This blog is originally published as a sub-chapter of The G.O.S.P.E.L. of Strategy.
To best understand your options, you need two kinds of facts, i.e., the facts about your business' external and internal environment. We will discuss External Analysis in this post.
2.3. Analyze External Factors
Your available options are highly influenced by your external factors, e.g., sizeable customer base, fast-growing demand, absence of aggressive competition, friendly regulation, and stable technology. McKinsey's research on ~3,000 companies across 128 industries suggested that only ~60% variance of companies’ profitability depends on the company’s internal actions. In other words, external factors explain ~40% variance of the companies’ profitability.[iii]
For illustration: In the USA, the average net profit margin of the apparel industry is a mere 5%. Regional Banking enjoys 30%. A typical pharma company can expect a 10% net profit. In contrast, a typical railroad player can expect a 50% net profit.[iv] The top quartile players of the Apparel industry obtain a lower margin than the bottom quartile players of the Railroad industry. Such is the power of external factors.
There are five external factors you need to consider when analyzing your options:
1. Drivers of Demand and Supply.
2. Structure of the Industry.
3. Competitive Reactions.
4. Market Trends.
5. Industry Lifecycle.
2.3.1. Drivers of Demand and Supply
All companies need to understand the Demand-Supply Drivers, i.e., what makes customers buy more and inhibits sellers from selling more? Knowing the drivers of demand and supply of your industry is important.
You can go far just by predicting the demand and supply correctly. For example, Urban Outfitters, an American apparel and homeware retailer, started its European business by first setting up a local design and merchandising unit in London – so that it could tailor goods to European tastes. This delayed its European launch, but it helped Urban Outfitters successfully expand throughout Europe.[v]
You don’t have to be a commodity player to use the demand-supply analysis. Even a monopoly or oligopoly business can benefit much from understanding the drivers of demand and supply. Pertamina Retail once had a monopoly right on running petrol stations in Indonesia. When the market was deregulated in 2004, Pertamina lost its monopoly right, and big competitors (Shell, Total, BP, Petronas) quickly entered the market. Many industry observers then predicted that Pertamina would lose ~50% of its market share within a mere three years. But Pertamina Retail understood the customers’ demand well, modified its offerings, and managed to fend off the competitors. By 2020, Pertamina still retained more than 95% of the market.[vi]
It is sad to see that many business leaders still don’t understand what drives the demand and supply in their industry. They are like a pilot flying a plane while being oblivious to the external weather condition.
The result can be disastrous, as learned by Walmart, the world’s largest retailer. When Walmart expanded into Germany and Korea in the late 1990s, it didn’t adapt its stores to local customs and tastes. It failed to understand the respective countries' demand and struggled to grab a significant market share. Walmart ended up withdrawing from these countries in 2006 to stem its billion-dollar losses.[vii]
You may think that Walmart executives would learn from their mistakes and start to pay more attention to the drivers of demand and supply. But old habit dies hard. Walmart’s tone-deaf management repeated the same mistake in other countries. For example, in Japan, Walmart kept its American business model and failed to understand that:
Japanese consumers prefer to purchase smaller portions in more frequent intervals over the American habit of ‘stocking up.’
Japanese buyers have an overwhelming preference for fresh produce, which opposes the pre-packaged goods that serve as a major selling point for Walmart.
Japanese consumers prefer smaller average meal sizes; this further undercuts the need for Walmart’s discounted bulk orders.
Most farms and fisheries (i.e., the suppliers) in Japan are small, family-run businesses.
These Japanese suppliers prefer smaller orders and struggled to offer bulk-purchasing discounts. This is a significant challenge to Walmart, whose proposition remained unchanged in Japan (i.e., passing bulk-purchasing discounts to consumers).[viii]
Compare this to Costco, another American retailer that is successful in Japan. Unlike Walmart, Costco has adapted its business model. Instead of offering pre-packaged, bargain products (as it does in the US), Costco positions itself as a premium American brand. It provides exclusive private-label offerings, exotic treasure-hunt shopping experiences, and an abundance of fresh food. No wonder Costco is thriving in Japan while Walmart flopped. Failure to understand the demand and supply drivers eventually forced Walmart to pull out of Brazil in 2018, the UK and Japan in 2020.[ix]
Another example is McDonald's. Around the world, it tailors its menu to local tastes and demands. In Indonesia, McDonald's is more famous for its fried chicken and rice than its burgers. In Sri Lanka, McDonald’s Fish & Rice Happy Meal is popular. It consistently experimented and introduced many local flavors, e.g., mushroom burgers in Hong Kong, jalapeño burgers in Mexico, kebab burgers in Turkey, and spicy paneer burgers in India.[x] It is not by chance that McDonald’s is flourishing all over the world.
It is not only the Business-to-Consumer (B2C) companies that need to understand the demand-supply drivers, but also the Business-to-Business (B2B) companies. For example, Hosokawa Micron is a global leader in designing high-quality powder and processing machines. It has become a leading company in this arduous industry because it understands the customers’ demands very well. Hosokawa frequently invites customers to its lab – so that the customers can touch the mock-up designs, test the prototypes, and provide feedback. This way, Hosokawa can ensure its customers will be happy with its products.[xi]
The below questions help analyze drivers of demand and supply:
Market Size and Growth
How big is the market? By monetary value and by unit volume?
How fast is the market growing?
What is the future size of the market?
Market Profitability
What is the average profit margin in this industry?
How big is the profit pool?
What causes the profit margin to be so low/high?
Market Trends
How is the market changing?
What are the drivers of change?
Market Structure
How many buyers and sellers? How fragmented are they?
Can barriers to competition be established?
Are there benefits of scale, including network effects?
Is the market homogenous? Are there regional differences?
Demand and Supply Equilibrium
What is the current market price level? And what is the aftershock level?
What is the current demand quantity? And what is the aftershock level? How will it affect the price?
What is the current supply quantity? And what is the aftershock level? How will it affect the price?
Demand Drivers
What factors influence the demand? For example:
Number of customers, demographic profile, needs.
Under-served, latent demand, pain points, problems.
Growth in downstream industries.
Network effects, fashion, fads.
Changing incomes and purchasing power.
Novelty and uncertainty around a new product.
Supply Drivers
What factors influence the supply? For example:
Barriers to entry.
Local labor market dynamics.
Shipping challenges of a geographical place.
Changes in production technology.
Risks and uncertainty.
2.3.2. Industry Structure
In Tennis, you have to be in the right place at the right time to strike the ball. If the ball is on the left side of the court and you're on the right, there's no way you can hit that ball. You have to be in the right place even to have a chance of hitting the ball and returning it effectively.
The same is true in Business: you have to be in the right industry at the right time to make big money. If your industry is highly competitive and hostile, there’s less chance you can make big money. You have to be in the right sector even to have a chance of getting the right opportunity and making a handsome return. Thus, it is essential to analyze the structure of your industry – because particular industry structures create a hostile market.
There are two valuable tools to do so. The first tool, Porter’s Five Forces, is frequently used to analyze the external forces affecting the structure of a particular industry to estimate the typical profitability of the players in the industry. If all the forces are hostile, the industry players most likely have poor profitability. If all the forces are favorable, the industry players most likely have high profitability. Any change in the Forces changes the overall profitability of the industry.
A friend of mine asked me why this manual includes basic frameworks, such as Porter’s: “Everyone knows the Porter’s. Why not show something new and fancy?” My answer: “Basic frameworks, despite their simplicity, are useful, easy-to-use, and applicable in many situations. They highlight the principles well. Since this manual is about the principles, I think basic tools are worth presenting here.”
Furthermore, I am aware of bubble confirmation bias. Even if many business people know about a framework, it doesn’t mean every business person knows it. I have met a billionaire who runs successful businesses but never heard about Porter’s Five Forces; a single mom entrepreneur who works hard building her business without knowing the definition of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization – a popular measure of a company’s operating profitability); a former drug dealer who successfully markets his funky fashion brand without knowing the 4P of marketing.
These successful people might not know the names of the technical tools. Still, they grasp the fundamental principles (e.g., competition intensity, profitability, connecting with customers). What’s important isn’t the tools but the principles behind the tools.
Let’s back to Porter’s Five Forces. The steps to do the analysis (just a refresher/in case you aren’t familiar with the tool):
Define the Industry, i.e., what the vertical and horizontal boundaries are. Need to be clear because it determines your competitive landscape. For example, are you in the biscuit market or the larger snacking market? (Horizontal boundary, i.e., in different industries.) Are you a garment factory or a fashion retailer? (Vertical boundary, i.e., in the same industry but other parts of the value chain.)
Assess the Competition Intensity, i.e., how many players are there? Are they fragmented? How fiercely do they compete with each other? Less intense competition leads to higher average profitability of the industry. Sometimes, it's not about the number but the behavior of the players. For example, in the UK, there were only three big poultry players. Still, they competed intensely, driving the market prices down significantly.[xii] The market price of chicken fillets in the UK was $7.7/kg, much lower than the market prices in other Northwest European countries, e.g., Switzerland ($28.9), Norway ($15.9), Austria ($12.6), France ($12.4), Italy ($10.2), and Germany ($8.8).[xiii]
Assess the Supplier Power, i.e., how many suppliers are there? Are they fragmented? How fiercely do they compete? The lower the bargaining power of suppliers, the better it is for the focal industry's average profitability (and worse for the suppliers’ industry). For example, in 2019, there were 18,000 car dealers in the US, but only a couple dozen giant car makers.[xiv] In this case, the car makers hold higher bargaining power.
Assess the Buyer Power, i.e., how many buyers are there? Are they fragmented? How fiercely do they compete? The lower the bargaining power of buyers, the better it is for the focal industry's average profitability (and worse for the buyers’ industry). For illustration, in 2019, there were 12,000 dairy farmers in the UK but only a dozen big supermarket chains.[xv] As a result, the supermarkets hold much higher bargaining power than the farmers.
Assess the Threat of Entry, i.e., is it easy for a new direct competitor to enter the market? If it is easy and the industry has a decent profit level, then new competitors will flow in and increase the competition level. For example, in the UK poultry market, the threat of new entrants is low due to a lack of farming lands, strict and lengthy approval processes, and a limited number of hatcheries.
Assess the Threat of Substitutes, i.e., is the product/service offered by the focal industry easily replaced by product/service from other related industries? To illustrate, for a sweet biscuit manufacturer, the chocolate manufacturers are its indirect competitors as chocolate consumption can substitute sweet biscuit consumption.
Assess Changes to the Forces, i.e., are there any changes that affect the forces? For instance, a government decision to deregulate an industry can significantly increase the threat of entry; new technology can make the old technology obsolete.
Caveat: Porter’s Five Forces is suitable for analyzing the structure of a traditional industry which follows a conventional value chain, i.e., Upstream Suppliers >>> Focal Industry >>> Downstream Buyers. But it isn’t suitable for modern platform businesses with a complex, non-linear, multi-sided value chain (e.g., Amazon, Uber, LinkedIn, eBay, Airbnb). For this type of business, use the second tool, Network Mapping, to analyze the industry structure.
The steps to do the Network Mapping analysis:
Identify all the ‘sides’ of the platform. For example, the Uber platform has three sides, i.e., the company, the drivers, and the riders. The LinkedIn platform has six sides, e.g.,
Intermediation Platform: the company that owns, controls, and manages the LinkedIn platform (i.e., the LinkedIn database, website, and app).
Users: people who use the app and website to post their professional experience and qualification or consume content.
Recruiters: people or companies who use LinkedIn services and databases to find potential candidates.
Advertisers: the companies that advertise their products/services to the users via published content.
Content Developers: people who create content to be consumed by users, e.g., articles, comments, videos, pictures, quotes. Many of the content developers are Users themselves, but this doesn’t have to be the case. Some content developers are employed by LinkedIn, and many of them are commissioned by advertisers.
App Developers: the companies that use created add-on applications for users, recruiters, advertisers, etc.
Identify the interactions across sides and within sides.
Is it positive/negative? In the LinkedIn example, users may find advertisers annoying and content developers useful.
Is it strong? For example, users have frequent interaction with the content developers but minimal interaction with the app developer.
Identify any reinforcing Network Effect. For example, the more riders use Uber, the more valuable the platform is to the drivers. Similarly, the more drivers in Uber, the more valuable the platform is to the riders. Often this creates a ‘chicken and egg’ dilemma, e.g., without a high number of drivers, users won’t come, and without a high number of users, drivers won't sign up. Uber solved this dilemma by using intensive local marketing to drivers in the launch city while offering free rides for riders. I met the founders of Uber in one of the classes at Harvard Business School. They told me about the gruesome work of convincing riders when they first started. Surely not a walk in the park.
Evaluate the overall Network Effects:
What are the key drivers of adoption? What makes each side come to the platform in the first place?
What are the key drivers of active engagement? What makes each side come to the platform regularly?
Identify how to enhance the Network Effects by:
Improving or weakening link strength (e.g., limiting the advertisers, encouraging the content developers);
Adding or deleting links (e.g., removing interactions between the recruiters and the advertisers);
Adding or deleting sides (e.g., adding training companies or universities); or
Stimulating a side link (e.g., introducing special incentives for the recruiters – as more recruiters attract more users).
Whether you use Porter’s 5 Forces or Network Mapping, a full understanding of the industry structure allows you to see the gaps in the market. These gaps are opportunities that you can exploit.
2.3.3. Competitive Reaction
When you are assessing your options, don’t forget to consider your competitors' likely reactions. Never forget this: whenever you act, your competitors react. You can only win if you can be several steps ahead of the competition.
If you don’t think several steps ahead, the result could be disastrous. Take the US steel industry, for instance. In the 1970s, the upstart mini-mills (small players) established themselves in the steel business by making cheap concrete-reinforcing bars known as rebar. Established steel-makers like U.S. Steel (the big players) ceded the low end of the business to the mini-mills. They deeply regretted that decision when the mini-mills crept into higher-end products.[xvi]
Another example: In the early 2010s, the chicken processing industry in Poland enjoyed booming growth (increasing demand for chicken meat in the EU and relatively low chicken processing costs). This high growth encouraged many players to expand their existing factories/established new factories in Poland in the mid-2010s. But, since everybody was expanding, the market quickly became oversaturated. In the late 2010s, the market prices of processed chicken meat fell significantly (too many producers), while the costs of live chickens were increasing (not enough farms to supply all the new producers). As a result, many players were losing money and failed to recoup their investments in the new factories. What initially looked like a thriving market you want in becomes a cutthroat market you want out – due to competitive reaction.
So, don’t get surprised by the competitive response and put up a lame excuse: “I didn’t see it coming.” Napoleon Bonaparte, the great general, correctly said: “a leader has the right to be beaten, but never the right to be surprised.”[xvii] You can avoid many costly mistakes by simply asking: “If I were the competitor, what would I do?”
What if a business is so unique that it doesn’t have a competitor? Oh, please! Don’t believe people who told you that their business is unique and doesn’t have competitors (many entrepreneurs like to claim this). A business always, no matter what, has competitors. If someone thinks his business is unique and doesn’t have a competitor, he is most likely dead mistaken. Even a monopoly company without direct competitors still has to face indirect competitors, would-be competitors, and new competing technologies around the corner. More often than not, if you look more carefully, you’ll find that you do have competitors.
Being a winner is not about having no competition. It is about facing tough competition head-on. As in athletics, where competitors have a healthy respect for their top rivals, winning companies use this competitive instinct to drive them forward constantly. They actively take a performance-oriented approach. And they prepare for the worst competition – including the competitors who are trying to steal market share by reducing prices and having destructive effects on entire industry dynamics and profitability.
Never underestimate competitors, even when you are in a leading position. Even if they are weak, assume that they are improving and will be dangerous. It is better to act like a challenger when you are a champion than to act like a champion when you aren’t one.
Sony, the electronics manufacturer, for example, simply assumes their competitors will be able to imitate whatever new, innovative products Sony launched within two years.[xviii] As a result, they aren’t fooled by the illusion of invincibility and make the right decisions to maintain their leading position.
There are different ways for competitors to compete. For example, they can compete on/by:
Capital: BHP Billiton, a global mining company, has sufficient capital to develop larger mines that smaller miners can’t handle.
Service/product: Starbucks offers premium coffee in a welcoming atmosphere, with personalized attention. Compared this to the coffee and service you get at Dunkin Donuts.
Price/cost: Bangladeshi clothing manufacturers steal orders from Indian clothing manufactures because they have a lower cost base.
Copying: Merrill Lynch copied Goldman Sachs’ profitable derivative trading products.
Execution: Philip Morris, a cigarette maker, can get more shelf space compared to its competitors.
Marketing: Coca-Cola uses more ingenious advertising to increase its brand awareness.
Technology: Netflix introduced online streaming to replace Blockbuster’s DVD-by-mail program.
Substitutes: McDonald's and KFC decimated many of London’s local fish and chips shops.
Relationships: 99 Cent Only Stores, an American price point retailer, pays suppliers quickly and never cancels a purchase order – making the suppliers prefer to sell their excess inventory to 99 Cent Only Stores instead of other retailers.
Supply chain integration: Moy Park Poultry is more efficient than its smaller competitors because it has its own chicken hatchery and farms.
Corporate responsibilities: Nespresso helps small coffee farmers in impoverished areas to create more successful crops.
Incremental innovations: Chrysler stole market share from General Motors in the 1990s by consistently offering new features.
Let’s examine three useful tools for analyzing competitive reaction: 1) Action-Reaction Chain; 2) Game Theory; and 3) War Game.
The Action-Reaction Chain is a useful tool for analyzing how your competitors might respond and what you could do given the likely reactions. The steps to do the analysis:
Step 1: Identify the new shock to the market equilibrium, either caused by you or not.
Step 2: Identify the actions you are going to take.
Step 3: Predict the competitors’ likely responses to your actions.
Step 4: Determine how to respond to the competitors’ responses.
Step 5: Repeat Steps 3 and 4 until a new equilibrium has formed.
See the example below on how the entry of Aldi and Lidl (the discounters) has changed the UK’s supermarket landscape.
Pre-shock Equilibrium: The market is dominated by traditional supermarkets.
New Shock: The Discounters entered the market and gained share by undercutting prices.
Initial Action: Some supermarkets cut prices to compete with the discounters.
Initial Reaction: All players were dragged into a price war as they tried to narrow the price gap.
Temporary Equilibrium: Fierce price competition drove up the cost of doing business and reduced profitability for all players.
Follow-up Action: To escape the price war, some supermarkets started to differentiate on:
Product range,
Product quality,
Shopping experience,
Customized offering, or
Price point.
Follow-up Reaction: All players chose a position and differentiated themselves to capture a different market segment.
Final Equilibrium: There would be new winners and losers when compared to the pre-shock equilibrium.
Another popular tool to analyze the competitive reaction is Game Theory. It is helpful because it quantifies the payoff to determine the most optimum option. This tool is frequently applied in pricing strategies. But it is versatile beyond pricing. For example, during the COVID-19 crisis, the experts working for the UK Government used the Game Theory to weigh the benefits and costs of no lockdown, partial lockdown, and complete lockdown.[xix]
An example of Game Theory:
Step #1: Understand the context
Company X, an incumbent, expects another firm, Company Y, to enter its market.
Company X wants to understand Company Y’s incentives so that it can plan its best response.
Step #2: Generate the options
What can Company X do?
Reduce prices, or
Hold prices.
What can Company Y do?
Do not enter the market,
Enter the market at lower prices, or
Enter the market at the same prices.
Step #3: Quantify the payoff of each combination of the options
Estimate the impact on EBITDA for Company X and Y for each combination of options (can be based on simple estimation or complex research, depending on needs).
Will the market size grow?
How will the market share be split?
Will the consumers switch providers for a lower price?
What is the competitor’s margin at different price points?
Based on the estimations, you can generate the Game Theory matrix. For illustration, based on the matrix below, holding prices is the best strategy for Company X – no matter what Company Y does. Company Y is more likely to enter at lower prices.
What if you have no idea about what the competitors’ likely reactions will be? In this case, you need another tool, i.e., War Game. Also known as Conflict Simulation, War Game is a role-playing game based on the market situation. It is a simulation used to put yourself in the competitors’ shoes, understand each player’s strengths and weaknesses, test a myriad of scenarios, and chart a path to winning.
This versatile tool is commonly used in the military, legal, and political field. For example, 90 days before the 2020 US election, 67 experts (including law professors, retired military officers, former senior US officials, political strategists, and attorneys) held war games on the Donald Trump vs. Joe Biden election. The experts role-played the aftermath of four scenarios:
Scenario A: Decisive Biden win.
Scenario B: Narrow Biden win.
Scenario C: Close electoral win for Trump. But a five percentage point popular vote loss.
Scenario D: The possibility of the outcome remains in doubt for weeks because of a deluge of mail-in ballots.
They split into seven groups – representing the Biden camp, Trump camp, media, federal bureaucracy, military, Democratic officials, and Republican officials – and forecast how they thought each group might react after the election.
After playing for four days, they concluded that all scenarios except for Scenario A (i.e., Biden’s landslide win) ended in violent protests and a constitutional crisis. As a result, the experts cautioned that the election race between Donald Trump and Joe Biden could turn into a post-election crisis.[xx], [xxi] And this was indeed what happened in real life – 90 days later!
War Games are fun to design and fun to play. Once, we ran a war game and offered five iPads as prizes for the winning team – the players were competing like crazy. War games generate insights and powerfully change the players' behavior lastingly beyond the game.
The steps to do war-gaming:
Identify the different roles and objectives of each role.
Design the rules of the game (should represent the real-life situation of your business).
Assign your people into different roles, e.g., as a competitor, supplier, customer, employee. Give them the objectives and explain the rules.
Let them be creative in playing the game. You’ll see your people responding creatively to win the game.
Repeat the round many, many times. The more war game rounds you do and the more scenarios you see, the more robust your strategy will be.
The flowchart below will help you think about designing, playing, and rethinking the game.
2.3.4. Market Trends
When assessing your options, also take market trends into account. First, identify the top trends that would affect your business in the next five to ten years. Then, determine the effect these trends would have on your business performance.
There are sayings about trends in Finance: ‘Don’t fight the trend’ and ‘The trend is your friend.’ Trend following is one of my winning strategies in stock trading (despite the Efficient Market Hypothesis saying that past prices can’t predict future prices). In the stock market, following the market trend is a smart, profitable move.
It’s the same in business. Market trends can both help or hinder you. For example, in the first half of the 1980s, crude oil prices were between $80-100 per barrel. As the cost of electricity soared, it was an excellent time to sell energy-efficient products. But, in the second half of the 1980s, crude oil prices dropped to $20-30 per barrel. Not so good time to sell energy-efficient products as demand plummeted.
Often, a critical part of the strategy process is knowing when market trends are with you or against you. It is much easier to win if the trend is helping you instead of hampering you. Take, for example, Steve Hick International’s case. The company historically focused on developing high-quality pipe systems to serve demanding nuclear, water, oil & gas companies. However, Steve Hick realized that level of scrutiny its customers placed on safety and inspection was steadily increasing. So, instead of focusing on producing even higher-quality pipe systems, the company pivoted its focus to becoming a provider of pipe inspection services. This way, it rides the trend into the safety part of the industry.[xxii]
The tool PESTEL (Political, Economy, Social, Technology, Environmental, Legal) helps capture various industry trends affecting your business. Once you find these trends, you can start to exploit them. Example of PESTEL analysis for a cracker company:Major Trends
The ‘So wat’
When you are analyzing the trends, consider whether the trends are persistent or easily change. Don’t be surprised by a sudden turn of trends. For example, when China first opened its economy to foreign businesses, it needed foreign capital. So the Chinese government offered many incentives and benefits to encourage foreign companies to invest in China. As China’s reliance on foreign capital has decreased, the government started to impose stricter rules on foreign companies, favor state-owned enterprises, and subsidize its domestic companies.
Bear in mind that a trend affects companies differently. For instance, when the 2008 economic crisis hit, the fashion retailer M&S sales was badly affected (the analysts even called it a ‘shocking’ sales result).[xxiii] However, the same crisis had a small impact on Louis Vuitton or Compagnie Financiere Richemont (that owns Cartier, Montblanc, Alfred Dunhill). Their ultra-wealthy customers continued their spending habits despite the economic crisis. Another example is when the COVID lockdown occurred in 2020, many pubs suffered losing sales, but face mask manufacturers were reaping sales boost.
2.3.5. Industry Lifecycle
Be aware of the changes in the industry. Change always happens, but we often fail to see it. Why? Two reasons.
First, most of the time, a change starts slowly with a small, negligible impact that is difficult to see. Hence, we tend to ignore a change until it has become a significant disruption when it is already too late to respond. Change is like the Amazon River. It starts as a small stream but slowly grows to become a raging, big river.
So, remember this: every industry has a life-cycle, nothing lasts forever, and change is inevitable. Force yourself to ask: “Is there a technology under development that looks inferior or uncertain today but will undermine our business from beneath once it is properly developed?”
Second, change is full of uncertainties. For instance, the Internet portal industry before Google became the winner. In the earliest days of the Internet search portal industry, it was far from clear what structure would emerge. Players in the market experimented and made mistakes. The tech-savvy founders of Lycos, for instance, saw themselves competing on a high-tech battlefield and assumed that the company with the best search technology would win. Magellan’s founders, the twin daughters of publishing magnate Robert Maxwell, aimed to build “the Michelin guide to the Web” and developed editorial abilities. The pioneers of Yahoo, seeing the portal industry as a media business, invested in the company’s brand and the look and feel of its sites.[xxiv] The structure was apparent only after Google gained widespread user acceptance (due to their uncluttered and straightforward search page).
The S-curve model tells us how a change usually happens. According to the model, a significant disruption usually follows a four-stage life-cycle:
Fermentation phase (small size, growing slowly): A significant disrupter (e.g., new technology, new consumer trend, new business model) enters the industry. However, it has a slow adoption and small impact due to uncertainties and experiments. Some of them may have big hype, but the risk is high, and in terms of monetary impact, there is no strong return yet. As a result, many conservative companies won’t seriously consider it. Only the most innovative and risk-taker companies are willing to try new technology. This phase can take a long time.
Take-off phase (fast growth from small to big): As more companies adopt the new disrupter, they learn more about it, and they improve it. As a result, they enjoy a better return. This better return then attracts others to adopt the new disrupter. Then companies race to adopt the disrupter to win. The overall industry will see a fast change. But by this time, any new companies that just started may already be too late. This phase usually happens quickly.
Maturity phase (big size, growing slowly): Many conservative and risk-averse companies try to follow the trend or adopt the new trend/technology in this phase. But, most likely, it is too late for them – they would see a low return and slow growth. The new technology/trend has become business-as-usual and generates decreasing returns. It may stay this way for quite a long time.
Discontinuity (declining): Eventually, another new disrupter will enter the industry and lead to the new S-Curve.
If you are ever facing this kind of disruption, there are four positions that you can consider:[xxv]
Shape the Future: Embrace the new disruption and play a leadership role in establishing how the industry operates. This high effort, high investment option is precarious. But if you are successful, you’ll be seen as the industry leader. For example, Apple in the smartphone industry with the introduction of the iPhone in 2007.
Adapt the Fastest: Carefully wait while closely monitor how things are developing/progressing. And prepare yourself to use speed, agility, and flexibility to capture the big opportunities. While the risk is lower, gearing your company for speed and agility once ample opportunity is confirmed isn’t a simple feat. Think of Samsung as an example: how it quickly introduced its own smartphone once the trend was clear.
Reserve the Right to Play: Invest sufficiently to stay in the game and avoid any premature commitments. Only embrace the new technology/trend once proven. It is the lowest risk option, but it comes with a price – you become a follower instead of a leader. Hence, you usually need to compete on something else (e.g., on price, on reliability, on a one-stop solution). For example, despite being a latecomer in the smartphone industry, Huawei managed to secure a market share via low-priced smartphones.
Exit: Decide not to participate in the new business going forward. Focus on other businesses instead. For example, IBM exiting the smartphone industry despite creating the world’s first smartphone in 1994.
Which position is the best for you depends on your internal and external context. If your company is a group with various business units, then the different business units can take different positions depending on what suits them best. One thing for sure: when the disruption happens, your business has to make the hard choices.
Furthermore, different life-cycle phases require a different business model (i.e., Exploitation vs. Exploration mode). Like the old sayings: "Everything has its season. And there is a time for everything under heaven. A time to be born and a time to die. A time to weep and time to laugh. A time to rend and time to mend. A time to love and a time to hate. A time for war and a time for peace." It’s the same for strategy. When the market is so volatile and uncertain, it isn’t a time for maximizing performance. Instead, it’s a time for maximizing adaptability. Change your focus to match the phase of the industry life-cycle.
In the Fermentation phase, use the Exploration model to maintain opportunism.
In the Take-off phase, use the Exploitation model to outperform the competitors.
In the Maturity phase, use the Exploitation model to maximize return.
In the Discontinuity, use the Exploration model to scout for disruption chance.
Overview of the differences between the Exploitation and Exploration mode:
Continue to explore the secrets of Winning Strategy here.
To read about Internal Analysis click here.
[i] Andrew Roberts. 2015. Napoleon the Great. Penguin Books. [ii] www.napolun.com/mirror/napoleonistyka.atspace.com/Napoleon_tactics.htm [iii] www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/the-strategic-yardstick-you-cant-afford-to-ignore [iv] pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html [v] Michael Arndt. 2010. Urban Outfitters’ Grow-Slow Strategy. BusinessWeek. [vi] ICCT. 2020. The Retail Fuels Market in Indonesia. Working Paper 2020-23. [vii] Matthew Boyle. 2009. Wal-Mart’s Painful Lessons. BusinessWeek Online. [viii] wharton-ibr.com/blog/2020/11/25/why-walmart-was-destined-for-failure-in-japan-by-sarah-zhang-w22 [ix] asia.nikkei.com/Spotlight/Comment/How-Walmart-flopped-in-Japan-and-elsewhere-overseas [x] Based on personal experience while travelling to these countries. [xi] The Manufacturer. Vol 23. Issue 9. December 2020. [xii] Based on personal observation. [xiii] www.numbeo.com/cost-of-living/country_price_rankings?itemId=19 [xiv] www.statista.com/topics/3594/auto-dealers-in-the-us/ [xv] www.dairyuk.org/the-uk-dairy-industry/ [xvi] hbr.org/2005/04/how-strategists-really-think-tapping-the-power-of-analogy [xvii] www.quotes.net/quote/40044 [xviii] Michael Shearn. 2012. The Investment Checklist: the Art of In-depth Research. John Wiley & Sons. [xix] Based on discussion with a friend of mine who worked for the UK Government. [xx] www.telegraph.co.uk/news/2020/11/17/donald-trump-concede-joe-biden-election-2020-what-happens-president/ [xxi] eu.usatoday.com/story/news/politics/elections/2020/08/06/election-2020-War Games-trump-vs-biden-race-show-risk-chaos/5526553002/ [xxii] The Manufacturer. Vol 23. Issue 9. December 2020. [xxiii] www.independent.co.uk/news/business/news/shocking-sales-results-from-m-s-deepen-fears-of-recession-in-uk-769273.html [xxiv] hbr.org/2005/04/how-strategists-really-think-tapping-the-power-of-analogy [xxv] Adapted from McKinsey & Company’s Strategy Under Uncertainty, [xxvi] insight.kellogg.northwestern.edu/article/what-went-wrong-at-aig [xxvii] www.investopedia.com/articles/economics/09/american-investment-group-aig-bailout.asp [xxviii] www.thebalance.com/aig-bailout-cost-timeline-bonuses-causes-effects-3305693 [xxix] The Manufacturer. Vol 23. Issue 9. December 2020. [xxx] quotefancy.com/quote/1548411/Sun-Tzu-Know-yourself-and-you-will-win-all-battles [xxxi] Four Season’s Annual Report. www.sec.gov/Archives/edgar/data/1030555/000116923203003172/d55326_ex99-1.htm [xxxii] www.shopify.co.uk/retail/119531651-how-nordstrom-made-its-brand-synonymous-with-customer-service-and-how-you-can-too [xxxiii] blog.goptg.com/microsoft-office-365-statistics [xxxiv] www.windowscentral.com/there-are-now-12-billion-office-users-60-million-office-365-commercial-customers [xxxv] Michael Shearn. 2012. The Investment Checklist: the Art of In-depth Research. John Wiley & Sons. [xxxvi] www.westernunion.com [xxxvii] Michael Shearn. 2012. The Investment Checklist: the Art of In-depth Research. John Wiley & Sons. [xxxviii] www.brainyquote.com/quotes/jack_welch_173305 [xxxix] strativity.com/hbr-change-report/ [xl] Michael Shearn. 2012. The Investment Checklist: the Art of In-depth Research. John Wiley & Sons. [xli] American Woodmark’s Annual Report Year 2010. [xlii] American Woodmark’s Annual Report Year 2019. [xliii] hbr.org/2005/04/how-strategists-really-think-tapping-the-power-of-analogy [xliv] www.gobigcreativelab.com/a-punch-is-just-a-punch-leadership-lessons-from-bruce-lee/ [xlv] quotefancy.com/quote/757912/Albert-Einstein-Make-everything-as-simple-as-possible-but-not-simpler [xlvi] hbr.org/2005/04/how-strategists-really-think-tapping-the-power-of-analogy
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