter 6) that fill gaps without threatening the firm.
Defensive product varieties and marketing activities should not be expected to be as profitable as a firm’s core business, and prices must reflect their defensive value.5 However, the defensive value of such products or marketing activities does not necessarily require that a firm spend heavily on them. Even if gap-filling products are not pushed aggressively, their mere presence acts as a deterrent because of the threat that they will be activated if a challenger threatens. Raising barriers may thus at the same time lead a challenger to expect greater retaliation.
Block Channel Access. When a firm makes it more difficult for a challenger to gain access to distribution channels it raises a major structural barrier. Defensive strategy should be directed not only toward a firm’s own channels but also toward blocking access to other channels that may be a substitute channel or a springboard for the challenger’s entry in the firm’s channels. For example, challengers often gain incremental volume and experience by using private label channels.
Channel-blocking tactics include the following:
- Exclusive agreements with channels.
- Filling product line gaps in order to offer the channel a full Competitors then have a harder time getting established.
- Expanding the product line to include all possible sizes and forms of a product, in order to clog the channels’ shelf or warehouse space.
- Bundling or unbundling as appropriate to reduce vulnerability to challengers (Chapter 12).
- Aggressive volume discounts or discounts based on the channels total purchases to discourage experimentation with new suppliers.
- Attractive after-sales service support of a firm’s products that prompts channels to forgo their own investment in after-sales support personnel and
- Willingness to supply private label sellers in order to preempt a challenger’s access to volume.
- Encouraging good competitors, who fill up channels without threatening the firm.
Raise Buyer Switching Costs. The firm can raise barriers by raising the switching cost of buyers. I have described the ways to increase switching costs in Chapters 4 and 8. Some common approaches in defensive strategy include:
- Free or low-cost training of buyer personnel in the use or maintenance of a firm’s product, or in specialized procedures such as record keeping that are only compatible with purchasing from the firm. Johns Manville has employed buyer training effectively to raise the switching costs of roofing contractors in buying roofing products.
- Participating in joint product development with buyers, or providing applications engineering assistance to them to help integrate a firm’s product into the buyer’s product or process.
- Establishing ties to the buyer through the use of dedicated computer terminals to allow direct ordering or inquiries, or through maintaining buyer data bases on the firm’s computer.
- Ownership of on-premise storage facilities or equipment that is used at the buyer’s location. In motor oil, for example, leading suppliers own tanks for bulk storage located on the garage or repair shop’s premises.
Raise the Cost of Gaining Trial. If a challenger faces high costs of getting buyers to try its product, it faces a considerable barrier. Raising this barrier requires that a firm understand those product varieties that are purchased first, as well as the types of buyers that are most likely to be early experimenters and purchasers of a challenger’s product. Steps to close off these avenues of trial for competitors include:
- Selective price reduction on items in the line most likely to be purchased first.
- High levels of couponing or sampling of buyers most prone to experiment.
- Discounting or deals that increase the inventory held by the buyer, lengthen the time between orders, or lengthen the period of contracts. All these impede a challenger’s access to orders.
- Announcing or leaking information about impending new products or price changes that cause buyers to postpone purchases.
Defensively Increase Scale Economies. Barriers increase if economies of scale grow. It is often possible to increase scale economies in areas such as advertising and technology development, where scale thresholds are competitively determined. By boosting its spending rate on technology development and hence increasing the rate of new product development, for example, a firm can increase the challenger’s required technology development investment, which is amortized over a smaller base of sales. A firm can increase scale economies most effectively in value activities where minimum scale is determined by competitive spending levels rather than determined by technology (see Chapter 3). Often this implies differentiating in ways where the firm has a cost advantage in differentiation (Chapter 4).
Scale thresholds are often increased defensively in a number of ways:
- Increased advertising spending.
- Increased spending to boost the rate of technological change.
- Shorter model life cycles, where models require fixed or quasifixed development costs.
- Increased sales force or service coverage.
Defensively Increase Capital Requirements. If a firm can raise the amount of capital needed to compete with it, a challenger may be discouraged. While many defensive tactics in effect raise a challenger’s capital requirements by increasing start-up costs, a number of defensive moves have a particular impact on capital requirements:
- Raising the amount of financing provided to dealers or buyers.
- Increasing warranty coverage or liberalizing policy toward returns.
- Reducing delivery time for products or spare parts, implying an increase in the amount of inventory required or the need for excess manufacturing capacity.
Foreclose Alternative Technologies. If a firm can foreclose alternative technologies a challenger might employ, it blocks this avenue of attack. Some tactics for foreclosing technologies are:
- Patenting the feasible alternative technologies in the product or process, as Xerox did effectively in the early phases of the copier industry.
- Maintaining a participation in alternative technologies, through purchasing licenses, maintaining pilot plants employing alternative technologies, forming coalitions with other firms with expertise in alternative technologies, or actually producing products using an alternate technology. All these tactics let a challenger know that the firm has access to the alternative technologies if it needs them.
- Licensing or encouraging good competitors to employ alternative technologies (see Chapter 6).
- Discrediting alternative technologies through signaling.
Invest in Protecting Proprietary Know-how. If a firm can protect its proprietary know-how in products, processes, or other activities in the value chain, it raises barriers. Firms often have no systematic program in place to limit the diffusion of their know-how. Building on the discussion in Chapter 5, some elements of such a program include:
- Strictly limiting access to facilities and personnel
- Fabricating or modifying production equipment in-house.
- Vertical integration into key components to avoid passing knowhow to Michelin practices this aggressively in tires.
- Human resource policies to minimize personnel turnover and prevent disclosures.
- Aggressive patenting of inventions.
- Litigation against all infringers. Litigation may delay investments by challengers until the uncertainties are resolved, even if the possibility of success in the litigation is low.
Tie Up Suppliers. Barriers increase if a firm can foreclose or limit a challenger’s access to the best sources of raw materials, labor, or other inputs. Some representative tactics are as follows:
- Exclusive contracts with the best suppliers.
- Backward integration or partial or complete ownership of suppliers to foreclose sources of supply.
- Purchasing key locations (mines, forest lands, etc.) in excess of needs to preempt them from competitors.
- Encouraging suppliers to customize their value chains to meet a firm’s needs, raising supplier switching costs to serving new competitors.
- Signing long-term purchasing contracts to tie up supplier Coca-Cola reportedly pursued this strategy in sourcing high-fructose corn syrup, a low cost substitute for sugar.
Raise Competitors’ Input Costs. If a firm can raise a challenger’s relative input costs, it raises barriers. Most opportunities to do so rest on differences in competitors’ (or potential competitors’) cost structures, so that a given input price change has a greater impact on them than on the firm. Some common tactics are as follows:
- Avoiding suppliers that also serve competitors or potential competitors, raising these suppliers’ costs and avoiding the transfer of some of the firm’s scale economies to competitors through the suppliers.
- Bidding up the price of labor or raw materials if they represent a higher percentage of costs for competitors. This tactic may well have been used by large beer companies against smaller firms with less automated plants.
Defensively Pursue Interrelationships. A firm can often reduce its costs or enhance differentiation by harnessing interrelationships that competitors cannot match (Chapter 9). At the same time, pursuit of interrelationships by competitors that a firm cannot match are threats that must be defended against. Defensive considerations may suggest that a firm pursue particular interrelationships, including entering some new businesses, to enhance its defensive posture.
Encourage Government Policies That Raise Barriers. Government policies can become major structural barriers in areas such as product or plant safety, product testing and pollution control. Policies such as these can increase economies of scale, capital requirements, and other potential barriers. A firm can often shape the character of government policies in ways that are favorable to defending its position. It can:
- Encourage stringent safety and pollution standards.
- Challenge competitors’ products or practices in regulatory proceedings.
- Support requirements for extensive product testing.
- Lobby for trade financing or other favorable trade policies to deal with foreign competitors.
Form Coalitions To Raise Barriers or Coopt Challengers. Coalitions with other firms can raise barriers in many of the ways described above, such as foreclosing alternative technologies or filling product gaps. At the same time, coalitions with likely challengers may be a way to convert a threat into an opportunity.
2. Increasing Expected Retaliation
A second type of defensive tactic is an action that increases the threat of retaliation perceived by challengers. The threat of retaliation hinges on both the perceived probability of retaliation and its expected severity. A range of tactics are available to a defender to signal its intentions to retaliate against potential challengers. For example, Dow Chemical has built capacity in advance of demand in magnesium for many years, indicating its commitment to defending its share. Had Dow been continually constrained for capacity, challengers might have been more tempted to enter.
Expected retaliation can be increased by tactics that indicate that a firm intends to vigorously defend its position, that create conditions making it inevitable that the firm must retaliate, or that indicate it has the resources to do so. The threat of retaliation perceived by potential challengers is continually being influenced by a firm’s behavior. A firm’s reputation for retaliation is strongly influenced by its history, particularly its response to past challengers. The firm must carefully manage the image it projects to actual and potential competitors. Some of the most important ways of increasing a firm’s perceived threat of retaliation include:6
Signal Commitment To Defend. A firm increases expected retaliation if it consistently signals its intention to defend its position:
- Announced intentions by management to defend market share in the industry.
- Corporate pronouncements of the importance of a business unit to the firm.
- Announced intention to build adequate capacity ahead of demand.
Such signaling can and should be carried out consistently via all the available channels, such as public statements, trade press, distributors, and buyers, in order to have the greatest defensive impact.
Signal Incipient Barriers. Most tactics that raise effective structural barriers require the firm to make a significant investment. However, a firm may sometimes be able to achieve the same effect through market signaling or partial investment. Market signaling of planned moves or partial investment has the purpose of increasing expected retaliation by the firm in the future. For example, a firm might announce or leak information about a new product generation, a fighting brand or new process technology, raising the risk perceived by a chal- lenger that the actual move will be forthcoming. Such market signaling can cause challengers to postpone future commitments until more information can be gained to learn if the signals are credible. IBM frequently announces new product generations well in advance, for example.
Establish Blocking Positions. A firm can provide a lever for retaliation by maintaining blocking or defensive positions in other countries or industries occupied by competitors or potential competitors (see Chapter 9). Blocking positions in business units where competitors generate a disproportionate share of their cash flow or profitability become the basis for particularly effective retaliation.
Their value rests on the principle that price cutting and other retaliatory tactics may be less costly in industries or countries where a firm has a small position than in a firm’s key industries. Blocking positions may also be a less risky form of retaliation than direct retaliation, which has a greater propensity to trigger escalation and to spill over to damage good competitors.
Match Guarantees. A firm raises the expectation of retaliation if it commits itself to match or better prices or other terms offered by competitors (“We will not be undersold”). A public stance that it will do so often deters challengers from attempting to gain position through discounting, particularly if a firm backs its claim once or twice in a publicized way. Of course the firm must be capable of supporting such a claim in the eyes of challengers.
Raise the Penalty of Exit or Lost Share. Anything that increases the economic need for a firm to maintain its market share (raises its shrinkage barriers) is often a convincing way to demonstrate seriousness about retaliation:
- Constructing capacity well ahead of demand.
- Entering into long-term supply contracts for fixed quantities of inputs.
- Increasing vertical integration
- Investing in specialized facilities
- Publicized contractual relationships that raise the fixed cost of exit.
- Interrelationships with other business units in the firm that demonstrate an overall corporate commitment to succeeding in the industry.
Raising the penalty of lost share or exit surely introduces the risk that a firm will actually have to pay that penalty. However, this and most other effective defensive tactics raise cost or risk in order to enhance the sustainability of position.
Accumulate Retaliatory Resources. The threat of retaliation is increased if a firm has the resources in place needed to retaliate effectively. Some ways of demonstrating the capacity to retaliate include:
- Maintaining excess cash reserves or liquidity (a “war chest”).
- Holding new models or product generations in reserve, though leaking their existence.
Encourage Good Competitors. Good competitors increase the threat of retaliation in many industries by serving as a first line of defense against challengers (see Chapter 6). The presence of the right competitors may also divert attacks in their direction.
Set Examples. A firm affects its image for retaliation through its behavior toward competitors that may not be real threats as well as through its behavior in response to threatening challengers. Defensive value is often reaped from using moves against nonthreatening challengers to demonstrate how tough the firm is in responding to real challengers. A very vigorous response to one challenger sends a message to others.
Establish Defensive Coalitions. Coalitions with other firms may increase the threat of retaliation by affecting many of the factors described above. A coalition, for example, may provide blocking positions or retaliatory resources a firm itself does not have.
Many of the ways to increase the perceived threat of retaliation force the firm to increase its level of risk. Indeed, by raising the firm’s risk the tactics become significant to competitors. Thus a firm must be prepared to invest if it wants to improve the sustainability of its position in this way.
RETALIATION DURING ATTACK
So far I have discussed the steps a firm can take to increase the perceived threat of retaliation and prevent an attack. The period imme-diately after a move has begun is a particularly delicate one for a challenger, however, during which it is hungry for information on its progress and is sensitive to early successes or setbacks. Challengers have a tendency to read a great deal into early results, often using them as a basis for longer-term projections. Hence, even if a defender’s retaliation is unsustainable for long, it may serve to shape a challenger’s expectations. As a general rule, quick and vigorous retaliation is necessary to limit an attack.
A number of additional tactics become possible once an attack has been mounted, because a firm then knows the identity of the challenger and something about its strategy.
Disruption of Test Markets or Introductory Markets. A wide range of actions can disrupt market introductions and cloud the interpretation of early results. Procter & Gamble is a tenacious rival in competitor test markets, for example. Such actions can raise a challenger’s level of uncertainty about its position or cause it to adopt a more pessimistic view of future prospects. Typical disruptive tactics include:
- High but erratic levels of advertising, couponing, or sampling
- Low-cost service, warranties, or trade-ins.
Leapfrogging. If a firm can introduce a new product or process during a challenger’s attack, this can be very discouraging to the challenger. This is particularly true if such a move forces the challenger to make further investments to stay in the game just after it has expended considerable resources.
Litigation. Litigation can raise the risks or costs of further investment by a challenger, thereby delaying its progress. Forms of litigation that can be used in retaliation are as follows:
- Patent suits that raise uncertainty about the future of a challenger’s product or process
- Antitrust suits that contest any aggressive tactics used by the challenger
- Suits that dispute product performance claims by challengers
3. Lowering the Inducement for Attack
A third type of defensive tactic is actions that lower the inducement for attack instead of raise its cost. Broadly, profit serves as the inducement for a challenger to attack a firm. The profits expected by a challenger if it succeeds are a function of a firm’s own profit targets as well as the assumptions held by potential challengers about future market conditions.
Reducing Profit Targets. The profits earned by a firm are a highly visible indication of the attractiveness of its position. An essential part of any defensive strategy, then, is to decide what current price and profit levels are sustainable. Many firms have invited attack by being too greedy. A firm can deliberately choose to forgo current profits to reduce the inducement for attack. This may imply lowering prices, raising discounts, and so on.
There must be a balance between structural entry/mobility barriers and threat of retaliation on the one hand, and a firm’s profitability on the other.7 If a firm’s profitability is very high, challengers will attempt to cross even high barriers or combat strong retaliation. The high historical profitability in oil field services and pharmaceuticals industries, for example, attracted many firms to invest heavily in entry despite the presence of high entry barriers and entrenched competitors. For example, TRW has moved into oil field services while Procter & Gamble has entered pharmaceuticals. Many entrants attracted by high profitability fail to consider carefully the costs of entry, and often underestimate them. Similarly, high temporary profits in a cyclical industry are frequently misread as a long-term opportunity. The effect of being too greedy is thus to begin an implicit or explicit harvesting strategy as challengers erode the firm’s position.
Managing Competitor Assumptions. A challenger’s assumptions about future industry prospects may lead it to attack a firm. If challengers believe that an industry possesses explosive growth potential, for example, they may attack a firm despite high barriers. Managing competitor assumptions was discussed in general terms in Chapter 6. While a firm cannot credibly cause potential competitors to dismiss realistic assumptions about the industry, defensive strategy should attempt to make potential challengers’ assumptions more realistic. Some options include:
- Making realistic internal growth forecasts public
- Discussing realistic interpretations of industry events in public forums
- Sponsoring independent studies that will question unrealistic assumptions held by competitors
Defensive strategy can be viewed in a broad sense as influencing competitor assumptions, including their assumptions about retaliation and the height of barriers. Influencing competitor assumptions about future industry conditions is an important part of the task.
Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.