Chapter 6

Crafting Business Strategy

for Dynamic Contexts
1
OBJECTIVES
Identify the challenges to sustainable competitive
advantage in dynamic contexts
1
Understand the fundamental dynamics of
competition
2
Evaluate the advantages and disadvantages of
choosing a first-mover strategy
3
Analyze and develop strategies for managing
industry evolution
4
Analyze and develop strategies for technological
discontinuities
5
Analyze and develop strategies for high-speed
environmental change
6
Explain the implications of a dynamic strategy for
the strategy diamond and strategy implementation
7
2
THE TALE OF NAPSTER
S
o
l
d


t
o

S
o
f
t
w
a
r
e

B
u
s
i
n
e
s
s

s
o
l
d

Business model options
Roxio
Software
and music
Software Music
Software
Sonic
solutions
Napster Music
Bank-
rupt
Subscription
Unlimited downloads
for $9.99/month
Streaming
Real-network's Rhap-
sody lets music lovers
listen as much as they
want for one monthly
fee
A la carte
Roxio and iTunes
sell single songs
3
THREE CAUSES OF DYNAMIC CONTEXTS
Examples
Competitive
Interaction
When incumbents and,
especially, new entrants use a
new business model they drive
dynamism in market
Mini-mills entered with a new
business model and incumbent
steel companies did not respond
As industries evolve and
competition shifts from
differentiation to price/low-cost,
advantages shift between rivals
Arm and Hammer almost lost its
lead position when baking soda
became commoditized
Industry
evolution
When technological change is
discontinuous, it does not
sustain existing leaders
advantages
The shift to digital photography
favors the strengths of Sony not
photography incumbent like
Kodak
Technological
change
4
PHASES OF COMPETITIVE INTERACTION
Phase 1
Discovery
and
competitive
new action
Phase 2
Customer
reaction
Phase 3
Competitor
reaction
Phase 4
Evaluation of
action and
reaction
effectiveness
Source: Adapted from K.G. Smith, W.J. Ferrier, and C.M. Grimm, King of the Hill: Dethroning the Industry Leader,
Academy of Management Executive 15:2 (2001), 59-70
5
THE SPECTRUM OF COMPETITIVE RESPONSES STRATEGIES
E
a
s
e

w
i
t
h

t
h
r
e
a
t

c
a
n


b
e

c
o
n
t
r
o
l
l
e
d


G
r
e
a
t

D
i
f
f
i
c
u
l
t

Scope of response
Limited Extensive
Any firm that invests in
resources and capabilities that
support retaliation to the
exclusion of innovation and
change may only be prolonging
its inevitable demise
6
CONTAINMENT
Containment
Neutralization
Shaping
Absorption
Annulment
Limit the extent to which the new entrants
innovation impacts your business
For example: American Airlines can partially
contain Southwest by using its bargaining
power to secure more exclusive airport gates
7
NEUTRALIZATION
Containment
Neutralization
Shaping
Absorption
Annulment
Try to short-circuit the moves of
innovators or new entrants before they
make them
For example: The Recording Industry
Association of America launched such a
fierce legal attack on Napster that it
forced even smaller Napster-like firms to
stay out of the fray
8
SHAPING
Containment
Neutralization
Shaping
Absorption
Annulment
Shape the innovation so it becomes
something the incumbent can live with or
even benefit from
For example: For years the American
Medical Association used regulators to
attack chiropractors; now they shape
chiropractic medicine to become a
complement to traditional medicine
9
ABSORPTION
Containment
Neutralization
Shaping
Absorption
Annulment
Minimize the risks entailed by being
either a first mover or an imitator
For example: In the late 1980s Microsoft
purchased Intuit, the maker of Quicken
and QuickBooks; because it identified
money-management software as a high-
growth opportunity.
10
ANNULMENT
Containment
Neutralization
Shaping
Absorption
Annulment
Improve incumbent products and
services to annul an innovation or new
entrants offering
For example: Kodak has improved the
quality of its film-based prints so that they
are superior to many digital-based
alternatives
11
PROS AND CONS OF FIRST MOVERS
Rapid technology advances allow a
fast-follower to leapfrog the first mover
It achieves absolute cost advantage
The first movers offering strikes a
chord but is flawed
Its reputation and image advantages
are hard to copy
The first mover lacks a key
complement (e.g., channel access) that
the follower possesses
Its customers are locked in (i.e.,
switching costs exist)
First-mover costs outweigh the
advantages of being the first-move
Scale of the first move makes imitation
unlikely
A first-follower is often better off than
a first mover when:
A first-mover is often better off than a
fast follower when:
12
A GALLERY OF FIRST-MOVERS AND FAST FOLLOWERS
Product Pioneer(s)
Imitators/fast
followers Comments
Automated
teller machines
(ATMs)
DeLaRue (1967)
Docutel (1969)
Diebold (1971)
IBM (1973)
NCR (1974)
The first movers were small entrepreneurial
upstarts that faced two types of competitors: (1)
larger firms with experience selling to banks and (2)
the computer giants. The first movers did not
survive
Ballpoint pens Reynolds (1945)
Eversharp (1946)
Parker (1954)
Bic (1960)
The pioneers disappeared when the fad first ended
in the late 1940s. Parker entered 8 years later. Bic
entered last and sold pens as cheap disposables
Commercial
jets
DeHaviland (1952) Boeing (1958)
Douglas (1958)
The pioneers rushed to market with a jet that crashed
frequently. Boeing and Douglas (later known as
McDonnell-Douglas) followed with safer, larger, and
more powerful jets unsullied by tragic crashes
Credit cards Diners club (1950) Visa/Master-
Card (1966)
American
Express (1968)
The first mover was undercapitalized in a business
in which money is the key resource. American
Express entered last with funds and name
recognition from its travelers check business
Diet soda Kirschs No-Cal
(1952)
Royal Crowns Diet
Rite Cola (1962)
Pepsis Patio Cola
(1963)
Cokes Tab (1964)
Diet Pepsi (1964)
Diet Coke (1982)
The first mover could not match the distribution
advantages of Coke and Pepsi. Nor did it have the
money or marketing expertise needed for massive
promotional campaigns
13
A GALLERY OF FIRST-MOVERS AND FAST FOLLOWERS (CONT.)
Product Pioneer(s)
Imitators/fast
followers Comments
Light beer Rheingolds and
Gablingers (1968)
Meister Brau Lite
(1967)
Miller Lite (1975)
Natural light
(1977)
Coors light
(1978)
Bud light (1982)
The first movers entered 9 years before Miller and
16 years before Budweiser, but financial problems
drove both out of business. Marketing and
distribution determined the outcome. Costly legal
battles, again requiring access to capital, were
commonplace
PC operating
systems
CP/M (1974) Microsoft DOS
(1981)
Microsoft
Windows (1985)
The first mover set the early industry standard but
did not upgrade for the IBM PC. Microsoft bought
an imitative upgrade and became the new
standard. Windows entered later and borrowed
heavily from predecessors (and competitor Apple),
then emerged as the leading interface
Video games Magnavoxs
Odyssey (1972)
Atans Pong (1972)
Nintendo (1985)
Sega (1989)
Microsoft (1998)
The market went from boom to bust to boom. The
bust occurred when home computers seemed likely
to make video games obsolete. Kids lost interest
when games lacked challenge. Price competition
ruled. Nintendo rekindled interest with better games
and restored market order with managed competition.
Microsoft entered with its Xbox when perceived
gaming to be a possible component of its wired world
Source: Adapted from S. Schnaars, Managing Imitation Strategies (New York Free Press, 1994), 37-43
14
Status of complementary assets
EVALUATING A FIRMS FIRST-MOVER DEPENDENCIES
ON INDUSTRY COMPLEMENTS
Freely available
or unimportant
Tightly held and
important
B
a
s
e
s

o
f

f
i
r
s
t

m
o
v
e
r

a
d
v
a
n
t
a
g
e
s

S
t
r
o
n
g

p
r
o
t
e
c
t
i
o
n

f
r
o
m

i
m
i
t
a
t
i
o
n

W
e
a
k

p
r
o
t
e
c
t
i
o
n

f
r
o
m

i
m
i
t
a
t
i
o
n

It is difficult for anyone to
make money: Industry
incumbent may simply
give new product or
service away as part of its
larger bundle of offerings
Value-creation
opportunities favor the
holder of complementary
assets, who will probably
pursue a fast-follower
strategy
First mover can do well
depending on the
execution of its strategy
Value will go either to first
mover or to party with the
most bargaining power
15
STRATEGIES FOR MANAGING COMMODITIZATION
Managing
commoditization
Anticipating
Responding
Value-in-use
approach
Process
innovation
approach
Market
focus
Service
innovation
Timken bundles commodity
product with key components
Dell sells directly to
consumers
K-mart and KB Toys both
reduced number of customers
when they restructured
Hotels may charge extra for
cable TV and computer hookups
Examples
16
EFFECT OF TECHNOLOGICAL DISRUPTION
Maturity
Maturity Growth
Disruption
Embryonic
Embryonic
Growth
Performance
Time
17
FOUR ACTIONS FRAMEWORK: KEY TO THE VALUE CURVE
Reduce
What factors should
be reduced well
below the industry
standard?
Raise
What factors should
be raised well above
the industry standard?
The key to discovering a
new value curve lies in
answering four basic
questions
Source: Adapted from W.C. Kim and R. Mauborgne, Blue Ocean Strategy, California Management Review 47:3 (2005), 105-121
Creating
new markets:
A new value
curve
Eliminate
What factors that the
industry has taken for
granted should be
eliminated?
Create/Add
What factors that the
industry has never
offered should be
created or added?
Cirque du Soleil example
18
HIGH AND LOW-END DISRUPTION
Strategy that may result in huge
new markets in which new
players redefine industry rules to
unseat the largest incumbents
Strategy that appears at the low
end of industry offerings,
targeting the least desirable of
incumbents customers
High-end
Low-end
19
VALUE CURVE for U.S. WINE INDUSTRY YELLOW TAIL
Expensive wines
Yellow tail
Cheap wines
Price
Use of technical
wine terminology
Above-the-line
marketing
Aging
quality
Vineyard
prestige
Wine
complexity
Wine
range
Easy
drinkability
Ease of
selection
Fun and
adventure
Low
High
20
CONVENTIONAL VS. NEW MARKET-CREATION STRATEGIC MINDSETS
Strategic group and
industry segments
Industry
Buyers
Business model
Time
Product and
service offerings
Emphasizes competitive position
within group and segments
Emphasizes rivalry
Emphasizes better buyer service
Emphasizes efficient operation
of the model
Emphasizes adaptation and capa-
bilities that support competitive
retaliation
Emphasizes product or service
value and offerings within industry
definition
Dimensions
of competition Head-to-Head competition New-market creation
Looks across groups and
segments
Emphasizes substitutes across
industries
Emphasizes redefinition of the
buyer and buyers preferences
Emphasizes rethinking of the
industry business model
Emphasizes strategic intent-
seeking to shape the external
environment over time
Emphasizes complementary
products and services within and
across industries and segments
21
SOME WELL-KNOWN DISRUPTIONS
Compaq grew from zero revenues to $ 1billion
in 5 years
Microsoft took 15 years to grow from boutique
software firm to Goliath
Atari grew from $50 million to $1.6billion over 5
years, doubling every year
22
CREATING OPTIONS FOR FUTURE COMPETITIVE ADVANTAGE AND
PROFITABILITY
Horizon 3
Seed options for future
growth business
Horizon 2
Drives growth in
emerging new business
Horizon 1
Defend and extend
current business
Profit
Time
Tactical
probing
23
IMPROVISATION AND SIMPLE RULES
Just as Jazz musicians can improvise
when they play together because they
follow a set of simple rules ...
... corporations can become more
flexible by allowing improvisation
under a set of simple rules
Simple rules
Customer is always right
Always run highest profitability
products
Never
24
TACTICAL PROBING OPERATIONAL TACTICS CAN BECOME STRATEGICALLY
IMPORTANT
Though some initia-
tives failed, several
enabled Charles
Schwab to further
differentiate itself
from its bare-bones
competition
M
e
r
r
i
l
l

l
y
n
c
h


d
i
s
c
o
u
n
t

i
n
i
t
i
a
t
i
v
e


E
*

T
r
a
d
e

Charles
Schwab
Tactical initiatives
Futures trading
Simplified mutual-fund offerings
Internet products services
Credit cards
Outline mortgage
25
STAGING AND PACING IN THE REAL WORLD
Source: S. Brown and K. Eisenhardt, Competing on the Edge: Strategy as Structure Chaos (Boston: Harvard Business School Press, 1998)
British Airways
Five years is the maximum that you can go without refreshing the brand ... We did it
(relaunched Club Europe Service) because we wanted to stay ahead so that we
could continue to win customers
Emerson Electric
In each of the last three years weve introduced more than 100 major new products,
which is about 70% above our pace of the early 1990s. We plan to maintain this rate
and, overall, have targeted increasing new products to (equal) 35% of total sales
Intel
The inventor of Moores Law stated that the power of the computer chip would
double every 18 months. IBM builds a new manufacturing facility every nine
months. We build factories two years in advance of needing them, before we have
the products to run in them, and before we know the industry is going to grow
Gillette
40% of Gillettes sales every five years must come from entirely new products (prior
to its acquisition by P&G). Gillette raises prices at a pace set to match price
increases in a basket of market goods (which includes items such as a newspaper,
a candy bar, and a can of soda). Gillette prices are never raised faster than the
price of the market basket.
3M
30% of sales must come from products that are fewer than 4 years old
26
REAL OPTIONS FIVE CATEGORIES
1. Waiting-to-invest options. The value of waiting to build a factory
until better market information comes along may exceed the value
of immediate expansion
2. Growth options. An entry investment may create opportunities to
pursue valuable follow-up projects
3. Flexibility options. Serving markets on two continents by building
two plants instead of one gives a firm the option of switching
production from one plant to the other as conditions dictate
4. Exit (or abandonment) options. The option to walk away from a
project in response to new information increases its value
5. Learning options. An initial investment may generate further
information about a market opportunity and may help to determine
whether the firm should add more capacity
27
THE VALUE OF REAL OPTIONS
Total busi-
ness value
DCF value Value of
real options
Source: L.E.K. Consulting LLC, Shareholder Value Added: Making Real Decisions with Real Options (Accessed September 12, 2005),
www.lek.com/ideas/publications/sva 16.pdf.
+ =
Current
business
value
Real-
options
value
Total
business
value
28
SUMMARY
Identify the challenges to sustainable competitive
advantage in dynamic contexts
1
Understand the fundamental dynamics of
competition
2
Evaluate the advantages and disadvantages of
choosing a first-mover strategy
3
Analyze and develop strategies for managing
industry evolution
4
Analyze and develop strategies for technological
discontinuities
5
Analyze and develop strategies for high-speed
environmental change
6
Explain the implications of a dynamic strategy for
the strategy diamond and strategy implementation
7
29
EXERCISES
1. If you were the CEO of Napster, what material from this chapter would be most relevant to you? How
might it help you formulate strategy? What might the key components of the strategy be? How should
Microsoft use this chapter to formulate a strategic response to Napster?
2. Consider first and second mover advantages. What specific resources and capabilities do you think
successful first and second movers must possess? Do you think a firm could be both a first mover and
fast follower if it wanted to be?
3. Choose an industry you believe is very dynamic and identify the drivers of that dynamism. Now pick a
firm in that industry and formulate a strategy and basic implementation scheme to exploit its dynamic
context