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General Motors and IBM have been battered to their cores. Jack Welch, the chairman of General Electric, called the frenzied competition of the 1980's "a white knuckle decade" and said the 1990s would be worse. In this pathbreaking book that will define this new age of "hypercompetition," Richard D'Aveni reveals how competitive moves and countermoves escalate with such ferocity today that the traditional sources of competitive advantage can no longer be sustained. To compete in this dynamic environment, D'Aveni argues that a company must fundamentally shift its strategic focus. He constructs a brilliant operational model that shows how firms move up "escalation ladders" as advantage is continually created, eroded, destroyed, and recreated through strategic maneuvering in four arenas of competition. Using this "Four Arena" analysis, D'Aveni explains how competitors engage in a struggle for control by seeking leadership in the arenas of "price and quality," "timing and know-how," "stronghold creation/invasion," and "deep pockets." Winners set the pace in each of these four competitive battlegrounds.
Using hundreds of detailed examples from hypercompetitive industries such as computers, software, automobiles, airlines, pharmaceuticals, toys and soft drinks, D'Avenie demonstrates how hypercompetitive firms succeed in dynamic markets by disrupting the status quo and creating a continuous series of temporary advantages. They seize the initiative, D'Aveni explains, by employing a set of strategies he calls the "New 7-S's" Superior Stakeholder Satisfaction, Strategic Soothsaying, Speed, Surprise, Shifting the Rules of Competition, Signaling Strategic Intent, and Simultaneous and Sequential Thrusts. Paradoxically, firms must destroy their competitive advantages to gain advantage, D'Aveni shows. Long-term success depends not on sustaining an advantage through a static, long-term strategy, but instead on formulating a dynamic strategy for the creating, destruction, and recreation of short-term advantages.
America must embrace the new reality of hypercompetition, D'Aveni concludes in a compelling analysis of the potential chilling effect of American antitrust laws on competitiveness. This masterful book, essentially an operating manual of strategy and tactics for a new era, will be required reading for managers, planners, consultants, academics, and students of hypercompetitive industries.
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Richard A. D'Aveni (Ph.D., Columbia University) teaches business strategy at the Amos Tuck School at Dartmouth College and consults for several Fortune 500 corporations. He received the A.T. Kearney Award for his research on why big companies fail, and has been profiled as one of the next generation's promising new management thinkers by Wirtschafts Woche, Germany's equivalent to Business Week.Excerpt. © Reprinted by permission. All rights reserved.:
HOW FIRMS OUTMANEUVER COMPETITORS WITH COST-QUALITY ADVANTAGES
TRADITIONAL VIEWS OF COST-QUALITY ADVANTAGES
Cost and quality are the staples of competitive positioning. As discussed, Porter identified three generic strategies based on cost and quality advantages: overall cost leadership, differentiation, and focus strategies. The cost-leadership strategy involves offering a mass-marketed, low-priced, low-quality product. The differentiation strategy involves offering a premium-priced, high-quality good, and the focus strategy targets a premium-priced product for a smaller niche audience with a special definition of what is high quality. While there has been much discussion of strategic positioning using cost and quality, this chapter offers an overview of the process of the evolution of this competition.
The traditional, static understanding of the relationship between cost and quality and competitive advantage is based on accounting approaches, such as those popularized by the DuPont model. According to this model, the company's return on equity (ROE) is a function of its margins, sales volume, and the financial policy of the firm. As shown in the equation below, ROE is related to (1) profits/sales (also called operating-margins or return on sales, often labeled ROS), (2) volume (high sales volume given the firm's asset investment), and (3) assets/equity (which is equal to 1 + debt/equity, a major part of the financial policy of the firm). Thus:
ROE = profits/equity = ROS x sales/assets x ( 1 + D/E)
or (margins) x (volume) x (financial policy)
Porter's low-cost strategy achieves profits through a high-volume, low-margin approach, while his other two strategies are low-volume, high-margin approaches to generating profitability. Under this view of competitive advantage, firms compete for the high-volume market primarily through cost improvement, and they compete for lower-volume markets primarily through quality improvements. For all three strategies profits are produced by improving margins and/or volume.
Useful Insights from the Cost. Quality View of Competitive Advantage
This view of competitive advantage has proven highly useful. Kenichi Ohmae provides an example of the kind of strategic analysis that can be done using this view. In his set of "profit diagrams" in The Art of Strategic Thinking, he demonstrates a systematic way to look for margin- and volume-improving strategies based on cost and quality. A machine-tool company had asked him how it could improve the profitability of the products in its line. Ohmae developed a diagram to address the question of how the profitability of a certain product can be increased. The diagram outlines a series of decisions managers must make in deciding how to increase profits. For example, the first choice in raising profits is to lower product costs, increase pricing, or increase volume. If managers decide to raise prices, they can do so by raising the market price or reducing margins for distributors. Sales volume can be increased by boosting market share, expanding the market segment, or moving into new segments. Each decision thus leads to a new set of choices, and ultimately to a set of actions to boost quality or decrease cost.
In addition, Ohmae recommends assessing whether each component of a product needs to be changed, analyzed, or left alone, depending upon whether it is more or less costly and of lower or higher quality than the component used by the firm's best and fiercest competitor. Product costs and quality can be improved by changing design, reducing fixed costs, or cutting variable costs, through value analysis (VA) and value engineering (VE). Value analysis and engineering are methods of reverse-engineering the product from the perspective of both the customer and manufacturing costs. Each component of a firm's product is identified and redesigned or eliminated to reduce cost (via value engineering) or increase quality (via value analysis) to the customer. Value engineering and analysis are used whenever the components of a firm's product are inferior or too costly compared to the components of the best products in the marketplace. In sum, according to this view, advantage is created by the components contained in the product and the price and attributes of the product as a whole. Advantage is said to exist when the product offers the correct combination of price and quality. Product positioning at a given point in time matters.
Critique of Traditional View
While this analysis captures the fundamental relationship between cost and quality, it is reactive rather than proactive. The model considers competitors only to the extent that they shape market conditions and the current benchmark levels of price and quality. This view does not look at potential competitive responses and future actions in the market. Ohmae himself cautions that competitor positions should be considered. "No product is sold in the desert or on the moon; manufacturers' prices and the various competitive segments they serve are determined in a competitive environment," he warns. "What if all manufacturers in the market are producing similar high-quality products and offering them to the market at a relatively low price (i.e., with narrow profit margins)? In this case, it would be disastrous for the company to modify Product A's design in order to reduce costs...because the seemingly lower quality product would be driven out of the market by the low-priced, high-quality products already competing for the customer's favor." But even here he is concerned primarily with current competitor positions rather than future actions. This analysis sees the market at one point in time rather than examining how it evolves over long periods of time. There is no dynamic aspect to the profit improvement and product component analyses suggested by Ohmae and discussed earlier.
While Porter examines some movement within industries, even he does not consider how cost-quality positioning evolves. He presents an extensive discussion of competitor analysis and tools for analyzing the future evolution of the industry, including product life cycles and changing buyer behaviors. But competition on cost and quality are viewed from the more static position of the generic strategies. As he notes, one of the primary risks of the generic strategies is for "the value of the strategic advantage provided by the strategy to erode with industry evolution."
The Dynamic View
It is our contention that the risk posed by evolution that Porter mentions has become so great that it can no longer be considered as an afterthought to strategic thinking. Competition is so intense and markets are so dynamic and volatile that this evolution has become the dominant force in strategic action. Companies can no longer count on succeeding by choosing a generic strategy. The most important aspect of competition is, not current position, but the changes created by the dynamic interaction between rival firms. Thus the position of the firm offers only a temporary advantage. It is the firm's ability to manage a series of interactions successfully that determines the success of the company.
Over long periods of time, companies are forced to shift their cost (and price) and quality positions. Industries readjust their minimum acceptable level of quality and maximum acceptable price required to be a player in the marketplace. There are revolutions in quality that raise standards and then new revolutions that shatter those standards. There are innovations in product or process technology that drive dramatic improvements in quality or reductions in cost. These cycles of change are growing progressively shorter. Advances in information, manufacturing, and basic technology have accelerated so quickly that many processes and products now have lives of three months or less before they become obsolete.
DYNAMIC STRATEGIC INTERACTIONS AND THE ESCALATION LADDER
We begin this chapter with the most primitive of all economic situations -- the case where two companies make the same product (with the same quality) and thus are forced to compete on price. We see how this simple situation escalates into price wars, then differentiated markets, then full-line producers, and then niche strategies, as competitors try to avoid the brutality of price wars. A sophisticated movement toward offering progressively higher customer value evolves. Like the force of gravity, the overall process of moves and countermoves tends to draw the industry back toward a price-competitive market after all the firms focus on imitating or outmaneuvering earlier moves. At some point everyone must move toward high quality and low cost to survive, and many firms offer the same range of product variety. Thus, the dynamics of competitive interaction cause product price and quality to cease to be opportunities for gaining advantage over competitors.
The individual players might be better off if they didn't escalate the competition toward this situation. But the dynamics of their interaction force them along this path. If one of them were to drop out of the competition, the other would gain a temporary advantage. Each one cannot trust the other to de-escalate the conflict. This course is set in motion the minute the two players step into the arena of competing on price and quality.
We have observed during our research that finns interact competitively at each step of the way so as to escalate the conflict. This series of dynamic strategic interactions defines each step or level of competition within the cost (and price)-quality arena. We will observe each dynamic strategic interaction between players, looking at how it was caused by the previous dynamic strategic interaction and at how it leads to the next level of interaction. Overall, each step moves the industry up the "escalation ladder" toward a situation in which cost and quality are no longer a source of competitive advantage.
What Is Quality?
When we discuss quality here, we are referring to "perceived quality" of consumers. This can sometimes be very close to more concrete measures of quality (all of which are defined by consumers), but for some products consumers just don't take the time to carefully assess quality, particularly for products that are low investment. Some consumers may be relatively unconcerned about costs for a product for which quality is the fundamental concern or a product such as a tube of toothpaste for which the cost is small enough not to matter much. Differences in customer perceptions can distort the broader view of price and quality presented here. Perceived quality also changes over time as customer preferences shift. A concern with automobile luxury shifts to a concern with gas mileage during the oil-strapped 1970s and then becomes an obsession with safety in the 1980s and 1990s.
From a marketing standpoint such broad approximations leave much to be desired. From an economic viewpoint the approximation of referring to "quality" as a clearly defined characteristic is one that is taken as a given in most models. We assume that there is a general standard of quality in an industry and that consumers are concerned about both price and quality. At the level of analyzing an individual company or industry, on the other hand, differences in perception of quality can be key and should be given careful consideration.
What is even more important is that these differences in the perception of quality and changes in the view of quality can be put to good use by companies searching for advantages. These quality perceptions change, and differences can provide key points of leverage in influencing the dynamic process of competition. As we will discuss in considering stakeholder satisfaction and strategic soothsaying in Part III, keeping in touch with emerging needs of customers and identifying new ways to meet those needs or emerging needs are essential strategies in hypercompetitive markets.
The First Dynamic Strategic Interaction: Price Wars
Unlike some other longer-lasting competitive moves, price changes can be very rapidly imitated, leading to all-out price wars. These conflicts can be particularly intense if the two firms have different costs, making it easier for one of them to cut prices. This encourages firms to compete by seeking cost reductions. Thus, price wars result when quality is not a factor. In Figure 1-1, if all firms are at point C, price moves downward. Price wars are not so simple, however. There are, for example, some interesting strategies for fighting price wars, which we consider below.
ALL-OUT WAR: TYLENOL'S HEADACHE
Typically a price war looks like the situation that occurred when Datril took on Tylenol in the pain reliever market. Datril offered the same-formula medicine for a lower price, capturing half of Tylenol's sales in test markets in 1975. But Tylenol responded aggressively by lowering its price and launching its first ad campaign. Tylenol, which had as much as 37 percent of the analgesic market at one time, could fight with lower prices because of its economies of scale. As a result, Datril ended up with less than 1 percent of the market. But the battle was not without damage. In the process Tylenol gave up millions in profits.
However, less aggressive alternatives are available. Competitors can use restraint, hidden price wars, and phantom price wars to avoid a head-to-head confrontation on prices.
In purely competitive markets price should fall to the marginal cost of the lowest-cost producer, who would normally be expected to expand to capture market share from higher-cost producers until it fills all of its capacity. Ultimately the lowest-cost producer should capture 100 percent of the market if he expands capacity to meet demand.
There are several reasons why industries don't always evolve this way. Antitrust regulations discourage single-player dominance in most industries. Often the low-cost producer has inadequate resources to build the capacity to cover the entire industry. Even if the firm has the resources, it might not want to take on the risk of putting all its eggs in one basket. To avoid problems of demand fluctuations such as those created by seasonality or business cycles, the company might restrict its capacity and raise its prices above its own costs, thereby leaving some market share for a second or third player. This forces some of the risk of demand fluctuations onto the higher-cost players and concedes the unattractive niches to competitors. This strategy satisfies the pressure on the low-cost producer for short-term profits and allows the company to share the market with a smaller, higher-cost player for antitrust reasons.
If the low-cost producer does not capture the entire market, the second or third-lowest-cost producers move into this opening with goods at their higher costs. This depends on the capacity of the next two or three players compared to the demand for the product beyond what is fulfilled by the lowest-cost player in the industry. In such cases, the small number of competitors makes it easy for firms to tacitly collude to keep prices up. The low-cost producer may raise his price to the cost of the second- or third-low-cost producer. This keeps everyone happy, except the customer. Of course, this collusion has to be implicit, because an explicit agreement would violate antitrust laws.
HIDDEN PRICE WARS
If, as suggested by our discussion of restraint, prices in the industry have equalized at a point above the costs of the lowest-cost producer, this allows room for more subtle price...
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