Competitive Strategy - Canvas

CHAPTER 11

Competitive Strategy

LEARNING OBJECTIVE

Studying this chapter should provide you with the knowledge to:

1. Create a strategic group map and a strategy canvas of a competitive landscape.

2. Analyze a company's competitors to identify the likely ways they will respond to a company's strategic moves using a competitor response profile.

Delta Simplifies Its Fares

In January 2005, facing increasing competition from low-fare

carriers, Delta Airlines introduced a new pricing plan called slm­

plifares that dramatically cut ticket prices across most of Delta's

domestic US routes. Paul Matsen, Delta's chief marketing officer,

stated, «we could sit back and wait for low-fare competition to force

us to react, but we're going on the offense.''1 The company cut ticket

prices by as much as 50 percent and eliminated the Saturday-night

stay requirement that had long helped alrllnes distinguish between

leisure travelers and business travelers. Furthermore, It capped the

price for a last-minute coach fare at $499 and a first-class fare to anywhere in the country at $599. Although the new pricing scheme

would immediately create a drag on revenue, Delta expected that

194

3. Describe the different types of competitive strategies that can be deployed contingent on the environment in

which a company operates.

4. Choose or create a competitive strategy suitable to a company's competitive situation.

over the long run the pricing move would be good for the airline by

helping it take back passenger volume from the low-fare carriers.

Business travelers, in particular, had been increasingly moving to

low-fare carriers for their travel. In fact, near Cincinnati, wheresim­

plifares was first piloted, many business travelers preferred to drive

to a smaller airport and pay the fares of AirTran or ATA rather than

the higher fares of Delta. The new pricing structure was expected to

bring these customers back to Delta.

Although Delta hoped for a new source of advantage from this

pricing move, Delta's main competitors- the full-fare carriers such

as American and United-responded to simplifares by immediately

matching Delta's prices. Within days, business fares in the top 40

routes flown by major airlines were down by an average of one-third,

and American Airlines' fares were down by 44 percent.1 Perhaps as a way to slow the free fall, Northwest airlines warned the industry that

"fare simplifications" would immediately and adversely affect indus­

try revenues, but other airlines ignored the warning.l

By July, just six months later, Delta was already making

upward price adjustments, citing a spike in the cost of fuel.• The

company abandoned the $499 cap and raised the celling by $100.

Again, major carriers immediately followed suit. On the day of the

announcement, a spokesman for Continental stated, "All I can tell

you is that we dld match Delta 's fare, and the match was effective

today. Whatever Delta did, we did ."s Meanwhile, the low-fare car­

riers welcomed the move as evidence that full-fare carriers were

burdened with cost structures that were simply too high to match

their low ticket prices.

Understanding the Competitive Landscape 195

Despite the effort exerted to implement the new pricing

strategy, by 2008, Delta had completely abandoned the simplifares initiative. Richard Anderson, Delta's CEO, seemed to suggest that

efforts to compete on price with the low-fare carriers had been mis­

guided. Cutting prices for business travelers had disastrous effects

on revenue because the expected growth in passenger volume never

materialized. This was largely because of competitive price match­

ing. In a clear return to its previous strategy, Mr. Anderson stated,

"You really have to have a differential [between business and leisure

travel). We offer different products to different customers based

on their attributes. That's better for an international carrier offer­

ing ... different products on the same airplane."6

Competition is a reality for business firms. Whether a company faces competitors that are actively striving to erode its market share or potential new entrants to its market, nearly all managers must grapple with how to compete. In some markets, competition is light because firms are highly differentiated or because they face few rivals. In other ma rkets, competition can be very intense. In such markets, and as the opening case demonstrates, a company must acknowledge the reality that competitors are watching and are likely to react to its strategic actions. Had Delta realized how quickly its competitors would respond to its pricing moves, the company might have tried a different strategy to improve its performance against low­fare carriers.

How does a company know which actions to take in the face of competition? And what actions are likely to be the most effective in the differing competitive situations that a firm might face? How will compet itors respond to a company's strategic moves? This chapter pro­vides answers to these questions by identifying a set of tools for competitive analysis along with strategies for responding to competitors that are useful under a variety of market circum­stances. The overall objective is to help strategists understand how a company can improve its performance in the face of competition.

In order to effectively compete, a company must first know the competition and then it must launch strategies to win against the competition . The first two sections of the chapter, "Understanding the Competi t ive Landscape" and "Evaluating the Competition," address know­ing the competition. The latter two sections, "Principles of Competitive Strategy" and "Com­petitive Actions for Different Market Environments," address winning against the compet ition.

Understanding the Competitive Landscape

In order to compete effect ively, a firm must understand the structure of the competitive envi­ronment in which it operates. Most industries contain groups of companies that compete directly against each other but only indirectly against companies in other groups. This situa­tion arises because of differences in customer needs and preferences, which give rise to various customer segments. As companies pursue these segments, they develop business models that are well-suited to serving one segment but not so well -suited to serving other segments in the market. Firms with similar business models clu ster toget her by pursuing the same segments of

customers.

Strategic Groups and Mobility Barriers

An analysis t hat breaks down the structure of a market or industry into these constituent groups is called a strategic group analysis. Visualizing this group structure is an important component of competit ive analysis because it identifies the major arenas of competition and who competes directly with whom.

In the United States, Delta, United, and American Airlines compete in the full-fare segment of the indust ry (See An imated Executive Summary, "Competitor Interaction "). Delta encoun­ters American or United on many of its routes between pairs of cities because these compan ies compete in Delta's primary customer segment- business travelers. Among the companies in this group, airlines compete head-to-head and watch the moves of their competitors closely. They respond to one another's competitive moves almost immediately in order to maintain

strategic group A set of companies that compete in similar ways with similar business models pursuing similar sets of customers.

196 CHAPTER 11 Competitive Strategy

barrier to mobility Any factor that limits the ability of a company to move between strategic groups.

a valuable competitive position. Other airlines, such as Southwest, JetBlue, Frontier, or Spirit compete in the discounted or low-fare segment of the industry. They offer few frills, less popular airports, or no reserved seating. These com panies compete head-to-head with each other more than they compete with the full -fare carriers.

Even though companies within groups compete head-to-head, and companies in other groups are less of a threat, riva ls in other groups cannot be completely ignored. Rivals could begin targeting customer segments with new offerings or more favorable value propositions and eventually steal customers. This is exactly what happened in the case at the opening of the chapter. Low-fare carriers were gaining ground in the business traveler segment of the market when Delta launched its effort to compete on price with these carriers.

Strategic group maps are constructed by identifying the main differences in the ways in which firms in an industry compete to deliver value. These differences typically relate to value chain activities such as relative price, geographic placement, product line breadth, extent of vertical integration, niche or full-service offerings, and so forth. The factors that are relevant vary based on the industry in question. In the airline industry, for example, clues about the most important differences in how firms compete can be found in the opening case description. Two of the important factors mentioned are price and whether airlines are flying to primarily large or small airports (recall that Delta was losing business travelers to smaller airports near Cincinnati). Therefore, to draw a strategic group map of the airline industry, you would place these two factors on the horizontal and vertical axes of a simple two-dimensional chart and plot the companies relative to these axes as outlined in Figure 11.1. If you observe clustering of companies, you have identified strategic groups within the industry, at least along the dimen­sions chosen. The ru le is to choose factors that are the most relevant in describing the differ­ences in how companies compete for customers. In other words, choose the dimensions that create the most distinctive clusters.

Companies find that switch ing strategic groups is difficult once they have built a history in one. The reason is that companies in specific strategic groups choose particular ways to con­figure their activities and these activity systems do not change quickly or easily. This creates a barrier to mobility between groups. After a firm is in a particular group, it is not mobile and can 't simply leap to a different group.7 For Delta to effectively compete with low-fare carriers, the company would have to acquire many of the busi ness characteristics of the low-fare carriers. For example, the company would have to change its cost structure, airline fleet routing, and airport locations, effectively abandoning much of its existing customer base. In the opening case, Delta attempted to compete head-to-head with the low-fare carriers by changing only its price. But the company would have had to change many more of its characteristics in order to be successful.

Large

Small

,,,----- .............

,," 0 ', ,/ 8 JetBlu:\ / Southwest I Low-fare , J group

\ 0 ' \ I Spirit / , ..... __ ,,,,,,, ~-----"

Low High

Relative fare price

Otd'i;Jl•H• St rategic Group Map

Understanding the Competitive Landscape 197

A stra tegic group map provides a basis for making competitive assessments not only because it defines who a company's competitors are but also because it can help to analyze potential changes in the landscape. For example, It can indicate whether compan ies in one group are beginning to appeal to the primary markets of another group. Such was the case when low-fare carriers near Cincinnati began to steal business customers from Delta .

Are firms in any group attempting to change the value they offer and the basis of competi­tion? ls this leading to any changes in the boundaries of groups? Delta attempted to alter group boundaries when it launched a low-fare pricing strategy. Are new firms entering the industry with fundamentally different business models? Southwest certainly did when it first entered the Texas market in Dallas. Are there "empty spaces" on the strategic group map that may invite successful entry? In Figure 11.1, no firms currently operate with high fares at small airports, or with low fares at large airports. If this is the case, does this fact suggest possible alternative competitive approaches to the market? These types of questions can be asked and addressed effectively in the context of the strategic group map (See Strategy in Practice: A Real World Stra­

tegic Group Map).

Strategy Canvas

Another way to evaluate differences among competitors is to employ a strategy canvas. Th is idea was first introduced by W. Chan Kim and Renee Mauborgne as a way to assess relative competitive strengths and weaknesses against specific purchase criteria.8 By rating firms on various criteria that customers use to make purchase decisions, the analyst is able to qu ickly grasp similarities and differences in how companies attempt to offer unique value to customers relative to competitors.

For example, consider a strategy canvas analysis of Southwest Airlines and its unique value proposition relative to full-fare airlines and automobile travel (see Figure 11.2). Various features that customers care about when selecting among travel options are identified and placed on the horizontal axis. These features include price, meals, lounges, seating choices, hub connectivity, and so forth. Next, company performance is evaluated against these criteria

and scored on the vertical axis. This scoring is typically based on rigorous quantitative scales, such as those obtained from surveys or other market research. The completed strategy canvas provides insight into how competitive offerings are differentiated.

In Figure 11.2, Southwest's scores more closely resemble automobile travel than they do the scores for other full-service airlines. This analysis uncovers a key point about Southwest's

approach to the market. When Herb Kelleher founded the airline in 1971 at Love Field in Da l­

las to fly passengers to Houston and San Antonio, he set out not to compete with airlines but, rather, with automobile travel.

Cl) Cl) C 'C

~

High

Low

Meals Lounges Sealing Hub Friendly Speed Frequent choices conr,ectlvlty service departures

Oh'Uf ffj Strategy Canvas of the Short-Haul Airline Industry Source: Adapted from C Kim and R M b "Ch · · • au orgne. arting Your Company's Future,'' Harvard Business Review (2002).

198 c HA PTE R 11 Competitive Strategy

Strategy in Practice

A Real-World Strategic Group Map

1vanti is a provider of enterprise software solutions for IT admin­

istrators who manage the many devices on corporate computer

networks. When lvanti wanted to gain strategic insight into the

dynamics of its competitive landscape, the company created a stra­

tegic group map (see Figure 11.3). First, the company chose two fac­

tors that seemed to distinguish the business models of firms in the

industry: relative price and product capabilities, especia lly around

calability, or the ability of the software to handle very large cor­

porate networks. All relevant competitors were placed on the chart

based on how they scored on these two dimensions. The circle size

for each company was scaled to represent revenues. Clear strate­

gic groups emerged and these were circled (dotted black) and then

given a name for quick reference. Competitor bubbles were further

color coded with a proprietary lvanti indicator.

The chart provided a clear view of which companies were on the

landscape, how the companies were competing with respect to price

and product capabilities, and which companies lvanti primarily com­

petes against. By examining the chart, it was also clear that some of

the companies were well positioned to present threats to companies

in other groups by changing products or pricing. For example, compa­

nies in the Alternative Delivery Providers and Small Business Segment Full Suites groups seemed to be the biggest threat for encroaching

on lvanti 's market share. Meanwhile, companies such as Novell, HP,

and CA, which offered similar software, seemed to have fallen out of

Ivan ti 's strategic group. Still other firms, such as those in High-Growth Niche Providers, seemed to be improving their product scalability.

These dynamics are represented on the chart with arrows. The stra­

tegic group map successfully informed the development of targeted

competitive strategies, but also helped identify potential acquisitions,

pricing, and product feature enhancements.

✓

✓ , , I

✓ ✓

--------' ' '

Full Suite-Large Enterprise Revenues/

Market Share Declining

I I

I

' ' ' ' High

I I

f

0 I ,: I

a. ' CD Medium [ > I :.: ' al I 'ii \ a: \

Low

,

VDI and Point Players

✓

✓

-----

High-Growth Niche Providers ------

-----

, I

f

I

I I

I I

I I I I I I I I I I \

IBM Bigfbt

\ \ I I I I I I I I I I

' J J

f

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' ______ .,,.

\ ,____ ~ _,;;,- /

', -----;,:_:,,, ----e--= -----s~•rom-~~~t :;_;:.;~;;,:;:··-' I I

\\_____ 0 // (f! ___ /) - Small Business Segment Full

Alternative Delivery Providers (Primarily Small Business Segment)

Suite

Size ot bubbl re ects the s,ze (revenue) of the organization

Product Capabili1ies/Scalability

■jt31j;jjff■ tvanti Software- Strategic Group Map and Competitive Landscape

The stra tegy canvas is a useful tool not only for uncovering existing differences among

competltors, but also for Identifying new ways to beat rivals. Imagine Figure 11.2 w ithout

Southwest's lin drawn on it. If you were launching a new airline, or even if you were runn ing

an existing airline, you might be able to identify new opportunities for competitive positioning

by studying the differences between how other airlines and ca rs are competing across relevant

purchase criteria.

Evaluating the Competition

Now that we've explored how to look at the competitive landscape, we can turn to examining the motives and likely behavior of individual competitors. Anticipating the actions ofrivals is an important skill for companies because it helps them evaluate their own competitive moves to identify those that will have the most advantageous effect. A useful way to examine a competi­tor is to develop a competitor response profile.9 A competitor response profile identifies char­acteristics of a competitor in order to assess how it might respond in the face of rival actions, as

outlined in Figure 11.4.

What Drives the Competitor?

To illustrate how to build a profile, let's return to the airline industry. Let's assume that South­

west Airlines wants to compete on international routes in Europe and is evaluating Delta as a competitor. The first question to ask is, "What drives the competitor?" Within this category,

objectives and assumptions are identified. An objective for Delta could be, "Leverage the ben­efits of international scale for overall cost savings," or, "Capture a greater share of market by providing home-to-destination travel for international passengers."

What assumptions reinforce these objectives? One is that passengers want to fly the same ai rline domestically and internationally, possibly because of co-located terminals or easier bag­gage transfers. Another is that scale savings exist by having a global footprint, and that this per­mits competitive pricing on international routes (since scale savings lower costs). These kinds of assumptions often point the way to potential rival moves. For example, if Southwest theo­rized that the scale savings from Delta's global footprint were small, or that Southwest's own operating model gave it significant cost benefits, it could plan on using this as an advantage against Delta and contest some of its rival's more popular international routes.

WHAT DRIVES THE I WHA~·THE CciM~ET0

ITO~··-· · IS DOING OR IS · ...

COMPETITOR CAPABLE OF DOING . ,.

Objectives

• Leverage the benefits of international scale for overall cost savings.

• Capture a greater share of market by providing home city to destination travel for international passengers.

Assumptions • Passengers want to fly the same

airline domestically and Internal anally.

• Scale savings exist by having a global footprint, which permits competitive pricing on lnternatlonel routes.

Strategy

Delta ✓-~------- • Position as an international travel

• Delta Is likely to largely ignore entry Into Its International city-to-city markets by Southwest, as long as these entries remain few.

choice to as many customers as possible by building an extensive travel network.

Resources & Capabllltles • Locations In major cities • Airline partners that provide global

reach • Fleet of large aircraft • Reliable and service-oriented travel

Hid'Mif i■ Competitive Response Profile

Source: Adapted from M. E. Porter, Competitive Strategy (New York: The Free Press, 1980).

Evaluating the Competition 199

competitor response profile A profile of a competitor that identifies its objectives and assumptions, its strategy, and its resources and capabilities in order to anticipate how the competitor might respond to rival actions.

200 CHAPTER 1 1 Compet it ive Strategy

game theory Astructured approach to analysis of competitor interaction that yields predictions about which strategic actions are most likely to be chosen by rivals.

What Is the Competitor Doing or Capable of Doing?

After identifying the objectives and assumptions that drive the compet itor, the next question would be: What is the competitor doing and capable of doing? Here is where a competi tor's

strategy and its resources and capabilities are identified. What is Delta's strategy? Pu simply, Delta's strategy is to position itself as an international travel choice to as many customers as

possible by building an extensive travel network. What resources and capabilities does Delta use to accomplish this? Resources include

its locations in major US cities that are international gateways, such as New York, Atlanta,

Seattle, and San Francisco; airl ine partners that provide coverage where Delta is weak; and a fleet of large planes that are characteristic of long-haul travel on international routes. Further, the airline has built a capability for reliable, t imely, and service-oriented internationa l trave l.

These resources and capabilities point directly to what Delta can do on a competitive basis, such as supplying international corporations with end-to-end travel services. These are the

strengths that Southwest, in our hypothetical example, must acknowledge if it is going to

challenge Delta.

How Will a Competitor Respond to Specific Moves?

After these four factors-objectives, assumptions, strategy, and resources/capabilities- are laid out for a specific competitor, a company such as Southwest can anticipate how the competi­tor might respond to specific moves. For example, given this profile, how would Delta respond to Southwest entering one of its existing city-to-city routes? Given that Delta differentiates, in part, by providing a broad set of international route options to customers, the company will probably not react to Southwest entering a single city-to-city route or even several routes. Why? Think about Delta's objectives, assumptions, strategy, and resources/capabilities. These include international scale, cost savings based on this scale, an end-to-end extensive travel network, and substantial global assets. Because Delta is adding value by being in as many places as possible and is building an extensive network, the company is unlikely to view the entry of a competitor without these objectives and resources as a threat to its broader strategy. In formulating its competitive strategy, Southwest can feel confident that entering into mar­kets already occupied by Delta will be accommodated; at least while Southwest's international travel network remains small. If it begins to grow large, Southwest could wind up moving into Delta's strategic group, which could then invite intensive competition.

Using Game Theory to Evaluate Specific Moves

A competitive response profile provides an extensive look at a particular rival and also lends insight into how this rival might respond to specific strategic actions. When rivals are locked in intensive back-and-forth competition, such as that experienced in the airline industry, a struc­tured approach to analysis can lend even more insight. The tools of game theory provide such a structured approach. The word game in game theory refers to strategic interaction among competitors and the word theory refers to a set of predictions about how competitors play games.

In most games, rivals are expected to make moves that deliver the greatest profit, ca lled a pay-off. Firms typically make their choices with this objective in mind. But rivals have choices, too. With both firms facing choices, each must consider what the other will do in order to reach their own best outcome. This logic of anticipating what is in a rival 's best profit interest before making your own move is central in game theory. Had Delta considered this in the opening case, the company might have anticipated how quickly rivals would respond to its price cut.

Game theory is especially useful in contexts in which only a few rivals exist (such as air­lines) and these rivals are considering such moves as price changes, capacity adjustments, or new product features, and are wondering how competitors are likely to respond. Let's examine the logic of game theory to see how it can be used to anticipate and respond to rival actions.

Simultaneous Move Games To illust rate the basic logic, let's consider a simple game

with two players each of whom has two choices. Assume t he players make thei r moves simulta­neously and they play the game only once. This set up Is called a simultaneous move, one-shot game. The most famous gam of this type is the prisoner's dilemma. The prisoner's dilemma

is as follows: 10 Two individuals, prisoner 1 and prisoner 2, rob a bank of $2 million and hide t he loot. They have been captured and are being held by police in separate cells. The police believe

that the two robbed the bank but lack sufficient evidence to convict. So they decide to sepa­

rately offer to each prisoner the following deal: " If you implicate your partner, we will give you

leniency. But if your partner implicates you , you will get jail time." The prisoners know that if

neither implicates the other, they will both go free. Now consider the following 2 x 2 matrix representation of the game shown in Figure 11.5. It

shows that each prisoner has two choices. Prisoner l's choices are on the rows and prisoner 2's

choices are on the columns. The numbers in the cells are payoffs. The payoff on the left in each

cell belongs to prisoner 1 while the payoff on the right belongs to prisoner 2.

To interpret payoffs, assume that one year of jail time is the equivalent of $1 million of the

loot. If neither prisoner implicates the other, they go free and share the loot. If both implicate,

they go to ja il for one year each. If one implicates the other while not being implicated, he gets

off and takes all the loot for himself, while the other goes to jail for two years. Assuming that the

prisoners play the game only once, they either get off free and go thei r separate ways, or do so

after they get out of jail. If they both go to jail , assume the loot is recovered by the authorities. Since the prisoners are being held in separate interrogation rooms, they must make their

choices ("implicate" or "do not implicate") without knowing the choice of their partner. This is the simultaneous move aspect of the game. Assume both players know the structure of the game and the payoffs accruing to their respective actions.

What is the predicted outcome for this game? John Nash, a famous game theorist, devel­oped an equilibrium concept in games that has come to be known as the Nash equilibrium. The

Nash equilibrium is represented by a set of moves in a game that: (1) maximizes each firm 's payoff given the choices of rivals and (2) removes the incentive to defect in the sense that no

player can improve his payoffs by changing his choice. The fi rst component of the definition reflects that players are striving to achieve their best possible outcome while the second ensures that the outcome is stable (i.e., the players have no incentive to change their action). The Nash

equilibrium is the solution concept used to predict the outcome of competitive interaction.11

To find the Nash equilibrium, think through what a player should do under each possible move of its rival. Let's look at the game from prisoner l's perspective. Suppose prisoner 1 thinks that prisoner 2 might implicate (look at the implicate column for prisoner 2). Prisoner 1 has two

choices. He can implicate and receive - I, or not implicate and receive-2. Which does he prefer?

He prefers to implicate since we assume that players always prefer the better payoff. Now let's consider what prisoner 1 wou ld do if he believes prisoner 2 will not implicate.

Under this scenario, prisoner 1 receives a payoff of 2 if he implicates and a payoff of 1 if he does

not implicate. Clearly, he prefers to receive 2 over 1, so he wou ld implicate.

... ... GI C: 0 VI ·c: Q.

Implicate

Do not

Implicate

Htd'MIIIJ Prisoner's Dilemma

Prisoner 2

Do not Implicate implicate

- 1,-1 2,-2

-2,2 1, 1

Evaluat ing the Competition 201

Nash equilibrium A set of moves in a game that simultaneously maximize each fi rm's payoff, given the choices of rivals, and from which no player has an incentive to defect.

202 CHAPTER 11 Competitive Strategy

dominant strategy In game theory, a set of actions that is always played no matter what a rival chooses to do.

Notice that no matter what player 2 chooses to do, player 1 maximizes his payoff by choosing "implicate." Doing the analysis from prisoner 2's perspective gives the same answer. The intersection (cell) of any choices that are simultaneously preferred by the players of a game is considered a Nash equilibrium, as long as there is no incentive to defect. In this game, each player's best choice is to implicate, and neither has an incentive to change this choice.

Implicate is also what is called a dominant strategy because it is the best choice under every alternative choice of the rival. Searching for a dominant strategy makes finding a Nash equilibrium easier in games where such strategies exist. In the prisoner's dilemma, after discov­ering that "implicate" is a dominant strategy, the analyst can cross off both the row and column associated with "do not implicate.'' This choice would never be employed because it is always dominated by the implicate choice.

Notice how the style of analysis that we used to solve the game resulted in the development of a strategy for play. In game theory, a strategy is a set of best responses to every possible rival action. We systematically analyzed prisoner l's prospects under each possible alternative action of prisoner 2 and selected the best outcome. In the real world as well, this is a useful approach for developing a competitive strategy. If the number of possible moves of a rival is small, a potential response to each one of those possible rival actions can be planned. Having done so, a company would have identified a competitive strategy.

The key lesson from the prisoner's dilemma is that each player implicates and goes to jail when a much better outcome exists. If they both play "do not implicate," they share 1, or $1 million each. However, the competitive risk, the lack of trust, the worry that a rival will take advantage of the situation if he thinks the other will play "Do Not Implicate," keeps both players going to jail. The reason this is important in real markets is that it suggests a truth about com­petitive behavior. Namely, competitors will play with their own best interests at heart. Fur­thermore, since in most markets cooperation between competitors is anticompetitive and illegal, coordination typically does not exist-and neither does trust. Therefore, the prisoner's dilemma offers a compelling prediction about what happens in real markets when companies have opposing interests.

Now consider a prisoner's dilemma game in the business world. Let's return to the opening case and assume that Delta Airlines is playing a one-shot pricing game against American Air­lines (we'll make the one-shot assumption for now and relax it in a moment). Let's assume that in this game each firm has two choices. It can either maintain price or lower price. If both main­tain price, each earns a profit of 5, or $5 million. If both lower price, each earns a profit of 2, or $2 million. But if one company lowers price while the other maintains price, the first company receives a profit of 10, or $10 million while its rival loses 1, or $1 million. See Figure 11.6.

To solve this game, take the perspective of one firm and decide which move would be best under each alternative action of the other firm. If Delta believes that American will maintain price, it has a choice between payoffs of 5 and 10 for maintaining and lowering price, respec­tively. Clearly, Delta prefers to lower price. If Delta believes that American will lower price, then it has a choice between a payoff of -1 and 2. It prefers to lower price to receive the payoff of 2. The logic is similar from American's perspective.

American Maintain Lower

Maintain 5,5 -1 , 10

Lower 10, - 1 2,2

Otdli;jjiij Delta and American Play Out the Prisoner's Dilemma

As in the traditional prisoner's dilemma, both firms wind up with payo~s t~at a~e worse than they might have received. Specifically, if both companies would maintam price, they would each wind up with $5 million. However, in the one-shot game, the pull to try f~r _$10 mil lion is very strong. This leads both companies to a relative_ly po~r outcome of $2 _million. This game illustrates how the prisoner's dilemma can affect firms in_ real markets. R1vatrous

behavior can make both firms worse off than they might have been 1f they had been ~bl~ to cooperate. The example also illustrates how a simple game structure can be used for insight

into how players might respond to one another's strategic moves.

Infinitely Repeated Games Now let's relax the assumption that competitors interact

just once as in the one-shot game. In the real world, most companies are in competition with

rivals each and every day, month, or year with no certain end date. Game theorists call these games infinitely repeated games. Even though the games are not literally played forever,

they are treated this way since the competitors repeatedly interact and the ending period is

not known. In infinitely repeated games, players always believe there is a future. This alters the way

they play. Specifically, they look for opportunities to get a larger amount of profit over a longer period of time. In stable markets in which the players rarely change, firms play the game indef­

initely. They know that they will be facing their rivals each and every period. Delta and American play an ongoing pricing game in which they must decide whether to

maintain, lower, or increase price each and every period. (In fact, pricing games are played on

each and every route, often with multiple players). The companies do not know if or when the games will cease to be played so treating their rivalry as an " infinite horizon" game is sensible.

To see how this affects the outcome of the game between Delta and American, consider again Figure 11.6. We already know what happens in a one-shot game- both players choose to lower prices, which makes them both worse off. However, both players know that they are not playing a one-shot game. They can lower prices this period, but they have many future periods

to go. In this situation, we assume that the firms look at the payoffs and realize that they will be better off over the long run if they maintain prices. Firms reason that this type of collusion is in their mutual best interest, and they assume that their rival is thinking the same way. Therefore, each decides to maintain price and expects rivals to do the same.

In effect, companies in this situation enter into a style of play called "tit-for-tat." In a tit-for-tat strategy, companies watch each other closely and choose actions that mimic what

their rivals are doing. As long as a rival is "coop,erating," the firm chooses to cooperate. If a rival defects from a cooperative stance, the firm responds in kind. In the game between Delta and American, each firm chooses to maintain price unless it observes its rival choosing to lower

price. If at any time the rival lowers price, the firm will "punish" by lowering its own price. After a few periods of this kind of "punishment," it's possible that the rivals could return to collusion

' but doing so could grow increasingly difficult in the presence of repeated defections (see Ethics in Strategy: Is Collusion Ethical?).

One question that arises in these types of repeated games is whether playing the one-shot Nash equilibrium is ever in a firm's best interest. The answer depends on the differences in cash flows between collusion and defection (defection here means playing the one-shot action). The value of these cash flows, in turn, depends on the time value of money since payoffs are received each period in perpetuity. (See the Strategy Toot: When does defecting from collusion make sense?) Typically, however, ongoing collusion is the best approach and it is what most firms ln long-standing stable competition practice. As explained in the chapter opening case, when Delta c~ose to ~ower prices, its rivals immediately followed suit. The logic of game theory tha we have Just reviewed shows why. In fact, rivals did not even wait for Delta to obtain a tem­porary _advanta~e; they lowered prices immediately. They reacted quickly with their tit-for-tat strategies, refusin~ to allow Delta to use price as a competitive advantage .

. Ga~e theory 1s a useful tool for analyzing and predicting rival actions in any context in ~hich discreet actio~s are clear and payoffs can be specified. Constructing a game scenario is u~eful e~en when it represents a simplification of a real-world setting. The reason is that solving a simple game ~an provide insight into how competitors are likely to play more com­plex games, as we saw in the games illustrated by Figure 11.6. To construct payoffs for game

Evaluating the Comp i io 20

tit-for-tat strategy A strategy that responds in kind to the moves of rivals.

204 c HA p TE R 11 Competitive Strategy

Ethics and Strategy

Is Collusion Ethical?

companies that consistently do battle with the same set of com­petitors eventually develop norms of competition that help them avoid low profits. Although the companies are not communicat­

ing directly to develop these norms (which would be illegal), they watch each other so closely that consistent patterns of behavior­

norms- can quickly emerge. The norms can influence pricing, prod­uct or service features, or certain kinds of restrictions on customers that all companies impose.

On the one hand, by keeping profits high, these companies are able to invest in research and development and continue to

come out with great products. Such products can even improve the quality of life. In the pharmaceutical industry, for example, com­

panies would not be willing to invest billions of dollars in research and development without a reasonable assurance of recouping this

cost through high prices. On the other hand, high prices of drugs or other products limit

access. Through collusion, many products are priced out of reach

of less-affluent consumers. As large companies use their power to raise prices, higher proportions of economic resources are directed toward their products and away from other products or causes in

the economy. Some would say that this misallocates resources in ways that make consumers worse off and unfairly channels profits

to shareholders.

For example, many people own a cell phone and have signed a

two-year contract for service with a telecommunications company. All of the major cellular providers in the United States, AT&T, Veri­z.on, and Sprint, offer this two-year contract. How did this situation arise? Simply put, the major telecommunications providers tacitly colluded to set the contract requirement at two years. Whether it's airline pricing, in which airlines collude to keep prices high and avoid price wars for themselves, airline service features such as charging for bags on flights; the price of gasoline at the pump; or the cost of an automobile or medication, large and powerful companies- airlines, oil companies, auto companies, pharmaceu­tical companies, and so on-often collude to keep profits high.

What do you think? Should the legal form of collusion prac­ticed in markets by large firms be allowed? Should restrictrons be imposed? If so, how would such collusion be monitored and con­trolled? Are you wilting to accept collusion in exchange for better­quality products in some cases? Does your view change if you are a shareholder of a company that practices collusion?

scenarios, conduct detailed financial modeling or simply rank the value of conditional actions

for each competitor, with more valuable actions ranked higher. Even if conditional payoffs had

been only ranked in Figure 11.6, the insights would have been the same. By setting up simple

game scenarios, analysts can quickly predict the outcome of competitive interaction, and spe­

cifically, how a firm 's rivals may react to specific moves. This can contribute to successful eval­

uations of the competition.

Principles of Competitive Strategy

Now that we know how to evaluate the competition and to analyze the dynamics between

competitors, let's turn to identifying com petitive moves that are most likely to be effective.

Four general principles of competitive strategy should be followed as a company looks for suc­

cessful competit ive moves. 12 These principles~ when applied, strengthen a company's ability to compete:

1. Know your strengths and weaknesses

2. Bring strength against weakness

3. Protect and neutralize vulnerabiliti es

4. Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

Know Your Strengths and Weaknesses

The first principle is to know your strengths and weaknesses. A company's strengths are the

resources and capabilities that deliver unique value (see Chapter 3 for a detailed discussion

about resources and capabilities). A company must work to develop these strengths through focus, investment, and effort. A key strength of Apple is product design. But it is the relent­less focus on developing and investing in that strength that turns it into a strong and enduring source of competitive advantage.

A company's weaknesses are the resources and capabilities that are subject to rapid obso­lescence, easy imitation, or high cost not recouped by value. Apple has strengths in product design, but its products are subject to rapid obsolescence because of the rapid pace of techno­logical change. Similarly, Starbuck's atmosphere is easily imitated so the company cannot rely

on this as a source of competitive advantage. A company must make a careful and accurate assessment of its strengths and weaknesses

because these form the foundation of competitive strategy as the next two principles illustrate.

Bring Strength against Weakness

Second, bring strength against weakness. After a company's key strengths are identified, they should be targeted to competitor weaknesses. Bringing strength against weakness can have devastating effects on the competition. When Google launched Android in 2007 as a mobile

operating system for smartphones, Microsoft was already limping along in mobile phones, having suffered rapid market share declines because of products from Apple and Research in

Motion (RIM). Google leveraged its formidable strength in software engineering innovation and then built a coalition of manufacturers who would adopt Android (the open handset alliance) to deliver a strong body blow to Microsoft, whose rapidly decaying resource investments and

declining market share made the company vulnerable in this area. Sometimes competitor weaknesses may be masquerading as strengths, so any apparen t

competitor strength that can be undermined or eroded through direct competitive action can be considered a weakness. Therefore, in their hunt for competitor weaknesses, companies should not be afraid of attacking competitive strengths. As Kmart struggled to stay afloat amidst bankruptcy, Walmart attacked what was considered one of Kmart's few areas of success

by introducing a knockoff of Kmart's Martha Stewart product line.13 This strong blow contrib­uted to Kmart's downfall.

Protect and Neutralize Vulnerabilities

Third, protect and neutralize vulnerabilities. A company's own weaknesses, once identified, must either be strengthened or truly neutralized; that is, made irrelevant so that they don't

become targets of competitors. Starbucks neutralizes the effect of an easily imitable atmos­phere by also introducing a large variety of great tasting coffee blends, food items, store con­

venience, and brand positioning. In the last story, Microsoft might have assessed its weakness in mobile earlier than Google

did and made moves to strengthen this vulnerability by investing much earlier in a new mo­

bile operating system. As another example, some regard Apple's closed, proprietary mobile operating system, iOS, as a competitive vulnerability since other companies are not allowed

to deploy it on their devices. This could limit its market potential. In fact, Google attacked this

weakness by making Android an open platform. However, Apple has been highly effective at neutralizing this weakness through strong design of its products and development of an exten­sive developer network in which developers of applications share in the value of the proprie­tary system.

Develop Strategies That Cannot Be Easily Copied

Lastly, develop strategies that cannot be easily imitated or copied. This seems obvious, but

often companies are so busy copying competitor's moves that they fail to see how they could do something altogether different. The principle might be best captured in the idea of going to where the competitor is not. Sun Tzu, the great Chinese strategist, once said, "To be certain to take what you attack is to attack a place the enemy does not protect."" Whether a company is pursuing special market niches, reconfiguring the sequence of its activities along the value chain, or recombining and leveraging resources of themselves and partners in ways that deliver value, competitive strategy flourishes when companies are doing something unique."

206 CHAPTER 11 CompetitiveStrategy

market structure The way rivals in a market interact and bargain for advantage. In its simplest terms, it's the number of rivals in a particular market.

barrier to entry Any factor that increases the costs, lowers the profit margins, or limits the market share of entrants to a market.

In fact, most long-time competitors have found a way to occupy distinctive positions in their markets so that they can coexist with other companies profitably. Returning to the air­line industry even though American, Delta, and United compete in the same strategic group in the United States, each has carved out distinctive hubs within their nationwide hub and spoke system so that they don t completely overlap as they compete. Delta has hubs in Salt Lake City and Atlanta. United has hubs in Chicago and Denver. American has hubs in Dallas and Chicago.

So although there is some overlap between the cities to which they fly, each of the major com­petitors has staked out a somewhat distinctive position relative to rivals.

In summary, these four competitive principles may be used to develop strong and unique

competitive positions that improve the likelihood of long-term competitive success.

Competitive Actions for Different Market

Environments

Clearly, not just any competitive move wi ll work against a target competitor. A firm's circum­stances define which competit ive act ions are available and likely to be effective. Market context strongly influences the scope of competitive action. One particular aspect of market context, market st ructure, is highly influential. Think of market structure in its simplest terms as the number of riva ls in a particular market. Market st ructures typically fall into one of three catego­ries: monopoly, oligopoly, or perfect competit ion (sometimes referred to as just "competi­tion").16 Each of these market structures creates certain competitive conditions that lead to particular sets of strategy choices when facing competitors.

Competition under Monopoly

A monopoly is a market of one firm or one highly dominant firm, such as Sirius XM in satellite rad io or Microsoft in word-processing software for personal computers.17 The basic strategic objective of a monopolist is to reinforce its monopoly. It does so in several ways, such as by: (1) raising entry barriers, (2) limiting com pet itive access to scarce resources, (3) innovating and patenting, and (4) introducing new products frequently. If a monopolist has new competitors

threatening to enter its market, these are among the competitive actions they should consider taking as a response. On the flipside, the competitor attempting to enter the monopolist's mar­ket can expect these ki nds of retaliatory actions from the monopolist.

Raise Entry Barriers A barrier to entry is any factor that increases the costs, lowers the

profit margins, or limits t he market share of entrants to a market. For example, a monopolist may choose to practice limit pricing, which means to set the market price of a product just low enough so that a new entrant cannot pay the cost of entry to come into a market and be profit­able. Investing in heavy advertising or advertising over long periods of time also raises entry barriers. Coca-Cola's brand equity, worth billions, was built through long-term consistent advertising, and it is a formida ble barrier to entry for any firm looking to get into the cola market.

Limit Competitive Access to Scarce Resources If a monopolist can place a lock on the resources that it uses to produce its product, it can effectively bar competition. The monopolist might hire the most valuable scientists or other expert s; it might secure the most advantageous geographic or rea l est te positions; or it might procure all of the capacity avail­able in a market for some particular input. For example, when JetBlue launched its regional jet strategy, the company entered into contracts with Embraer, the Brazilian manufacturer of regional jets, to purchase all of Embraer's planes for t hree years. This effectively blocked any other competitors from procuring the same regional jets and implementing the same strategy.18

Competitive Actions for Different Market Environments 207

Innovate and Patent To maintain its competitive position, a monopolist is often required to innovate and patent.19 Indeed, in many monopolies both the monopolist and would-be entrants are in an innovation race. Potential competitors can bring down a monop­olist by making the monopolist's product obsolete through innovation, while monopolists can stay ahead of potential market entrants by innovating themselves. As already mentioned, Microsoft lost its hold on the mobile operating system market in 2008 after failing to innovate sufficiently.

Introduce New Products Frequently By introducing new products frequ ently, monopolists can maintain the customer demand associated with their products and stay ahead of potential entrants who are trying to get into their markets. Apple Inc. dominated the market for handheld music players (the iPod} in the early days. Other firms attempted to get into this market, and certainty other devices appeared, but these devices obtained only a small

fraction of the total share of market. Apple kept would-be entrants off balance by consistently and frequently releasing new product upgrades and enhancements. As already noted, this was also a way for Apple to overcome a potential weakness of rapid obsolescence.

Competition under Oligopoly

Oligopolies are markets of a few firms, typically two to five, though in some cases the number could be as high as 10. The upper bound is difficult to define because the oligopoly designa­tion depends on whether firms in these markets are monitoring and reacting to specific rival behavior. If there are few enough firms for each to monitor the others effectively, then they are probably operating in an oligopoly.

Because the firms in oligopolies are locked in tight competition with only a few other firms, they must make their moves carefully, knowing that rivals will detect their actions and respond accordingly. We saw this as we analyzed infinitely repeated games and looked at an illustration of the competition between Delta Airlines and American Airl ines. From a competitive perspec­tive, oligopolists monitor and mimic rival behavior, particularly in price and product features, and they employ tit-for-tat strategies.

Monitor and Mimic Rival Behavior Oligopolists try to avoid the negative effects of competition by monitoring and matching rival behavior. In this process, norms emerge in competition around particular approaches to the market. For example, pricing norms are very common. Companies know that they could dramatically cut their price and possib ly pick up market share in the short run, but they realize that this move would be quickly detected and

matched, leading to lower profits for all firms in the market. We analyzed this scenario using game theory. In the opening case, Delta airlines violated

the pricing norm of its strategic group by matching prices with the low-fare carriers. This led to immediate retaliation by rivals so that almost no advantage was obtained and the whole industry suffered. This is a clear example of how trying to beat the norm rarely pays. Thus, for the good of long-term profits, firms usually simply respond to one another's pricing and prod­uct features at levels that are profitable for all (also see infinitely repeated games}.

Although the firms in oligopoly almost always respond to one another's pricing moves, they don't always match price, since some companies position their products at a premium. Coke and Pepsi are oligopolistic rivals, but Coke has staked out a price position that is slight ly higher than Pepsi. Even so, if Pepsi raises its price, Coke will too in order to maintain the differential.

Price is not the only area of mimicking and matching among oligopolists. The behavior can also be seen in product or service-feature competition. When one airline announces a new frequent-flier program or significant new upgrades to its existing plan, so do the others. When one hardware manufacturer, such as Apple, introduces a new touch-screen device, rivals quickly follow suit. When Chevron adds a new detergent additive to its gasoline, Texaco does the same (the two companies have now merged}. By matching product and service features, oligopolists ensure that they do not fall behind. In this way, oligopolists protect their profits and command higher margins from the market overall.

208 c HAP TE R 11 competitive Strategy

Finally, oligopolists may tacitly respond to one another in ways that carve up the market so that all can profitably coe 1st. The airlines do this with major hubs in different cities as descnbed above. But the behavior can also be seen in the ways that oligopolists sometimes choose to appeal to particular market segments, with one providing price leadership in one egment and another providing it in a different segment (see Strategy in Practice: Tacit Collu­

sion Between AT&T and Verizon).

Em ploy Tit-for-Tat Strategies As previously discussed, tit-for-tat strategies are those that respond in kind to the moves of rivals, including the meting out of punishments for behavior that violates norms (e.g. price wars, lawsuits, etc.). Because of the threat of this type of pun­ishment, defections from tacit collusion are reasonably rare among oligopolists. When defec­tions do occur, they are often accompanied by a signal that communicates the parameters of the action, such as length of time, in a way that rivals can clearly read. For example, airlines may run sales discounts on certain city-to-city routes, but these discounts are almost always accompa­nied by specific dates for which discounted fares are available. This provides an explicit signal to rivals so that they can interpret the parameters of the discount and avoid a price war.

"Perfect" Competition

"Competitive" markets are markets with many firms. In competitive markets, firms are price takers rather than price setters because attempts to use price strategically, as is done in monopolies or oligopolies, are not effective and wind up hurting the firm that tries. The logic goes like this: Because a firm sells a homogeneous good in a market of many firms, raising price leads to a dramatic drop in sales as customers go elsewhere. On the other hand, lowering price can backfire because firms are assumed to operate at full capacity. If firms are at full capacity, dropping price reduces total margin by more than it increases sales, leaving the firm worse off. If firms are not yet at full capacity, then price will typically fall until they are, and further attempts by individual firms to cut price will have negative effects. This is why firms in per­fectly competitive markets set prices at the market prevailing price and largely avoid strategic manipulation of price.

Since a typical assumption of competitive markets is that products are largely homo­geneous, very little differentiation is assumed to exist in these markets. This leads to a very specific set of competitive strategies that are likely to be successful. The list includes: (1) con­solidate markets, (2) pursue low cost, or (3) pursue differentiation strategies.

Merge or Consolidate Markets Firms in competitive markets often suffer from the superior bargaining power of buyers or suppliers (forces that are part of Michael Porter's five forces model discussed in Chapter 2). Because many firms in the market are selling a homoge­neous product, bargaining power is difficult to obtain. This feature of the market also creates intense rivalry among firms.

One strategic remedy to this problem is for firms In the market to merge. As they merge, the

overall market consolidates, reducing the number of firms and strengthening the bargaining power between the firms' upstream suppliers nd down st re m customers. This merger and con­solidation process is the way that industries evolve toward oligopoly.u Merging before a com­

petitor does might be a way to obt in advantages in cost (owing to scale) or bargaining power. A competitive market of "mom-and-pop" video rental stores gave way to a consolidated

oligopoly of Blockbuster and Hollywood Video stores in the 1990s and 2000s. Hollywood video, in particular, began as a local video rental family business and, through the vision of its CEO, Mark Wattles, ev ntually expanded to 2000 stores nationwide. In the face of this consolidation, most of th mom-and-pop video rent I stores disappeared.

In this exampl , the consolidators built n w stores and the old stores disappeared, but with enough foresight, the old mom-and-pop stores might have merged in local markets and retained their hold on the business. This is a particularly good illustration of how firms in a competitive market can fail to anticipate the kinds of moves that could save them from obsolescence.

Competitive Actions for Different Market Environments 209

Strategy in Practice

Tacit Collusion Between AT&T and Verizon

From 2007 to 2011, AT&T enjoyed a monopoly on the iPhone since

it was the only cellular carrier that Apple, Inc. allowed to provide

services for the phone. But in January 2011, Verizon was also finally

permitted to carry the iPhone, setting up an oligopoly between

AT T and Verizon (Sprint was added in October of that year). Fol­

lowing a short period of offerihg unlimited data plans, both AT&T

and Verizon eliminated their unlimited data plans for new users.10

In addition to matching one another's moves in th is way, the

companies' pricing behavior took on a collusive flavor. AT&T priced

slightly lower than Verizon for data plans up to 4 GB and Verizon

priced slightly lower than AT&T for data plans above 4 GB. In addi­

tion, the slope of the pricing curve (the rate at which price rises as

additional data is added to a plan) was almost exactly the same for

the two companies at key GB levels (see Figure 11.7). In other words,

as AT&T's price rose, so did Verizon's as the companies sought to

maintain a consistent pricing differential. Notice in Figure 11 7

how the companies were not necessarily matching prices, but their

pricing structures were very similar. An understanding seemed to

exist between the two, in which AT&T, who historically served more

business customers, would charge higher rates for customers using

more data, while Verizon would charge higher rates for custom­

ers using less data. The matching behavior of the cellular carriers

in pricing and plan structure, and the different targeting of mar­

ket segments, demonstrate how oligopotists coll ude to maintain

profitability.

$120 l

i Verizon Cheaper $105

$100 AT&T Cheaper

1ii $80 0

(.)

"t:J $60 -~ a. E $40 $30 $30 $30

$20 --AT&T -- Verizon

$15 $25 $25

$0 0.2 1.0 2.0 3.0 4.0 5.0 6.0 10.0

Monthly Data (GB)

Otdlj;jjfff• Smartphone Monthly Wireless Data Cost Comparison- AT&T Cheaper

at the Low End, Verizon Cheaper at the Higher End

Source: Barclays Capital, company reports and websites

Pursue a Low-Cost Strategy Since companies in competitive markets are price

takers, they have little control over price. Therefore, in order to realize profit, they must drive down their costs. In fact, it might be said that companies in such markets wil l live or die on their

ability to get costs down. Especially in markets for which differentiation is difficult, rivals can expect other firms to aggressively lower costs. They must respond in kind in order to remain

competitive. Chapter 4 details strategies for reducing costs, and any of those strategies can help the firm in a competitive market be successful.

Pursue a Differentiation Strategy When possible, companies in competitive mar­

kets should pursue a differentiation strategy. To separate themselves from the pack, they can add product features, store locations, bundled services, or other variations to create unique value for customers. However, in markets with many firms selling homogeneous products, this is often easier said than done. Consider book selling on the Internet. For any given title, a book may be obtained from multiple different sources, including Amazon, Barnesandnoble.com, Walmart, Target, or a host of smaller sellers or even used booksellers such as eBay. The firms sell the same book. How can they differentiate? The product is the same no matter where it is bought. In this case, firms are left to differentiate on other aspects of the buying experience, such as the look and feel of the website, its ease-of-use, or the checkout process. Early in its his­tory, after realizing it could not make money on discounted bookselling, Amazon expanded its business into many other product lines. The fact that a customer can go to Amazon and buy not

10 CH PT 11

Summary

Sr egy

only a book but also many o her items now helps Amazo differen i for books alone. Chapter 5 details differentiation strategies, and th for firms in compe itive markets.

Dynamic Environments

The strategies discussed so far apply o stable mar et structures. However. some competitive

environments are very dynamic, with competition constantly changing. Perhaps technology ,

changing at a very rapid pace; or new en rants with new technologies products, or approaches

are entering markets very quickly; or market consolidation is changing the landscape in une -pected ways. In such environments, industry incumbents may not be able to raise entry barri­

ers or limit access to scarce resources rapidly enough to stave off competition. What companies must do in these environments is recon ,gure their processes nd c pa­

bilities to emphasize both innovation and speed. Imagine a comp ny without these character

istics. Even if such a company were able to erect barriers to entry or ecur access to scarce inputs, these advantages are likely to be fleeting because new competitors will rapidly innovate

around them. Without capabilities of speed and innovation companies in dynamic environ ­ments are rapidly left b hind. The smart phone industry provides an e ample. In n import nt growth era, the innovations and speed of Samsung, Google and Apple quickly outpac d the market positions of companies such as RIM, Nokia and Microsoft. To stay in the gam , thes companies too must be innovative and quick to market with value creating products. This will depend on their capacity to build effective internal processes, a topic addressed in Ch pter 12.

• To effectivety compe e, a strategist should know the competition, including unde1Standing the competitive landscape and how to evaluate specific competitors and their potential moves.

neu ralizlng vulnerabilities, and developing inimitable strat gl s1

are useful for identifying successful competitive options.

• Competitive actions depend on the market environments In which firms compet , with some actions being more effective for certain environments than for others.

• The tools o gpme eory can lend insight into competitive interac­

tion by helping the strategist think systematically about how a com• pany's moves affect competitors, and vice versa .

• Principles of competitive strategy, such as knowing strengths and weaknesses, bringing strength against weakness, protecting and

Key Terms barrier to erttnJ 206 barrier to mobility 196 competitor r~onse profile 199

Review Questions

dominant strategy 202 game theory 200 market structure 206

1 . Name two framewon<s for understanding the competitive landscape.

2. What is as ra gk group analysis, and how is it useful?

3. What factor mlgh limit a company's ability to switch strategic tun11nc'?

Nash equilibrium 201 strategic group 195 tit-for-tat strategy 203

4 . What is a competitor response profile, and how is it useful in evalu ating competitors?

s. Define the Nash equilibrium used in game theory to predict the out come of competitive interaction.

6 . Identify the four general principles of competitive strategy.

7. What are the three types of market structures?

8. What are the strategies most likely to be useful for a monopolist?

9. What are the strategies most likely to be useful for an oligopolist?

10. Why do firms in an oligopolistic environment often hesitate to

make moves that wilt take them outside of the status quo?

Ap plication Exercises

Exercise 1: Choose an industry and construct a strategic group map.

Do this by identifying some of the major players, and some of the key

differences in how they compete. Select two factors for the two axes

and plot the firms. Do you observe a group structure? Explain.

Using the same industry as above, identify th ree companies that sell a

similar product. List some of the product attributes. Now evaluate each

company's product on those attributes (OK to do qualitatively) and

plot the data using a strategy canvas view. What insights do you gain?

Exercise 2: Identify a company whose products you use frequently.

Now identify one of its competitors. Imagine that you are the chief

strategist for the first company. Using the principles of competitive

strategy, list several strategic moves that you think could be effective

against the competitor that you identified.

Exercise 3: Choose a competitive situation and model it as a game.

Identify at least two players and two actions. Possible examples cou ld

Strategy Tool When Does Defecting From Collusion Make Sense? In long-standing, stable oligopolies, most firms repeatedly play the

collusive outcome. (Collusion here is legal since the companies are not

explicitly coordinating or price-fixing.) However, we can use the payoff

structure to calculate the point at which firms wou ld find defection to

be preferable to collusion. To do so, we simply compare the string of

payoffs under each alternative.

In the Delta and American game (Figure 11.6), maintaining price

delivers a stream of $5 million in perpetuity. The value of this stream

can be calcu lated ass+ 5 / i (5 received now and a stream of Ss received

in perpetuity). The value of defection can be calculated as $10 million

received now, plus a stream of $2 million each year in the future. This

is because if either firm knows that its rival will maintain price, it can initially grab a profit of $10 million by lowering price. But then the firm knows it will be punished by its rival, and both firms will lower price in

References 1E. Perez, " New Pressure to Simplify Airfare; Delta Details Plan to Cut Some Prices by Up to 50%; Boston to Key West for $389:' The Wall Street Journal (Jan. 5, 2005).

References 211

11. What strategies are most likely to be useful for firms in perfectly

competitive markets?

12. What types of strategies are most useful for firms operating in

dynamic markets?

include two banks that are considering whether to offer free checking;

Google and Apple in the decision about whether to launch a self­

driving car; or two stores in a mall deciding whether to ra ise prices on

men's clothing. Sketch a game matrix. Estimate or rank the conditional

payoffs (higher values more valuable) for each player for each choice.

Treat the moves in the game as simultaneous and find the Nash

equilibrium outcome if the game is played once (one-shot game). Now

consider how the game would change if it is played repeatedly forever

(infinite horizon game). What insights do you gain into the competitive

situation you chose?

Exercise 4: Identify a company whose products you use frequently.

Determine whether this company operates in a monopoly, oligopoly,

or competitive market. What does this imply about the competitive

strategies most likely to be successful? List some specific strategies the

company could use against competition.

future periods. The value of the collusion stream is 10 +2/ i. We want to

know what discount rate on capital i will make cooperation a superior

strategy. In other words, what value of i solves the following equation:

5 2 5+-~ 10 +-; ;

Applying add and subtract operations to both sides and rearrang-

ing yields,

I~s i

"< 3 , --, or 60% 5

Therefore, in this example, as long as Delta or American's cost of

capital or discount rate stays equal to or below 60 percent, the com­

pany shou ld continue to maintain prices.

1E. Perez, "Business Fares Fall by One-Third; Delta's Reductions Spread Beyond Its Flight Network Following Cuts by American," Wall Street

Journal (Jan. 26, 2005).

212 CHAPTER 11 CompetitiveStrategy

1Perez, "New Pressure to Simplify Airfare"

◄s. W. Ames Bernstein, "Delta's Prices Reach he Sky, Soaring Fuel Costs

Force a Stunning $100 Fare Hike; United, Continental and US Airways

Follow Suit," Newsday, (July 15, 2005).

5S. warren and . Perez, "Southwest's Net Rises by 41%; Delta Li fts

Cap on Some Fares," The Woll Street Journal, Eastern edition (J uly 15,

2005): A.3.

S. McCartney, "lhe Middle Seat: Airlines Are Increasing Minimum-Stay

Rules; Step Is Effort to Force Business Travelers to Pay More for a Trip,"

The Woll Street Journal (Aug 19, 2008).

7R. E. Caves and M. Porter, "From Entry Barriers to Mobility Barriers,"

Quarterly Journal of Economics 91(2) (1977}: 241- 262.

8C. Kim and R. Mauborgne. "Charting Your Company's Future," Harvard Business Review (2002).

9M. E. Porter, Competitive Strategy (New York: The Free Press, 1980).

1°The description of the prisoner's dilemma employed here is adapted

from D. Kreps, A Course in Microeconomic Theory (Princeton: Princeton

University Press, 1990).

usome games have more than one Nash equilibrium and some have

no Nash equilibria. In these cases, game theorists have developed

more complex rules and techniques to predict game outcomes.

Describing these rules and techniques is beyond the scope of the current overview.

12For a look at different approaches to competitive strategic moves, see G. Stalk and R. Lachenauer. "Hardball: Five Killer Strategies for Trounc­

ing the Competition," Harvard Business Review (2004).

131bid.

1•s. Tzu . The Art of Wor. In Classics of Strategy and Counsel: The Col­

lected Translations of Thomas Cleary (Shambhala, 2000).

150. J. Bryce and J. H. Dyer, " Strategies to Crack Well-Guarded Markets,"

Harvard Business Review (2007).

16Falling into a fourth category are markets of many firms in which firms are sharply differentiated, or heterogeneous. These are called monopo\istically competitive. Although this term sounds like an

oxymoron it refers to the idea hat if the firm is differentiated it has

a local monopoly on customers who uniquely prefer its differentiated

product. Also, since the firm operates in a market of many other firms

that are likewise differentiated, the market gets the "competitive" t itle.

Consider a local restaurant market. All restaurants serve food and meet

the dining needs of their customers but the differences among these

restaurants in food variety, flavor, price, quality, ambience, service, etc.

are stark. Competitive stra tegy in monopolistically competitive mar­

kets typically follows the strategies, noted below, of a monopolist.

11For many years, analysts considered Microsoft to be a monopolist in

operating systems. Microsoft was not the only firm in this market, but

it owned such a dominant market share, and other players owned so

little, that it was able to behave as if it was a monopolist. (This ulti­

mately invited federal antitrust lawsuits).

18Bryce and Oyer.

191nnovatlng and patenting is a way to maintain competitive position

for firms in so-called Ricardian monopolies. These monopolies are

based on knowledge and invention and the fact that these firms pos­

sess unique intellectual capital. Other monopolies are based instead

on unique resource positions in which the monopol ist owns the vast majority of inputs required to produce the product. Here, monopo­

lists may maintain their position by restricting output, which drives up

price and profits.

20L. Dignan, "AT&T vs. Verizon Wireless: How Tiered Plans Will Shake

Out," blog, for Between the Lines (July 18, 2011), http://www.zdnet .com/ blog/ btl/at-a nd-t-vs-verizon-wire less-how-tiered-plans-will­

shake-out/52556.

21A well-known example is the pharmaceutical industry, whose con­solidation of the past few decades has starkly reduced the number of firms competing. Consolidation has created huge pharmaceutical conglomerates such as GlaxoSmithKline or Bristol-Myers Squibb. These firm names bear the remnants of previous firms (e.g., Glaxo Wellcome, and SmithKline Beecham), whose firm names, in turn , often bear the remnants of still previous firms. See also S. Klepper, "Firm Survival and the Evolution of Oligopoly," RAND Journal of Eco­nomics 33(1) (2002): 37- 61.