Traditional views of the deep-pocket advantage

The deep-pocket advantage appears to be intuitively obvious. Common sense tells us that a larger and better-supplied firm will usually win against a smaller, weaker competitor. Its resources give it the ability to outlast the smaller firm or to win in a test of strength, such as a war of attrition.

Besides the ability to invest in assets that others can’t afford (as Toyota did in forklifts) and the ability to sustain price wars longer than smaller competitors, deep pockets provide three other advantages: a wide margin for error, global or national reach, and political power. Each of these is addressed in turn in the next sections.

1. A Wide Margin for Error

Deep pockets offer a powerful advantage because they can be used to neu­tralize the effects of the strategies detailed in the preceding three chapters in the same way that a tractor-trailer operated by a driver with moderate abilities wins in a crash with a highly skilled driver in a subcompact. If a company has deep enough pockets, it can outlast its competitors even if they have a better strategy.

Deep pockets win in war as well as business. While military historians agree that the Confederacy had better generals and strategy during the American Civil War, the Union won. Its victory was largely due to a supe­rior level of resources. More men and supplies allowed it to “win” battles simply by being willing to sacrifice more men and use up more supplies. In many battles the Union’s inferior strategy was outweighed by its willing­ness and ability to sacrifice ten thousand men in one four-hour fight.

In business deep pockets allow firms to lose a price war or the battle for cost and quality and still develop the next level of technology or know­how and rebuild strong entry barriers. If it has deep enough pockets, it can make a strong foray into another company’s territory, even when the costs are so great that they don’t make sense except to prove to competitors that the firm is a force not to be trifled with. Companies use the brute force of deep pockets to overcome better skilled opponents by pursuing so many attacks and multiple strategies that competitors can prepare for them. A deep pocket eliminates the need to determine which countermove its competitor will make, because, no matter what the opponent does, it can be overwhelmed by sheer numbers. Many businesspeople say that the op­ponent they most hate to fight against is one who is stupid but very rich.

Thus, deep pockets give the company breathing room for errors in the other three arenas of competition. If you have deep pockets, poor quality, high costs, loss of a protected stronghold, and bad timing and know-how are not fatal mistakes (at least not in the short run). The large firm can sustain losses for long periods of time and still have the resources to catch up to or jump past competitors, neutralizing their advantage in the first three arenas.

2. Global or National Reach

Deep pockets also provide the ability to reach around the world or nation to tap the best talent, find the most modem equipment, purchase the lat­est technological advances, line up the most responsive and aggressive dealers, and search out the highest-quality suppliers in the world or na­tion.

Global reach also gives the firm the ability to monitor its competitors anywhere that they compete, eliminating surprises. It gives the ability to experiment in one location and transfer that knowledge elsewhere. So a firm can test a product in one place, work out many of the bugs, and then introduce it to key markets without risking its brand image for quality products. It will still have to work out local variations, but the core prod­uct and process technology can be refined in a smaller market with less room for serious damage. Smaller competitors, on the other hand, often are faced with a “bet the firm” proposition in launching new products.

Finally, global reach means the ability to move resources from place to place, so that the firm can overwhelm smaller domestic players. Once vic­torious, the deep pocket can then move its resources to new locations, much like a conquering invader on the march.

3. Political Power

Large firms with deep pockets also gain political power over the communi­ties where they operate. Often, multinational corporations have budgets that are bigger than the countries in which they operate. Exxon, for exam­ple, is bigger than all but a few countries.

This translates into political power in several ways. Not only may clos­ing a plant affect local jobs, but decisions of some multinationals about where to locate often affect regional economies and even U.S. foreign pol­icy. Many believe that the alliances between U.S. oil companies and Saudi Arabia and Kuwait affected U.S. willingness to send troops to the Gulf. Moreover, U.S. military contractors intentionally locate plants in the dis­tricts of key congresspeople so as to use their influence to insure the con­tinuance of contracts long after the military equipment is no longer needed. Even presidents succumb to the influence of military contractors, allowing fighter plane sales to Taiwan and Saudi Arabia to curry favor in key districts that might sway the Electoral College. Thus, largeness and the concomitant deep pockets allow some firms to influence governments in many locations and in ways that smaller firms cannot.

4. Banking on Size

When NCNB and C&S/Sovran joined forces in 1991 to create a $116 billion megabank, then the third largest in the country, the move sent shock waves through the southern banking industry. The new bank, NationsBank, was larger than the next three largest banks in the South combined. It created the greatest resource gap between the large and small banks in any region in the country.1

Hugh McColl, the CEO of NationsBank, who steered NCNB of North Carolina on its meteoric rise into the ranks of the largest banks in the United States, believed that a company is either growing or dying. His banking empire has grown as fast as the sixty-story office building he con­structed in Charlotte, North Carolina, that has been nicknamed the Taj McColl. Under his guidance, NCNB’s assets rose from $7.7 billion in 1982 to more than $100 billion when he merged with C&S/Sovran in 1991. With its new scope of operations, NationsBank was no longer reliant upon the declining economy of North Carolina, so it was no longer overly dependent upon textiles, furniture, and tobacco farming for its survival. In addition, real estate fluctuations in Texas, linked to the decline of its oil industry, became less of a factor in the bank’s success. The impact of major Florida hurricanes on real estate loan default rates was also reduced. The expanding asset base and national reach of the bank reduced the risks posed to the bank’s performance by unforeseen and uncontrollable shocks. The combined operations were expected to produce annual cost savings of $450 million by 1994.2

In addition, the large “supercommunity” bank can leverage its assets to provide better service to its local branches and to its customers. Its greater resources allow it to offer a broader product line, produce costs savings by centralizing some functions of the bank, and make investments in scale- sensitive technology.3 Moreover, large banks can compete longer on price. This is not just because of the effects of economies of scale, which are rather small in banking. (In fact, some research suggests that there may even be some diseconomies of scale in banking.) If large banks offer loans at lower interest rates, they can afford the lower margins in the short run without risking their survival.

Large banks also have political power. Where they invest affects the economies of cities and states, in turn affecting the fate of political leaders in those locations. Decisions concerning whether to fund an airport, a power station, or a port expansion can have serious political implications, placing the bank right in the middle of the political action. Even decisions about whether to work out a loan or force a large debtor into bankruptcy can have political implications. Closing down firms kills jobs, a hot polit­ical topic.

Shortages of resources also pose problems for smaller banks. Below a certain size, for example, banks do not have the resources they need to be profitable. Studies of small banks show that the minimum size for survival lies somewhere between fifty million and two hundred million dollars in assets.4

Thus, the building of a large asset base is one of the key arenas in which firms compete. Expanding resources through growth or mergers can be an important strategic tool.

5. Useful Insights from This View of Competitive Advantage

The main insights that this view of deep-pocket advantages has produced are in the public-policy realm, especially antitrust regulation. The govern-ment often steps in to protect small firms from large ones. Using a deep- pocket advantage has been considered anticompetitive because it is seen as driving the “little guy” out of business unfairly. When small firms offer a better product and have a better strategy, the use of brute force to crush them is seen as hurting the public interest. Among the many implications is the need for policies that prohibit predatory pricing (i.e., pricing below one’s own costs) and encourage tighter scrutiny of large market-share firms seeking to expand via mergers or acquisitions.

These two government policies are designed to reduce the impact of deep pockets and are testimony to the power of deep pockets. In fact, the U.S. government has long regulated the size of banks out of fear that they would grow too powerful and endanger the survival of a democratic society.

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

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