The dynamic view of strongholds: turf battles and breaching entry barriers

Thus, entry barriers and the five forces play an important role in competi­tive strategy. However, as competitors have become more aware of the strategic importance of entry barriers and as the market becomes more dy­namic, companies have become more creative and aggressive in cir­cumventing entry barriers. These barriers, as we will show in examples that follow, are often more effective in creating temporary delays than per­ manent obstacles to progress. When an incumbent builds a wall around a region or market, its competitors then try to find ways to overcome or circumvent that entry barrier. This launches a series of dynamic strategic interactions that eventually erode all entry barriers. We will examine this process in this chapter.

1. Falling Barriers

Like the Berlin Wall, barriers are falling around the world and across prod­uct markets. While some barriers continue to hold back competitors, they are being overcome with increasing rapidity. Geographic barriers are under pressure from growing globalization and technological improve­ments. Product market barriers are also falling because of the same forces and the increasing flexibility and aggressiveness of competitors as well as growing awareness and discrimination by customers. As product cycles be­come shorter, scale economies and product-based experience curves be­come less important. Rather than shoring up their existing strongholds, companies such as 3M move aggressively into innovations with their core competencies. In addition, improved telecommunications, transportation, and other technologies have created strong global markets and eroded local fiefdoms.⁶ In fact, each of the seven entry barriers we discussed can be and has been eroded. Consider a few ways to erode each of these barriers.

• Economies of scale By exporting from a larger plant in its home turf, the entrant can draw on its own economies of scale even if it has a small position in the incumbent’s market. For example, Japanese and Taiwanese semiconductor manufacturers used economies of scale gained in domestic markets to achieve low prices when entering the U.S. market. This gave them such an advantage that U.S. compa­nies filed dumping charges.⁷ The large size often required to achieve economies of scale can also decrease the flexibility of the company, making it vulnerable to more nimble competitors.

Although its economies of scale helped Gallo Winery become the largest wine producer in the United States, its size also inhibited its ability to respond to changes in the market. Tastes of consumers changed. Customers preferred Varietals using special or unique grapes which were more expensive. Gallo had difficulties obtaining the grapes from its suppliers. At the same time, a fitness craze and concerns about drunken driving began to dry up the market for cheap

wine in favor of limited consumption of more expensive wines. Fortune notes that early on Gallo’s name was associated by some customers with mass-produced, inexpensive table wine, making it harder for it to expand into premium wines⁸ Growers also forward-integrated to cre­ate new capacity in the market. When the market shifted, the barriers that once helped Gallo keep out competitors now tended to hold it in a less profitable segment of the market.

• Product differentiation In the chapters on cost and quality and tim­ing and know-how advantages, we examined how competitors can overcome a differentiation strategy through a variety of interactions. This can be done by direct imitation or by variations that create dif­ference or higher perceived quality.

Ben & Jerry’s successfully challenged Haagen-Dazs’s differentiation barriers by creating further levels of differentiation. Ben & Jerry’s matched Haagen-Dazs’s premium ingredients but then upped the ante by introducing a variety of unconventional flavors. They mixed in Heath bars, Oreos, and something called Rainforest Crunch and brought out exotic flavors such as Cherry Garcia and White Russian. Ben & Jerry’s also differentiated itself by its corporate philosophy of supporting social causes. This support of causes also helped the small Ben & Jerry’s gain widespread publicity and compete with its deep-pocketed rival (Haagen-Dazs is owned by Pillsbury). Instead of trying merely to catch up with the incumbent, Ben & Jerry’s went one or two steps farther. Marketing News reports that, by the end of 1991, Ben & Jerry’s had snatched nearly 29 percent of the superpremium ice cream market, enough to attract the attention of market leader Haagen-Dazs (with 43 percent). In 1992 Haagen-Dazs, in an appar­ent attempt to match Ben & Jerry’s differentiation on flavor, an­nounced plans to branch out from traditional flavors to such goodies as Carrot Cake Passion, Cappuccino Commotion, Caramel Cone Ex­plosion, Triple Brownie Overload, and Peanut Butter Burst.⁹ The move was expected to cut into Ben & Jerry’s market, eroding its own differ­entiation barrier.

• Capital investments We will examine strategies firms use to over­come capital requirements in the next chapter. For now, it is impor­tant to note that many foreign entrants are very large companies with lots of resources and sometimes even lower costs of capital, so capital often is not a problem.
• Switching costs The entrant can eliminate switching costs by reduc­ing the risk of trying the new product. It can offer free samples or redesign the product to make conversion less costly for customers. For example, Pepsi recently sent free cases of Diet Pepsi to Diet Coke drinkers. Computer software makers are also including free samples of their programs on the hard drives of new computers or packaging it with PCs or peripherals. This overcomes the cost of having to pur­chase the new software.¹⁰

While Nintendo retains its stranglehold on video game players, com­panies have found ways around its grip on the more lucrative game software market. Atari, who licensed its games for sale through Nintendo, announced plans in 1988 to market its own video games that could be used on Nintendo hardware.¹¹ Atari also rolled out game cartridges and accessories such as joysticks and battery packs for both Nintendo and Sega systems.¹² As lawsuits raged between Nintendo and Atari, Nintendo conceded the right to several smaller companies to produce Nintendo-compatible game cartridges which bypass Nintendo’s security chip, which is designed to keep out for­eign cartridges.¹³ Meanwhile, on the equipment side, Nintendo is under attack by innovations from Sega Enterprises, which developed a color screen for the portable video game players.¹⁴

• Access to distribution channels The new entrant sometimes acquires its own distribution network. For example, Schneider, a French elec­trical products firm, acquired the largest U.S. distribution network for electrical products when it bought Square D. Others piggyback on U.S. distribution networks owned by others. For example, when Kirin Beer, the largest Japanese beer company, was unable to crack the U.S. beer and wine distribution network, it tried to distribute through the network used by soda-bottling plants. Similarly, many Japanese car companies use the dealers of American cars.

IBM’s hold on computer distribution systems suffered tremendous erosion when the market shifted toward personal computers and buy­ers became more sophisticated. Dell Computer circumvented IBM’s direct-sales force and dealer network by shifting to mail-order sales.

In addition to staking out a new distribution channel, Dell also cut the high overhead of a dedicated sales force or dealer network. This helped it drive prices down far below IBM. This new distribution net­work provided other advantages. Dell could offer twenty-four-hour re­placement and service numbers, while dealers might take weeks to obtain parts. Four years after Dell entered the market, its revenues topped $250 million while IBM was laying off workers.¹⁵

The hold of the major networks on television channels has been sharply eroded by the rise of cable television. This grip on the market continues to weaken with the spreading coverage of cable and tech­nology that will allow cable companies to crowd more channels onto their lines. A new digital-compression technology was expected to allow cable companies to supply five hundred or more channels to subscribers by early 1994.¹⁶

• Cost disadvantages other than scale The entrant can use its own cost advantages (e.g., low-cost labor) and process innovations (e.g., just- in-time inventory systems) to overcome the cost advantages of the incumbent.

The Japanese rise in the shipbuilding industry—exploiting its non­scale cost advantages—was an inspiration to Korean shipbuilding. Korean firms duplicated Japan’s success and in the process showed that the gains that could be developed through government subsidies and other national advantages could also be eroded by a competitor with the same advantages. Although Korea lacked experience, an ex­perienced workforce, and economies of scale, its nonscale advan­tages allowed it to become a major player in the industry. The govern­ment targeted the industry for growth, offering special financing arrangements to shipbuilders. In addition, Korean companies had low-cost labor ($4.50 per hour compared to $18 per hour in Japan) and access to low-cost steel. Japanese and European shipbuilders, not recognizing Korea as a serious threat, shared training and tech­nology with Korean companies. By 1983 Korea had gained 19 per­cent of all new shipbuilding orders.¹⁷

• Government policy If the incumbent’s government is throwing up obstacles to the entrant, the entrant can turn to its own government for assistance. New technology has also allowed creative entrepre­neurs to circumvent barriers. Government regulations have also been under attack from innovative overseas competitors on the one side and customer pressures for new policies on the other.

Europe’s PTTs are losing their hold on the international long-distance market to entrepreneurs with sophisticated ring-back operations. These U.S.-based companies have circumvented the European stronghold by routing calls through a toll-free number to the United States at a substantial discount to customers. European businesses call the number, and a computer dials them back, so the call techni­cally originates in the United States, outside the PTT’s control. Custo­mer pressure is also forcing governments to open markets to keep their other industries competitive. Major companies in Europe, such as Unilever, are establishing their own communications networks and giving the contracts to U.S. firms rather than the sluggish European national monopolies. This has placed pressure on regulators, who are dismantling the national monopolies. The European Community has ordered its twelve governments to abolish the monopolies in sectors such as data transmission and electronic mail, and deregulation of voice transmission may not be far behind. Europe’s post, telephone, and telegraph markets, insulated so long from competition, cannot match the quality or cost of foreign competitors.¹⁸

U.S. firms have made headway in Japanese markets through aggres­sive marketing and alliances with Japanese companies. Two U.S. se-curities firms, Salomon Brothers and Morgan Stanley, have done so well on the Tokyo Exchange that they outranked all but two Japanese securities houses on pretax earnings in November 1991.¹⁹ In what may be a response to these gains, Japanese regulators introduced a wave of new rules in 1992 on arbitrage trading that hit non-Japanese firms hardest.²⁰ Apple has teamed up with Japanese giants such as Sony, Sharp, and Toshiba in creating its latest line of computers and electronic organizers, gaining more than 8 percent of the Japanese computer market in 1993. Microsoft has moved into the fragmented Japanese software market with a Japanese version of Windows, tak­ing sixty-five thousand orders in two days. Riding on the coattails of the Windows introduction, U.S. computer companies such as Com­paq, IBM, and Dell are making new inroads into the NEC-dominated Japanese computer market. Meanwhile, U.S. semiconductor compa­nies doubled their market share in Japan over the course of three years, gaining 20 percent of the market by 1993.²¹ The Ford-Mazda alliance has given Ford one of the strongest footholds in the market of U.S. automakers. Meanwhile, the Big Three automakers from Detroit have placed increasing pressure on U.S. officials to push the Japan­ese government for policy concessions that would promote increased foreign sales within Japan. U.S.-Japan negotiations on super­computers have resulted in a more open market for U.S. manufactur­ers.²²

Aggressive and creative U.S. companies have managed to break into the markets of the former Soviet Union. Consumer goods such as Pepsi and McDonald’s had a relatively easy time finding a spot in Moscow compared to complex industries such as petroleum. Yet even with the substantial political and technical challenges of oil ex­ploration in the former Soviet Union, Chevron and other companies have made their way through this minefield, drawn by some of the most promising oil fields in the world. Chevron—surviving the collapse of the Soviet Union and a military coup—spent four years working out the agreement that eventually led to a 50-50 joint venture with a Kazakh partner.²³ Even if such countries are not overly enthusiastic about the prospect of outside partners, they often have no choice be­cause they cannot find the expertise or capital for the project within the country.

In addition to overcoming the above entry barriers, entrants often rely on synergies with their other businesses and acquisitions to break into strongholds.

• Synergies with existing businesses Johnson & Johnson’s Ethicon unit used synergies with its existing operations to enter into the new mar­ket for noninvasive surgical equipment (laparoscopic equipment) dominated by U.S. Surgical, according to Business Week.²⁴ U.S. Sur­gical, which arrived in the laparoscopy market a year and a half be­fore J&J, had seized 85 percent of this market, expected to grow to three billion dollars by 1996 ²⁵ This headstart gave U.S. Surgical economies of scope and scale, creating switching costs and other bar­riers for doctors already using its equipment. But J&J overcame these barriers by using synergies with its Hospital Products Group and su­ture division. In entering the market for laparoscopy, J&J unleashed its preexisting sales force of five hundred people and opened a state- of-the-art training center for surgeons. J&J, although it had only a small position in that market, could throw the weight of its preexist­ing distribution network (to hospital purchasing agents), research fa­cilities, and good brand image behind the market entry. J&J also of­fered lower prices and high levels of customer service. By 1992 it had introduced forty-five new surgical instruments and was rapidly clos­ing the gap with U.S. Surgical, according to Financial World.²⁶

In what appears to be a response to J&J’s entry into the laparoscopy market, U.S. Surgical used its technological skills, brand image, and marketing channels to move into the $1 billion traditional suture busi­ness with a new line of absorbable products for orthopedic surgery. Sutures had been J&J’s stronghold for decades (but U.S. Surgical had already made some headway in the market with its surgical sta­pler). In this way U.S. Surgical appears to have responded to J&J’s entry with its own counterentry into J&J’s stronghold. This erodes U.S. Surgical’s position in the laparoscopy market and at the same time erodes J&J’s position in the suture market, merging the two market­places into one full line of surgical products. This illustrates some of the dynamic strategic interactions that work to undermine strong­holds, as we will examine in the rest of this chapter.

Similarly, Gallo used synergies with its existing wine production, mar­keting, and distribution to launch its Bartles & Jaymes wine cooler. The wine cooler was launched two years after pioneer California Cooler attempted to use beer distribution and bottling to sell its cooler. Building on synergies with its wine business, Gallo became top seller in the market just eight months after launching Bartles & Jaymes.²⁷

• Acquisition Companies often use acquisitions or alliances to over­come product/market and geographic entry barriers. Hershey Foods Corporation, which had almost no presence in European markets, entered through acquisitions. In 1991, for example, Hershey bought a German boxed-chocolate company and a 19 percent share of the largest confectionery company in Scandinavia.

These examples of the erosion of entry barriers are in line with percep­tions of managers. A study of 293 managers found that only a little more than half the respondents reported the “frequent” use of one or more entry barriers to keep out competitors. The main reasons for not deterring entry were the intensity of competition, product-line growth, or because deter­rence strategies were too expensive.²⁹ When another researcher asked 137 executives in 49 different companies about the importance of Porter’s bar­riers to entry, they indicated that only cost advantages seemed to be a significant barrier. If the entrant can meet or beat the incumbent’s cost, there is little to stand in the way of entry. Even for the remaining entry barriers, different respondents weighed the barriers very differently. Thus, a given barrier is unlikely to deter all potential entrants. These perceptions held for both industrial and consumer markets.³⁰

Is it just large, foreign companies that can batter down entry barriers? Innovative small companies can also maneuver around entry barriers, as we saw in the case of Ben & Jerry’s above. A cross-sectional study of 247 manufacturing industries found that small firms have successfully cir­cumvented or overcome entry barriers. Smaller companies have used strategies of product innovation and “flexible specialization” to enter and survive in markets in which they suffer severe size and cost disadvan­tages.³¹

This is not to imply that every potential entrant will have the ability to break down the entry barriers protecting an industry. In fact, for most po­tential entrants, the barriers will keep them out. However, to work, entry barriers must hold out every potential entrant. All it takes is just one hypercompetitive entrant anywhere in the world with the skills to breach the barriers—a likely scenario. Also, if the entry barrier is lowered even temporarily by technology shifts and other discontinuities, aggressive competitors will very likely enter through this “strategic window.” These windows can open as a result of new primary demand opportunities, new competing technology, market redefinition, and distribution-channel changes.³² Competence-destroying technological discontinuities can also permanently reshape markets through new product classes such as cement and plain-paper copying, product substitutions such as transistors for vac­uum tubes, and process substitutions such as open hearth to oxygen fur­naces in glassmaking. These discontinuities provide opportunities for new entrants in the market.³³

Figure 3-1 illustrates some major technological changes in three indus­tries, identifying whether these changes were competence destroying or enhancing (i.e., whether they obsoleted or neutralized the existing skills of the incumbent firms) and whether they were niche opening (i.e., whether they created a new skill not previously used by any competitor). The figure indicates that new firms entered by taking advantage of competence- destroying and niche-opening technological discontinuities. Thus, incum­bent firms saw their entry barriers fall, and entrants exploited these tech­nological windows of opportunity. Leaders also watched their position erode as technological windows allowed existing firms to surpass them with enhancements.

FIGURE 3-1

THE EXPLOITATION OF SIGNIFICANT TECHNOLOGICAL DISCONTINUITIES BY NEW FIRMS IN THREE INDUSTRIES

FIGURE 3-1

THE EXPLOITATION OF SIGNIFICANT TECHNOLOGICAL
DISCONTINUITIES BY NEW FIRMS IN THREE INDUSTRIES (ContU)

As long as one wild-card player may try to enter the market, the market is contestable; so it is no longer a safe haven. Thus, even where we observe that entrants have not attacked yet, we can’t be sure they won’t enter in the future. The mere threat of their entry is enough to force firms to act like they have entered. Incumbent firms will use “limit” pricing (pricing low enough to deter entry) or make excessive advertising or R&D expen­ ditures as additional barriers to entry. In the process they squeeze out all the profits and escalate the conflict with existing competitors to a higher level, usually moving up the escalation ladders discussed in the two earlier chapters.

This ability to erode geographic and market strongholds sets off a series of dynamic strategic interactions, described below. Even when entry barri­ers are no longer a source of sustainable competitive advantage, they con­tinue to be an important source of temporary advantage. Companies con­struct obstacles to competitors, and competitors overcome them. These barriers can be geographic or based on industries, products, or market seg­ments.

For the sake of simplicity, the following dynamic strategic interactions are described as related to geographic strongholds. As we will discuss at the end of the chapter, there is a similar pattern of interactions in market strongholds.

2. The First Dynamic Strategic Interaction: Building Barriers to Create a Stronghold

Creating strongholds to block competition has been a vital part of politi­cal and competitive strategy for centuries. The East India Trading Com­pany held monopolies that regulated trade in the East. Royal “franchises” to portions of the New World gave individuals exclusive rights to com­merce in certain territories. While today’s geographic barriers are less con­crete than the walls that were once used in the past, strongholds can be protected for a while by using the entry barriers discussed above, shutting out competitors from markets in ways that are challenging to overcome.

Geographic strongholds are often created to take advantage of the company’s “home court” advantage. Among the factors that can contrib­ute to a company’s home court advantage are:

Customer familiarity, that is, knowing the nearby local customers’ needs and tastes better than distant or foreign companies.

• Customer loyalty to a local brand, arising from customer loyalty for home-grown or domestically produced products. We have seen this advantage in Japanese loyalty to products made in Japan or the “Made in the USA” labeling used to sell American products.
• The low costs associated with operating over short distances, including (1) lower transportation costs, (2) elimination of exchange-rate fluctuations, and (3) the reduced costs of monitoring and enforcing compliance with contracts that comes from being able to see what is happening nearby.

• Government barriers to foreign entry created by licensing, tariffs, own­ership restrictions, or regulatory requirements. Even regulatory re­quirements related to consumer protection and safety requirements may restrict some competitors from entering.
• Control over domestic distribution systems, for example, major home appliances in the United States and Japanese vertical integration and keiretsu membership in the consumer electronics and car indus­tries in Japan.
• Local customs, that is, fear of outsiders, cultural abhorrence of for­eigners, and nationalism.
• Unique factor advantages in the home country; for example, lower costs of domestic labor, capital, and key skills such as technological expertise and natural resources.
• Dominance of domestic market share, so entrants can’t enter with full- scale advertising, manufacturing, or other operations.

These advantages are formidable, but as we shall see, they are not invin­cible for the resourceful competitor.

In the early stages of an industry, a stronghold can protect the company from forays from outside the geographic region or market. The company concentrates on the market within its stronghold and concedes other markets to competitors. However, once the company dominates its own stronghold, it has excess resources but nowhere else to expand at home. Managers within the firm want growth and enhanced power, shareholders want continued growth in profits and full utilization of corporate resources (e.g., via capturing global economies of scale and synergies), and everyone wants to reduce the risks of relying upon a single geographic region or mar­ket segment by becoming more diverse. We see this desire for diversifica­tion in the development of U.S. regional banks that fund real estate. These banks are seeking to become national to diversify the risks of re­gional business cycles. Demand in the stronghold market may also decline, as was the case for U.S. cigarette companies that are now seeking new markets overseas. Finally, sometimes firms move into another market to preempt an opponent’s move into that market.

Eventually success with the first dynamic strategic interaction moti­vates companies to look for entry opportunities in other regions or mar­kets. This often means entering another company’s stronghold, the second dynamic strategic interaction.

3. The Second Dynamic Strategic Interaction: Launching Forays into a Competitor’s Stronghold

LAUNCHING AN ATTACK FROM THE STRONGHOLD

The company may find that its dominance of the stronghold provides funds that it can use for expansion. At this point companies tend to make forays out of their protected strongholds and into another region.

When Honda, then a Japanese motorcycle manufacturer, decided to expand into new markets, it didn’t choose to enter the low-end car market in Japan. Instead it crossed the Pacific to enter the low-end motorcycle market in the United States. It moved from its stronghold in Japanese mo­torcycles to a geographic market where the competitors were weakest. Honda next moved to high-end motorcycles, then to the low-end auto market in the United States. Finally, it moved into the high-end auto mar­ket in the United States before finally exporting cars through the United Kingdom into Western Europe.

Honda is a good example of one strategy for launching an assault on a new stronghold: the escalating sneak attack. At each move it created and consolidated strongholds. Its stronghold in motorcycles in Japan allowed it to break into the motorcycle market in the United States. It entered ne­glected segments, consolidating its new beachhead into a stronghold and then moved up, leveraging the skills, reputation, and systems used in ear­lier strongholds. At each step it entered neglected niches to avoid a strong retaliation by the established competitors in the stronghold. By the time the established firms recognized Honda as a challenge, it was too large to be pushed back. In each new market the intruder had already established such a solid beachhead that it could not be turned away.

Honda’s example illustrates some critical success factors for forays into the strongholds of another firm:

A void or delay retaliation where possible To ward off an all-out retali­atory strike and avoid a war of attrition (price war), the foray should be launched against an enemy that will not or cannot respond in the entered niche or in the attacker’s own stronghold.

• Use adequate resources To achieve a quick victory by using decisive force, the attacker needs adequate resources to carry out the foray and picks a niche small enough to dominate. To secure the beach- head, the attacker must follow up with subsequent investments and move inland quickly, once the market has demonstrated receptivity to the product being introduced.

• Concentrate force on a single point To avoid becoming overextended itself, the attacker needs to concentrate its efforts on one point of entry, not several products. Scattershot approaches tend to diffuse the effort, draining the attacker’s resources and therefore leaving it more vulnerable to counterattack. Attackers tend to add products later on, only when the initial entry is complete and successful.
• Attack weaknesses first To avoid or minimize retaliation, the attack is usually launched against the incumbent’s weak point, not its strength. For example, if Honda had gone right for the jugular and tried to seize GM’s Cadillac market, it would have had a tough fight. But on the low end it had plenty of time to establish itself. The at­tacker finds places where the domestic firm has ignored market seg­ments or is not serving them very well. Alternatively, the attacker will strike at geographic areas where the established company does not serve customers as well as it should because it has overextended itself by entering too many markets.
• Minimize risk of failure To avoid excessive losses and explore other opportunities, attackers withdraw to their stronghold quickly if a rapid and violent response is elicited from the incumbent firm.
• Protect the home base To insure that the foray does not weaken the stronghold, forays must use only the “excess” resources generated by the home base. Thus, the foray must not cost more than the cash flow after reinvesting enough to guarantee control at home. Prefera­bly the cost should never be more than the cash flow when the home base is in a down cycle, so that hard times don’t put the home base at risk.

These forays are basically guerrilla tactics, following the principles of guerrilla war outlined by Mao Tse-tung. These guerrilla tactics help to cir­cumvent the entry barriers by making the incumbent delay use of (or less likely to use) its cost advantages from economies of scale, switching costs, and the other entry barriers.

Even if the intruding firm starts by sneaking into an unwanted part of the stronghold, large competitors in the market eventually launch a coun­terattack. If they are vigilant, they may see the long-term threat posed by this interloper early. If not, they may respond late. These responses are the next level of interaction.

4. The Third Dynamic Strategic Interaction: The Incumbent’s Short’Run Counterresponses to a Guerrilla Attack on Its Home Turf

If the entry grows, it will eventually trigger a response. Sometimes the re­sponse is more immediate and severe. Sometimes it is delayed and/or insuf­ficient to stop the attack because of the nonthreatening nature of the entry (as noted in the section on circumventing barriers). There are sev­eral factors inside and outside firms that prevent them from being aware of and responding quickly to forays into their territories.

Among these blind spots are a company’s tendency to filter and deny information about competitive threats. Many companies seem slow to re­shape their view of the world to acknowledge a foray as a serious threat. Obviously, the Big Three U.S. automakers might have easily crushed the German or Japanese entrants before they had a chance to gain a signifi­cant foothold in the U.S. market. Who at GM could have predicted at that point that these two countries would have such an impact on the development of the U.S. auto market?

Successful entrants tend to aim for a segment of the market that is not only the incumbent’s weak point but also its blind spot—the place that it will be least likely to recognize as a serious competitive threat. Once the incumbent company has recognized this threat, its response strategy de­pends on its strength at the point of attack.

CASE 1: A STRONG INCUMBENT

If the new entrant has misjudged the incumbent’s strength in the segment under attack and the incumbent recognizes the threat, the incumbent may try to deliver a quick and decisive crushing blow to the upstart before the entrant can gain a beachhead. Using the advantages inherent in the entry barriers or the home court advantages listed above, incumbents may use price wars and product introductions to drive the entrant back home be­fore it can grow into a big player that is much more difficult to compete against. However, such efforts may be costly, so many incumbents wait and see in order to gain more information about the seriousness of the attack before launching such a counterattack. The challenge is to recog­nize when a potential threat is a nuisance and when it is dangerous. If an incumbent were to defend itself against all attacks from competitors, it could waste substantial resources. But if it waits until the entrant emerges as a clearly defined threat, the entrant may already be too strong to be effectively defeated.

CASE 2: A WEAK INCUMBENT

If the entrant has attacked a niche where the incumbent is truly weak, the incumbent will not be able to respond and win easily. Under such circum­stances, the incumbent has two choices in dealing with the new entrant in the short run:

1. Raise new barriers and change the rules of the game The incumbent sometimes takes advantage of its home court advantage to throw up new barriers to the entrant. These might include new tariffs and regu­lations that would directly or indirectly shut out the competition. For example, when Volkswagen began making inroads into the u.s. auto market, domestic firms could have pushed for strong safety regulations that would have forced the Beetle off the road. However, the u.s. government is often reluctant to do this, fearing a trade barrier war that would hurt u.s. exports more than it will help protect domestic market share.
2. Cut and run If the incumbent can’t win the battle because it has truly been attacked in an area where it is weak, the incumbent is best off getting out of the way of the attack. If the entrant has found a weak­ness that cannot be overcome, the incumbent must withdraw and concede, otherwise the incumbent wastes its efforts. The incumbent may also withdraw because it decides the market is not worth fighting for. General Electric, for example, seems to have used the cut-and-run strategy in small home appliances, consumer electronics, computers, and aerospace, where it faced aggressive competitors or maturing markets.

ACCOMMODATION AND APPEASEMENT

In sum, whether the incumbent is weak or strong, the incumbent will usu­ally offer little or no reaction to the new entry. A study of 115 new en­trants in oligopolistic markets found that incumbents rarely reacted by marketing mix, changing their product lines, distribution methods, mar­keting expenditures, or pricing.³⁴ Incumbents responded aggressively to new entrants in only 9 percent of the cases during the first year after the entrant’s arrival, and the reaction tended to be an increase in marketing expenditures. The second year after entry saw a higher level of reaction, but still a mild one. In the second year incumbents responded aggressively in only 17 percent of the cases. A second study also concludes that “no reaction is the most common reaction by an overwhelming margin.”³⁵

There are several explanations for this lack of reaction. Normally, even if the incumbent is a strong one, the incumbent’s losses from fighting will be greater than the expected losses from allowing the entrant in. If the entrant is smart, it often gives signals indicating that it is not ambitious and will not seek a large market share, so the incumbent thinks the ex­pected losses from allowing entry are small. If so, the established firm will allow the newcomer to enter, especially because many incumbents believe that their higher market share will make it more costly for them to fight a price war than for the entrant. A price cut for a firm with 80 percent share will result in greater losses than the same price cut for a firm with only 2 percent share. For companies that are focused on immediate earnings, these losses during the fight offer a powerful disincentive to battle new entrants. Thus, whether a strong or weak incumbent is attacked, entrants are frequently accommodated in the hope of appeasing them.

Thus, in the short run, a strong incumbent often waits to see if the threat is serious, and a weak incumbent either (1) concedes and allows entry or (2) puts up token resistance. This encourages the entrant to be bold, allows it to prosper in a segment of the incumbent’s stronghold, adds to its resources, and often leads to further expansionary efforts. Moreover, other potential entrants recognize that this is occurring, so they also at­tempt to enter without fear of retaliation. By signaling only modest market share goals, they can forestall a strong reaction from the incumbent. Then, after gaining a toehold, these entrants often expand their goal. This leads directly to the next dynamic strategic interaction.

5. The Fourth Dynamic Strategic Interaction: The Incumbent’s Delayed Reaction

If the incumbent has not already launched a full-scale defense of its turf because it decided to wait and see, it will eventually react to defend itself, especially when failure to do so will result in significant market share losses due to the increasing number and boldness of entrants. Using the advan­tages inherent in its home court advantages and entry barriers, the incum­bent will respond, often trying to contain the entrant to its beachhead and only rarely to drive the entrant entirely out of the market. These responses may include price wars, product introductions, shoring up customer loy­alty, locking in established customers, and other activities that leverage off the advantages inherent in the entry barriers listed above. However, in­cumbents tend to use nonprice methods first, though these don’t work very well.³⁶ This forces the entrants to look for low-cost alternatives that will breach these barriers without creating massive losses for themselves.

The entrants usually respond to the incumbents’ moves and take action to overcome the new obstacles that are thrown in their path, thereby es­calating the conflict from merely trying to circumvent the barriers to try­ing to breach them. Thus, this dynamic strategic interaction leads directly to the next one, wherein the entrants attempt to overcome the barriers.

6. The Fifth Dynamic Strategic Interaction: Overcoming the Barriers

If the entrant can’t circumvent the barriers with guerrilla tactics or is hit with a retaliatory response that adds new barriers, it is forced to try to breach the barriers in a way that won’t exhaust its resources. When the Big Three managed to get Washington to impose import quotas and tariffs on Japanese imports, it looked like they may have at least slowed down the Japanese juggernaut. But the tariffs and the quotas tended to create more interest in (and higher prices for) Japanese cars because of the scarcity of supply. Then, when the U.S. automakers added an appeal to the U.S. pub­lic to buy American, the Japanese car companies responded to both threats by developing their own plants in the United States.

This move to overcome the U.S. firms’ defensive moves saved transpor­tation costs, increased sales, and also made it much harder for the U.S. industry to claim that jobs were being lost to Japan. When some of the Japanese car companies were contributing to employment and local econ­omies in the United States, it helped to mute the ^uBuy American” move­ment.

Even if the entrant is not successful in breaking through the obstacles to the stronghold, some entrant somewhere will eventually have the re­sources in place to enter the market. Numerous examples of this were de­scribed at the beginning of the chapter. The examples show that each of the entry barriers are not solid. Holes exist, and entrants eventually find a way over or around even the most formidable barriers created by giants such as GM, IBM, Caterpillar, Xerox, Kodak, and American Express.

When this occurs, this sign of the incumbent’s weakness often generates further problems. The entrant’s success may attract even more competi- tors to the market, so the incumbent is forced to take a longer-term coun­termove to deter additional entrants. This leads us to the next dynamic strategic interaction: protecting the stronghold from long-term erosion.

7. The Sixth Dynamic Strategic Interaction: Long-Run
Counterresponses to the Attack

Once the first entrant has established a solid beachhead in a geographic stronghold, other companies tend to move in, like sharks attracted to the smell of blood. If the incumbent loses the short-term and intermediate battle for the entered niche, it has to reshape itself and its strategy to maintain its long-term position in the broader stronghold.

Assuming that the incumbent has not decided to cash out of the market via harvesting, exit, or divestiture, there are two ways that established firms respond in the long run. Both are attempts to signal the incumbent’s strength and to scare away other potential entrants.

• Defensive moves—shoring up the walls Eliminating the weakness that drew the new entrant in the first place. This may or may not be fol­lowed by returning strongly to the entered niche to recapture its market position. In any event, successful incumbents try to close the door to later entrants by eliminating the portal of entry exploited by the first entrant. GM did this by joint-venturing with Isuzu and Dae Woo to produce a small car to compete with Toyota, Nissan, and Honda. Over the longer term GM developed Saturn to fill this niche. Ford improved quality quickly to eliminate its weakness.
• Offensive moves—teaching respect Some incumbents fight the guer­rilla attack with a guerrilla counterattack to force the entrant to back off. Such an incumbent finds the entrant’s weakness in the entrant’s own home territory and then launches a counterattack of the sort that was launched against it. This is not a frontal assault on the entrant’s home territory. Instead it is designed to discipline the intruder and cause it to back off or devote resources and attention to defending its home markets. This sometimes leads to the entrant’s withdrawal from the incumbent’s stronghold, or it weakens the entrant’s efforts by diverting resources back to its home market. For example, if GM had hit Honda in some niche of the U.S. motorcycle market at the time Honda entered the small car market, GM might have been able to deal a severe blow to Honda’s efforts in the U.S. auto market. At that time Honda was not a very powerful player, and it had a lot to lose at this early stage. GM, on the other hand, had little to lose in motorcycles and a lot to lose in the car market.

Note that the defensive move heats up the war on the incumbent’s own turf, while the offensive move shifts the focus to the entrant’s turf. The defensive option will appear more attractive if:

• The incumbent doesn’t have the resources to wage total war (be- cause the battle will escalate to two fronts if the incumbent counter- attacks the entrant’s home market).
• The incumbent’s weakness is easily corrected. If it is not, counterat­tacking may be quicker and more effective than allowing the entrant to exploit the weakness for years.
• The incumbent cannot afford to lose any share in its stronghold be­cause this market is central to the firm’s strategies; if, for example, it has many economies of scope with its other product lines.
• The incumbent doesn’t have the skills to enter the other player’s home markets.

One key question, however, remains: Will the defensive option be enough to stop the attack? Peter Drucker once noted that playing defense can only limit a firm’s losses, not improve its gains. In addition, unless executed properly by using the price-quality and timing-know-how cycles described in Chapters 1 and 2, the defensive option cedes the initiative to the opponent, allowing him to determine the rules of the game. Given the importance of maintaining their stronghold, many incumbents have no choice but to switch to the offensive. Moreover, the defensive and offen­sive options are not mutually exclusive, so some incumbents start with defensive moves and escalate to offensive ones if the defensive moves do not work.

Such actions can teach an entrant that its actions will not be ignored, and they demonstrate to other potential entrants that entry will not al­ways result in withdrawal by the incumbent. Unfortunately, not all en­trants get the message, and some of these counterattacks are not successful because they are poorly executed. This leads to further escalation and the next dynamic strategic interaction.

8. The Seventh Dynamic Strategic Interaction: Slow Learners and the
Incumbent’s Reactions to Entrants Who Don’t Get the Message

If the last round of threats and responses doesn’t cause the new entrant to retreat, the battle escalates to a higher level. With a very aggressive en­trant or incumbent, the incumbent may go directly to this level without going first to the preceding dynamic strategic interaction. If the incum­bent has sent a signal of its strength, either by eliminating weaknesses or launching a guerrilla counterattack, there may be several reasons why the entrant has not responded. First, the attacker may not back down because he doesn’t want to get a reputation for weakness or retreating too easily. This would hurt its future attempts to enter new markets. Another reason might be that the incumbent’s counterattack is not very costly to the en­trant.

The battle now escalates because the entrant leaves the incumbent lit­tle choice but to escalate the war by exporting it directly to the core of the entrant’s home turf. The incumbent will tend to find the opponent’s weakness and mount a large-scale assault there. This is usually not the initial response of established firms, which prefer to respond by working in their relatively secure stronghold. But when all else has failed, the use of excessive force in the entrant’s home base (its stronghold) can sometimes be much more effective than further tries to face the entrant down on the incumbent’s home turf.

Several sequential steps are required to successfully move into the entrant’s home turf. Successful counterattacks against the entrant involve

1. using the incumbent’s home government to negotiate away tariff bar­riers, force integration of capital markets, or take other actions to make entry into the entrant’s home base easier.
2. eliminating the entrant’s home court advantage. This is sometimes done by buying firms or establishing joint ventures in the entrant’s home country. Novell, a U.S. software firm, cracked the Japanese market by forming a partnership with six Japanese computer compa­nies to produce a Japanese-language version of NetWare.
3. gaining access to distribution systems in the entrant’s home country.
4. entering the stronghold of the entrant, with sufficient force to disrupt the market and redirect the company’s attention back home.

This last step is perhaps the most challenging. There are two options for launching this assault, with two different goals. Julius Caesar, in his com­mentaries about the battle for Gaul, notes that there are two types of war­fare—wars of punishment and wars of conquest. So, too, in business. In wars of punishment, one side tries to force its opponent to back off and stop attacking. In wars of conquest, the attacker doesn’t stop until it sub- jugates and controls the opponent’s former stronghold.

OPTION 1: A WAR OF PUNISHMENT IN THE OPPONENT’S HOME BASE

This is the “scorched earth” approach of burning the city down and sowing salt in the soil, the business equivalent of the approach used in Rome’s Third Carthaginian War or Sherman’s march to the sea in the U.S. Civil War. The intent of this strategy is to damage the profitability of the entire industry in the opponent’s stronghold and then withdraw. Once the en­trant has been counterattacked at home, it is weakened and demoralized so that it cannot move as aggressively abroad. Before retreating, however, this move may escalate to global war. It could trigger a violent price war in the incumbent’s stronghold as well as the entrant’s because the entrant may react in the incumbent’s market.

Until November 1991 MarkAir Inc. and Alaska Airlines peacefully coexisted in the Alaskan market. Then MarkAir, after it was spurned in its attempt to sell itself to Alaska Airlines, “declared war,” according to Business Week³⁷ MarkAir moved aggressively into its rival’s routes, including the prime Anchorage-Seattle route and Southern Alaskan routes where Alaska Airlines had had a monopoly according to Business Week. Even though MarkAir had just one-ninth the revenues of Alaska Airlines, the small carrier still had the ability to inflict serious damage. MarkAir chairman Neil Bergt retained Frank A. Lorenzo, former Texas Air chairman, as an adviser to help build resources through an initial public offering. As MarkAir moved into lucrative markets, Alaska Airlines’ stock plummeted by 18 percent between January and April of 1992, Business Week reported. MarkAir, in addition to seeking the IPO, was selling off planes and hangars to support the costly price war. Alaska Airlines responded with what appeared to be a war of punishment by moving aggressively into routes where, Business Week reported, MarkAir “had once enjoyed a monopoly.”³⁸ Alaska Airlines also opened up new routes in the far northern part of the state. Both airlines stretched their re­sources to sustain this war. Both were locked in a deadly battle in 1992 that would probably be won by the one with the deepest pockets, the one who backed down first, or a third party who would come in and take advantage of these two weakened rivals.³⁹

For a war of punishment to succeed, the incumbent, without destroying itself, must inflict heavy losses on its opponent and force it to exit the incumbent’s home market. This can sometimes be done by introducing a product with a low market share at a very low price into the entrant’s home market. If the entrant has large market share in its stronghold (as it usually will), then it cannot match or beat the price without suffering large losses. This may force the opponent to react only by counterattacking the incumbent’s home market. But if a price war has already been started in the incumbent’s home base, the incumbent has nothing to lose by escalat­ing in the entrant’s home market. Attacking the entrant’s home market with full force cannot escalate the war in the incumbent’s home base any more than it already had been. That is, the incumbent would have suffered the losses from the battle in its home market anyway. Following this coun­terattack, if the opponent doesn’t respond in its home base, it stands to lose market share. If it does, it will incur big losses, and it won’t be able to pay for its attacks in the other market. Either way the opponent loses.

OPTION 2: A WAR OF CONQUEST IN THE OPPONENT’S HOME BASE

This is a fight to the finish, laying siege to the city, winner take all, as in the Trojan War. The key to success in this battle is to nullify the opponent’s advantages in its stronghold by using the techniques described in Chapters 1 and 2 (moving up the escalation ladder toward the ultimate value position and imitating or leapfrogging). This is accomplished by in­novation, differentiation, outflanking, and systematically capturing niche after niche in the opponent’s stronghold.

Whereas the intent of the war of punishment was to discipline the com­petition, the intent of this approach is to move aggressively into the competitor’s territory not only to discipline him but also to conquer and control his markets.

Southwest Air is engaged in what might be described as a “war of con­quest.” Three airlines, Braniff, Texas International, and Continental, tried to shut down Southwest Air in court in the late 1960s, claiming that the Texas market could not sustain another carrier. Southwest won the court battle and launched a guerrilla attack against its larger competitors. Rather than com­pete head-to-head with the hub-and-spoke systems of the larger players, Southwest undercut the prices of the other major airlines by as much as 60 percent, according to Business Week*⁰ and outperformed its competitors.

In 1990 it was the only major airline to show a profit on operations, and it achieved these results by offering more frequent flights at lower prices than competitors.⁴¹ Southwest then moved into larger cities such as Phoenix and Chicago⁴² where it successfully competed against America West (Phoenix) and Midway (Chicago)⁴³ Southwest has apparently moved from market to market, capturing larger and larger market share.

When an incumbent counterattacks the entrant by launching a war of conquest or a war of punishment on the entrant’s home turf, it can be costly for both the incumbent and the entrant. Because of this, the two players may try to avoid such direct confrontation by maintaining a tem- porary standoff, which is the next dynamic strategic interaction.

9. The Eighth Dynamic Strategic Interaction: Unstable Standoffs

Competition across several geographic or industry strongholds sometimes leads to a standoff between multilocation firms (and conglomerates) that tends to reduce competition within both strongholds. Consider the situa­tion illustrated in Figure 3-2.

Company 1 can prevent company 2 from expanding in the U.S. market by shifting its attention to Japan and using price competition to sting com­pany 2 in that location. This stinging will hurt company 2 a lot. On the other hand, company 2 can apply the same strategy to keep company 1 from expanding its toehold in Japan. Thus, the two companies can disci­pline one another into being nonaggressive if neither has the stomach for a fight. Just the mere knowledge of the fact that each can sting (or even destroy) the other should force a stalemate. This is essentially the business equivalent to MAD, the doctrine of mutually assured destruction, which prevented the Soviet Union and the United States from starting a nuclear war during the Cold War period. Each knew the other could destroy it if it started a war, so neither escalated to a real conflict.

In business settings this type of standoff has a high probability of being broken if (1) a third competitor acts aggressively in one party’s turf, (2) one of the companies develops a protected stronghold so well as to be in­vulnerable to a sting by the other company, (3) one of the competitors gains a substantial advantage in quality and price or timing and know-how sufficient to allow it to win a war of punishment or conquest, (4) one party gains the will to endure a fight because of a change in leadership or cir­cumstances, or (5) one party loses the will to continue a credible threat to sting or discipline the other player. (Note: Many believe the standoff be­tween the United States and the U.S.S.R. ended because one or more of the above conditions were met. First, the United States gained the upper hand due to the declining economic power of the U.S.S.R., making it im­possible for the U.S.S.R. to continue the arms race. Second, the Soviets realized that the Strategic Defense Initiative (SDI), if successful at shield­ing the United States from nuclear attack, would make it possible for the United States to protect its stronghold from the sting that the Soviets could deliver. Thus, the United States would be free to break the peace with impunity, forcing the Soviets to prepare for such an event. Yet be­cause of their weak economy the Soviets didn’t have the money to pay for an SDI program of their own or to build enough missiles and submarines to compensate for the U.S. advantage. So the stalemate was broken.)

FIGURE 3-2

UNSTABLE STANDOFFS ACROSS GEOGRAPHIC MARKETS

Since it is frequently the case that the balance of power breaks down, especially in business, standoffs are rare. When they do occur, they are almost always broken, because each player has the incentive to try secretly to get the upper hand by finding a way to protect its own turf and then openly expand into the opponent’s turf. This may result in firms’ testing the resolve of their opponent and triggering the escalating battles outlined in this chapter.

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