The strategic benefits of competitors

The presence of the right competitors can yield a variety of strategic benefits that fall into four general categories: increasing competitive advantage, improving current industry structure, aiding market development, and deterring entry. The particular benefits achieved will differ by industry and the strategy a firm is pursuing.

1. Increasing Competitive Advantage

The existence of competitors can allow a firm to increase its competitive advantage. The mechanisms are described below, along with the industry characteristics that make them particularly valuable.

Absorb Demand Fluctuations. Competitors can absorb fluctuations in demand brought on by cyclicality, seasonality, or other causes, allowing a firm to utilize its capacity more fully over time. Having competitors is thus a way to control the capacity utilization cost driver described in Chapter 3. Market shares of industry leaders commonly rise during downturns and fall during upturns, for example, a manifestation of this phenomenon. Competitors gain share when the leader’s capacity is short during an upturn because the leader cannot or chooses not to meet all the demand. In a downturn, the leader gains share because it is the preferred source and now has capacity available. Letting competitors absorb the fluctuations is often preferable to maintaining the necessary capacity to meet demand over the cycle. However, a firm must ensure enough overall capacity in the industry to serve key buyers and not attract entrants, and that it has enough excess capacity to control industry prices if the product is a commodity.

Enhance the Ability to Differentiate. Competitors can enhance a firm’s ability to differentiate itself by serving as a standard of comparison. Without a competitor, buyers may have more difficulty perceiving the value created by a firm, and may, therefore, be more price- or service-sensitive. As a result, buyers may bargain harder on price, service, or product quality. A competitor’s product becomes a benchmark for measuring relative performance, however, which allows a firm to demonstrate its superiority more persuasively or lower the cost of differentiation. Competitors, then, can be signals of value for a firm’s product (Chapter 4). In consumer industries, for example, the existence of generic brands may actually allow a branded product to sustain higher margins in some circumstances. The benefit of a competitor as a benchmark, however, presupposes that the buyer can perceive product and other differences, and that a firm is really differentiated so that the presence of a benchmark does not expose an unsustainable price premium.

A related situation in which having a competitor enhances differentiation is where a firm is too superior to most of its rivals. It may be difficult to command a large premium over standard-quality producers without a competitor somewhere in between, even if the value created by the firm fully justifies the premium. For example, IBM reportedly had difficulty securing high prices in its management information system software development business until the Big Eight accounting firms entered the industry and charged high prices. The Big Eight had credibility, and their prices made it easier for buyers to accept the premiums IBM was asking over independent software  houses.

The benefits of a standard of comparison are most important in industries where accepted standards for product quality and service are not apparent, where a wide range of cost/quality tradeoffs are possible, and where buyers would be prone to price sensitivity in the absence of perceived differentiation. In such industries, pressure from buyers to continually improve products and services in the absence of a benchmark is likely to place downward pressure on a firm’s profitability.

Serve Unattractive Segments. A firm’s competitors can be happy to serve industry segments that it finds unattractive, but that it would otherwise be forced to serve in order to get access to desirable segments or for defensive reasons. Unattractive segments are those which are costly for the firm to serve, where buyers have bargaining power and price sensitivity, where the firm’s position is not sustainable, or where participation undermines a firm’s position in more attractive segments. The concepts in Chapter 7 can be used to identify strategically-relevant industry segments and their attractiveness.

A common example of the value of competitors is where particular items in the product line are difficult for a firm to differentiate and do not earn acceptable returns. If buyers must have them, they will seek a supplier for the items that may gain an edge in selling the whole line. A good competitor supplying these items is less threatening than the buyer finding an entirely new source. The essential factor that makes a good competitor valuable in this situation is that demand for items in the line is linked.

In a related situation, a particular buyer group may be price- sensitive and possess bargaining power. Without a good competitor, however, the firm may have to serve the unattractive buyers for defensive reasons to cut off a logical entry avenue for a bad competitor (see Chapter 14). Major mass merchandisers such as Sears, for example, are more powerful and price-sensitive than smaller chains because they are larger and compete with cost rather than differentiation strategies. If a firm serves the large mass merchandisers, it will earn a lower return than it does in serving the smaller chains and its overall profitability will be lower unless the incremental volume from the unattractive buyers is sufficient to improve its overall cost position. However, the large chains provide an inviting target for threatening new entrants unless served effectively by a good competitor.

A typical situation in industries where there is government procurement will illustrate how serving one segment can undermine performance in others. The sealed bids required in selling to government agencies are frequently open to public inspection. Thus the bid prices become known to less price-sensitive industrial buyers, potentially compromising a firm’s ability to charge them premium prices. A firm may be better off with a good competitor serving such a segment. Allowing a competitor to serve a segment can also be beneficial in situations where a firm has a weak product offering in the segment that would undermine its credibility in other segments.

A competitor can also be beneficial to a firm if it competes in segments with a buyer group that is particularly costly for a firm to service. If a firm is unable for legal reasons to price-discriminate1 sufficiently among buyers to reflect differences in servicing cost (e.g., because of the Robinson-Patman Act), or if possibilities for reselling among buyers prevent differential pricing, then a firm’s profits are increased if a competitor who can serve them more cheaply or has lower profit standards serves the high-cost customers.

A segment must truly be unattractive structurally to justify the benefits of a competitor, however. Sometimes seemingly unattractive segments are not really unattractive, but rather are being priced or served incorrectly. Rather than have competitors, then, a firm can profit from serving the segments itself. The risks of incorrect pricing are discussed in Chapter 3.

Provide a Cost Umbrella. A high-cost competitor can sometimes provide a cost umbrella that boosts the profitability of a low-cost firm. It is a common view that industry leaders provide a price umbrella for industry followers, and this is indeed the case in some industries.2 What is less often recognized, however, is that market price is often set by the cost position of the high-cost competitor in stable and particularly in growing industries. If a high-cost competitor prices at or near its costs, the low-cost competitor can earn a substantial margin if it matches that price. Without the high-cost competitor, however, the price sensitivity of buyers may be greater because there is a larger price premium that attracts buyers’ attention to price. The cost umbrella from a high-cost competitor is particularly valuable where buyers (including retailers) desire a second or third source and will therefore give the high-cost competitor a portion of their business.

The risk of letting a high-cost competitor set the price is that this price will attract entry. In order for the strategy to succeed, then, there must be some entry barriers. It is also important that the high- cost competitor gain enough business to remain viable or its demise may attract the entry of a bad competitor.

Improve Bargaining Position with Labor or Regulators. Having competitors can greatly facilitate bargaining with labor and government regulators, where negotiations are partly or wholly industrywide. A leader is vulnerable to being pressured for concessions in union negotiations, or into meeting stringent standards for product quality, pollution control, and so on.50 The presence of a competitor can have a moderating effect on such demands if the competitor is less profitable, less well capitalized, or more precariously positioned.

Lower Antitrust Risk. The presence of viable competitors may be necessary to reduce the risk of antitrust scrutiny and prosecution, in both government and private suits. Eastman-Kodak and IBM are notable examples of companies that have faced repeated antitrust prosecution that has consumed a great deal of management time and perhaps distracted attention from running the business.51 Even if the chances of government antitrust prosecution are low, having too large a market share can expose a firm to private litigation every time it takes a significant action such as a new product introduction, technology license, or price change. The risk of litigation often leads high-share firms to be consciously or unconsciously cautious in making moves, to the detriment of their competitive advantage. The presence of a viable competitor would improve the situation.

Increase Motivation. A role of competitors that is hard to overestimate is that of motivator. A viable competitor can be an important motivating force for reducing cost, improving products, and keeping up with technological change. The competitor becomes a common adversary that brings people together to achieve a common goal. Hav-ing a viable competitor has important psychological benefits inside an organization. Xerox, for example, is showing signs of benefiting from the emergence of serious competitors in copiers. Its manufacturing cost position appears to be improving after years where cost was unimportant to success, and its pace of new product development has quickened. The histories of firms with monopoly or near-monopoly positions, on the other hand, frequently provide examples of situations where a dominant firm was complacent and ultimately blinded to changes to which it failed to respond.

2. Improving Current Industry Structure

Having competitors can also benefit overall industry structure in a variety of ways:

Increase Industry Demand. The presence of competitors can increase overall industry demand and, in the process, a firm’s sales. If primary demand for a product is a function of total industry advertising, for example, afirm’s sales can benefit from competitors’ advertising. Followers often spend disproportionately on advertising because they are too small to reap economies of scale. A regular stream of product introductions by a firm and competitors may also broaden industry appeal and raise awareness of the industry, boosting demand. Finally, the entrance of competitors can sometimes lend credibility to a product, as the entrance of IBM did with personal computers.

Competitors can also boost industry demand where an industry’s product line includes complementary products, as with cameras and film, razors and blades, and laboratory instruments and consumable supplies. A firm with a proprietary position in one product can benefit if one or more competitors sell the complementary product. For example, Kodak has licensed camera technology to allow numerous competitors to sell cameras, thereby stimulating the sales of proprietary Kodak film. This strategy is based on the ability of competitors to enhance primary demand for a complementary good through their collective marketing efforts. The strategy is also a good one where it is difficult to earn an adequate return on the complementary product and thus the firm wants to meet only a portion of the demand itself.5

Provide a Second or Third Source. In many industries, particularly those involving important raw materials or other important inputs, buyers want a second or third source in order to mitigate the risk of supply disruptions and/or to hedge against the bargaining power of suppliers. This sort of buyer behavior occurs in turbine generators, metal cans, sugar, and chemicals, for example. The presence of a good competitor as the second or third source takes the pressure off a firm. It can prevent buyers from inviting more threatening competitors into such industries as well as delay or reduce the risk that buyers will backward integrate themselves.

Kyocera, the U.S. subsidiary of Kyoto Ceramics, has experienced the problem of not having credible competitors in supplying the semiconductor industry. Its share of ceramic housings for semiconductor chips is so dominant that U.S. semiconductor companies have been actively searching for new sources, and have actually invested resources to help new suppliers get into the business. With a more credible competitor, Kyocera would have been less vulnerable to such destabilizing behavior by its buyers and perhaps under less scrutiny from them on pricing.

While the examples cited above have been drawn from industrial products, the same issues apply in consumer goods. Retailers often desire more than one brand to provide a counterweight to any one manufacturer’s power. Having a good competitor can lower the chances that retailers will actively help other competitors enter the industry through favorable shelf positioning, heavy promotion, and other support.

Reinforce Desirable Elements of Industry Structure. A good competitor can reinfore desirable aspects of industry structure or promote structural change that improves the attractiveness of the industry. For example, a competitor that stresses product quality, durability, and service can help reduce buyer price sensitivity and mitigate price rivalry in the industry. Or a competitor that heavily advertises may hasten the evolution of the industry into one with a few strong brands and high entry barriers. Conversely, a bad competitor can undermine the structure of an industry in the pursuit of its own competitive advantage. In baby foods, for example, Beech-Nut historically reinforced positive aspects of the industry through its high levels of advertising, frequent product introductions, and stable prices before its acquisition by Squibb in the mid-1970s. Heinz, on the other hand, has undermined industry structure with a low cost/low price strategy in a futile effort to overtake Gerber. Squibb’s acquisition of Beechnut turned Beech-Nut into a bad competitor as well by altering its goals and strategy.

3. Aiding Market Development

Competitors can help develop the market in emerging industries or in industries where product or process technology is evolving:

Share the Costs of Market Development. Competitors can share the costs of market development for new products or technologies. Market development often involves costs of inducing buyer trial, battling substitutes (see Chapter 8), legal compliance, and promoting the development of infrastructure such as independent repair facilities.6 In addition, R&D spending is often necessary to refine the basic technology, to overcome switching costs faced by any prospective buyer, and to develop procedures for installation and service that are widely useful. Competitors can lower a firm’s cost of market development, particularly if competitors spend disproportionately on it relative to their sales and if their market development efforts are in areas that represent industrywide problems.

Reduce Buyers’ Risk. Competitors may be necessary in a new market (or a new technology) in order to provide an alternate source for buyers, even if buyers would not normally require another source later on. Buyers are often reluctant to purchase a new product if only one or two firms produce it, particularly where the cost of switching is high or the buyer would be hurt if a supplier failed to provide adequate service or went out of business.

Help to Standardize or Legitimize a Technology. Having competitors that employ the same technology as a firm can accelerate the process by which the technology is legitimized or becomes the standard. Buyers are often reluctant to accept a technology as the standard when only one firm is backing it, and may hold back from initial purchases to wait for technological change to progress further. When a credible competitor is also pushing the technology (and sharing in the cost of marketing it), buyers’ reluctance to adopt it can be much reduced. The move of the pioneers of VHS and Beta format video cassette recorders to license other leading firms to use their technology is a good example. A competitor with the same technology may also facilitate the process of gaining approvals by government or other standard- setting organizations for the technology.

Promote the Image of the Industry. The right competitors can enhance the image of an industry. Established companies with reputations in other businesses can lend credibility to an industry by signaling that the industry is legitimate and that promises by firms will be met.

The benefits of having competitors during market development are often transient ones, applying most strongly to the emerging or growth phases of an industry’s development. Having several competitors may thus be most strategically beneficial early in an industry’s development, with the ideal number of competitors declining thereafter.

4. Deterring Entry

Competitors play a crucial role in deterring other entrants, or enhancing the sustainability of a firm’s competitive advantage. The right competitors can contribute to defensive strategy (Chapter 14) in a variety of ways:

Increase the Likelihood and Intensity of Retaliation. Competitors can increase the likelihood and severity of retaliation perceived by potential entrants. Competitors can also act as a first line of defense against new entrants, battling them with tactics such as price cutting that would be prohibitively expensive for a firm with a large market share because its revenues across the board would be reduced. Further, an entrant may be less prone to enter if it faces a number of credible competitors than if it sees a dominant firm that is potentially vulnerable to focus strategies. Dominant firms often have mixed motives in serving particular segments that expose them to focused entrants.7

A competitor does not deter other entrants, however, if it is perceived as too weak. Instead, a weak competitor provides a new entrant with an inviting beachhead in the industry though the entrant would not dare to attack the leader directly.

Symbolize the Difficulty of Successful Entry. A competitor can bear witness to the difficulty of successfully competing against a firm, and demonstrate the unspectacular profitability of a follower position. The limited increase in market share and poor profitability of Procter & Gamble’s Folgers, for example, is a good lesson in the costs of gaining share in the coffee industry against General Foods’ Maxwell House. Without a competitor, a potential entrant may underestimate the height of entry barriers and the competitive strength of the leader.

Block Logical Entry Avenues. Competitors can occupy positions that represent logical entry paths into an industry, blocking them from potential entrants. In the lift truck industry, for example, small lift trucks sold to smaller buyers are a logical entry path. Small lift trucks require less service, and smaller buyers face fewer switching costs in changing suppliers because they often have only one lift truck and face no issues of fleet commonality. Thus the barriers to entry into this segment are lower than into other segments. In this example, however, the moderate profitability of the segment caused leading U.S. manufacturers to neglect it. Unfortunately for U.S. lift truck manufacturers, there was no credible U.S. competitor to block entry into the segment, and Japanese manufacturers successfully used the segment as a way to enter the U.S. market. Even though an industry leader might serve such a segment itself, it may be more profitable for the leader to cede the segment to a good competitor if the segment is structurally less attractive than the core business (see Chapter 7).

Competitors can also fill product niches that would themselves be too small for the leader, or in relation to which the leader faces mixed motives. Having competitors filling these niches increases the difficulty of entry because a potential entrant is forced to enter with a “me too” product, instead of having a protected niche in which to create a base for expansion.8 The desire of buyers for a second or third source also opens up logical entry avenues for competitors. Having a good competitor to fulfill this role can deter more threatening entrants.

Crowd Distribution Channels. Having a competitor gives distributors and/or retailers multiple brands, and may make it more difficult for a new entrant to gain access to distribution. Where there are only one or two firms in an industry, on the other hand, the channels may welcome new competitors to mitigate the bargaining power of the leaders or to supply private label merchandise. The presence of competitors can thus force a new entrant to bear much higher costs of gaining channel access because the channels already have a full complement of brands.

It may also be desirable for a leader to supply private label goods as a defensive move if no good competitor is present to serve the private label market. Despite this, many leaders tend to avoid private label business because they see it as undercutting the position of their branded goods, as RCA and Zenith reasoned in TV sets. This can be too narrow a viewpoint when the risks of future entry are considered; in TV sets, Sears actively encouraged Japanese entry into the U.S. color set market because of its inability to source a quality private label set from RCA, Zenith, or other capable U.S. manufacturers.

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

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