The strategic benefits of competitors

The presence of the right competitors can yield a variety of strate­ gic benefits that fall into four general categories: increasing competitive advantage, improving current industry structure, aiding market devel­ opment, 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 com­ petitive advantage.   The  mechanisms  are described below,   along with the industry characteristics that make them particularly valuable.

Absorb Demand Fluctuations.    Competitors  can absorb fluctua­ tions 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. M arket shares of industry leaders commonly rise during downturns and fall during upturns, for example, a manifes­ tation 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 main­ taining 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 compari­ son. W ithout 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 com petitor’s product becomes a bench­ mark 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 differen­ tiated so that the presence of a benchmark does not expose an unsus­ tainable price premium.

A related situation in which having a competitor enhances differ­ entiation is where  a firm is too superior  to most  of its rivals. It may be difficult to command a large premium over standard-quality produc­ ers 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 infor­ mation system software development business until the Big Eight ac­ counting 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 profit­ ability.

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. W ithout a good competitor, however, the firm may have to serve the unattractive buyers for defen­ sive reasons to cut  off a logical entry  avenue  for a bad   competitor (see Chapter 14). M ajor mass merchandisers such as Sears, for exam­ ple, are more powerful and price-sensitive than  smaller chains because they are larger and compete with cost rather than differentiation strate­ gies. 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 pro­ curement will illustrate how serving one segment can undermine per­ formance 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 com­ promising 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 partic­ ularly 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. W ithout  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 um ­ brella 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 im portant  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  govern­ ment  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.3 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. Eastm an-Kodak and IBM are notable examples of companies that have faced repeated antitrust prose­ cution that has consumed a great deal of management time and perhaps distracted   attention  from   running  the   business.4 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 li­ cense, 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 overes­ timate 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. Hav­ing a viable competitor  has   im portant  psychological  benefits   inside an organization. Xerox,   for example,   is showing  signs   of benefiting from the emergence of serious competitors in copiers. Its manufactur­ ing 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 advertis­ ing, for example, a firm’s sales can benefit from competitors’ advertis­ ing. 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 exam­ ple, Kodak has licensed camera technology to allow numerous competi­ tors 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, particu­ larly those involving important  raw materials  or other important in­ puts, buyers want  a second or third  source  in order  to mitigate the risk of supply disruptions an d /o r 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 semi­ conductor 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. W ith a more  credible competitor, Kyocera would have been less vulnerable to such destabi­ lizing 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 m anufacturer’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 o f Industry Structure. A good competitor can reinfore desirable aspects of industry structure or pro­ mote 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 rein­ forced positive aspects of the industry through its high levels of adver­ tising, 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  Beech­ n u t turned Beech-Nut into a bad competitor  as well by altering its goals and strategy.

3. Aiding M arket Development

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

Share the Costs o f Market Development.      Competitors can share the costs of market development  for new products  or technologies. Market development often involves costs of inducing buyer trial, bat­ tling 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 tech­ nology, 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 switch­ ing 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 com­ petitors 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 o f the Industry. The right competitors can enhance the image of an industry.  Established companies with reputa­ tions 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 competi­ tors may thus be most strategically beneficial early in an industry’s development, with the ideal number  of competitors  declining there­ after.

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  o f Retaliation.    Competi­ tors 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 dom inant firm that is potentially vulnerable to focus strategies. Dom inant 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 per­ ceived 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 o f 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. W ithout 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 manufac­ turers, 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.  Hav­ ing a good competitor to fulfill this role can deter more threatening entrants.

Crowd Distribution Channels. Having a competitor gives distrib­ utors and/or retailers multiple brands,  and may make it more  difficult for a new entrant to gain access to distribution.  W here 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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