The dynamic efficiency and fairness of hypercompetition

A group of economists who testified for IBM commented that a key weak­ness of the government’s economic analysis in the case was that it was based on a static view of the world.

[One] underlying error that the government’s economic analysis committed was to suppose that a dynamically changing competitive market whose basic feature is technological change can be analyzed in terms of theoretical long-run equilibrium. As a result, the Anti­trust Division lawyers and witnesses constantly mistook the price and product change compelled by competition for the restrictive be­havior of monopoly. Indeed, the whole of the government’s case was a reiteration of complaints about lower prices and better products— the antithesis of what monopoly produces.27

The government failed to recognize the realities of hypercompetition and actually suggested that IBM become less competitive by slowing down its activities in all four arenas of competition.

Many of the prevailing laws were based on the structure-conduct- performance model, which held that the source of competitive advantage is monopoly or market power. Monopolistic firms produce high profits by raising prices and lowering product quality. This view of how profits are generated implies that there is a basic conflict between “corporate strategy (which seeks monopoly) and the public interest (which seeks competi­tion).”28

In this context, antitrust laws are needed to promote the public interest by balancing the corporate drive to create monopolies. They seek to achieve this goal by preventing monopoly, predation, actions to exclude competitors from markets, and collusion among firms.

Traditional antitrust laws—designed to create perfect competition and fair play by leveling the playing field through forcing the players to accept competitive parity and eliminating sustainable competitive advantages— fail to address the dynamic realities of hypercompetition. The problem with the traditional approach to antitrust is that it focuses on “static equi­librium and costless optimization” in face of “dynamic, noncooperative competition among heterogeneous firms where many market transactions and administrative decisions are quite costly….29

Hypercompetitive markets are not in equilibrium. They are in motion. At any given point in time, companies may develop a dominant share of the market. At any given point in time, companies may create a strong­hold or build large resources. Companies may end up destroying less suc­cessful competitors. Thus, at any given moment in time, a market will al­most never achieve a state where all the players are in competitive parity, all with equal footing. Someone will have dominance. But the dynamic motion of the market ensures that these advantages are eroded over time. Companies only stay ahead by building a series of temporary advantages.

1. Dynamic Efficiency

Vigorous competition leads to four types of dynamic efficiency, corre­sponding to the four arenas of competition described in Part I. A snapshot of competition in a market at any given time may seem to show inefficien­cies, but these inefficiencies are ultimately removed by the dynamic prog­ress of competition. By racing up the escalation ladders in each arena, companies create four types of dynamic efficiency: production efficiency, innovation efficiency, access efficiency, and resource efficiency.

In recent years antitrust laws have been more concerned with promot­ing the economic efficiency of markets. Because of the influence of the Chicago School of Economics, they primarily have focused, however, on two types of static efficiency: allocative efficiency and X-efficiency.30 Al­locative efficiency is concerned with ensuring that prices are as close as possible to marginal costs at a given moment in time. Unchecked, monop­olistic firms can use their power to maintain excessive prices, thereby real­locating wealth from consumers to producers. This creates the inefficiency of reduced output and higher costs to consumers.

X-efficiency is concerned with maximizing the productivity of compa­nies at a given moment in time. Inefficient management may be uncon­cerned about whether the company’s costs are greater than competitors’ costs.

These static efficiencies do not consider the long term, however. Prices and costs may be low today because a firm is not making investments nec­essary to lower future costs, improve future quality, enter new markets, create new know-how, or build deep pockets for the long haul.

Therefore, a different type of efficiency—dynamic efficiency—may ac­tually be more important than these two types of static efficiency. Econo­mist F. M. Scherer comments that “X-efficiency is much more important quantitatively than allocative efficiency, and dynamic efficiency is almost surely even more important.”31

As early as 1942 Joseph A. Schumpeter recognized some of the weaknesses of traditional static models in explaining competition and pro­posed that more dynamic forces were at work. He wrote:

The fundamental impulse that sets and keeps the capitalist engine in motion comes from new consumers’ goods, new methods of produc­tion or transporation, the new markets, the new forms of industrial organization that capitalist enterprise creates…. A system—any system, economic or other—that at every given point of time fully utilizes its possibilities to the best advantage may yet in the long run be inferior to a system that does so at no given point in time, because the latter’s failure to do so may be a condition for the level or speed of long-run performance.32

In other words, markets may be out of balance and lack competitive parity among the players at a given point in time yet still achieve excellent long­term performance. It is not “how efficiently resources were allocated and utilized at any moment in time, but how well entrepreneurs seized oppor­tunities for reducing cost through technological (and other) innova­tions.”33

Schumpeter and others began to develop an understanding of dynamic efficiency at work in competition, particularly among entrepreneurial firms. By looking at how competitive forces work in each of the four arenas of competition, four types of dynamic efficiency become evident in hypercompetitive markets:

Production efficiency Racing up the escalation ladder in the price and quality arena creates production efficiency. Companies are forced to work toward better quality at lower prices or risk falling behind competitors. As described in Chapter 1, competition moves toward the point of ultimate value. As this point is approached, new definitions of quality restart the competitive cycle. Companies may temporarily gain lower prices and higher quality than their competitors, but the competitors can then match or exceed these levels of quality or price. Moreover, restarting the cycle in the price and quality arena by redefining quality forces new and better products on the market all the time.

Innovation efficiency Racing up the escalation ladder in the timing and know-how arena creates innovation efficiency. Companies generate new knowledge, and that knowledge quickly diffuses. They develop new appli­cations for that knowledge and undermine the positions of competitors, but the next round of innovations gives new or existing competitors an opportunity to seize the initiative.

Access efficiency Racing up the escalation ladder in the strongholds arena leads to access efficiency. Goods made by a company become avail­able anywhere in the world. Customers have access to a wider variety of goods and sellers. Competitors from all parts of the world and from differ­ent industries move quickly into markets. Separate industries merge. Companies may temporarily control a market, and concentration can occur in industries. But this does not lead to long-term exploitation of customers even if one firm achieves a dominant position by using a series of temporary advantages. This domination occurs only because companies keep new entrants out by competing aggressively and constantly moving forward. Coke and Pepsi control the soft drink industry, but they compete aggressively because of the threat of new entrants in soft drinks or the merging of the industry with other beverage industries.

Resource efficiency Racing up the escalation ladder in the deep-pockets arena leads to resource efficiency. Companies seek to expand their re­source base. They look for assets that are currently underutilized. They build their global reach so that they can find the best use for their re­sources. Even when companies build up a huge stockpile of assets, these assets are not themselves a threat to competition. Hypercompetitive com­panies must use these assets to build their next temporary advantage be­fore their competitors. Small, resource-poor competitors could arrive first at the next temporary advantage through assembling resources, teaming up with other companies, or shifting the rules of competition. IBM bet the company on the 360 series computers, and the bet paid off in the 1960s. But its vast resources were unable to sustain its position when it was un­able to keep up a strong position in the next temporary advantage (per­sonal computers). Instead tiny companies such as Apple and Microsoft became giants by seizing the next advantage. Their challenge now is to invest their newly found deep pockets to build the next temporary advan­tage. So there is a constant struggle over the best use for resources to elim­inate waste.

2. Fair Play

Hypercompetitive markets are dynamically efficient and allow a new type of fair play. Traditional antitrust sought to guarantee a type of fair play, which it defined as “competitive parity” wherein no bully dominated its opponents and knocked them out of the game. A new type of fair play exists in hypercompetition—no one is protected from failure based on their position at any given point in time. Size doesn’t matter, as much as ingenuity does. Victory goes to the smartest and hardest working. Fairness is based on merit.

But hypercompetition is not a level playing field in the sense that all the boxers are necessarily in the same weight class. In business, if you are outweighed, you get friends to help. Moreover, there can be winners that dominate for a long while. The firms who lead on the way up the escala­tion ladders in each arena are those that will build profits and position. It is these firms that will create jobs. The laggards in each arena will decline and lose jobs. We need policies that ensure that U.S. firms will be the ones moving quickly forward, building position, and creating jobs.

Source: D’aveni Richard A. (1994), Hypercompetition, Free Press.

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