Competition Demystified | Bruce Greenwald & Judd Kahn

Published in: 2005

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The decision for a car company to enter the SUV market is strategic, everything thereafter is tactical. Greenwald and Kahn define strategy as outward-looking decisions with two main issues: (1) the competition arena and (2) management of external actors. Strategy determines which markets we should enter (or leave) and how we should handle competitors and suppliers, etc. The authors’ hypothesis is that Michael Porter’s famous “Five Forces” is too complicated. All forces are important, but since they are differently important, the model becomes almost unusable. To understand a market – start by making an industry map.

BARRIERS TO ENTRY – MOST IMPORTANT. It is barriers to entry that create strategic opportunities. Barriers to entry mean that established companies can do what potential rivals cannot (the definition of a competitive advantage). If the last player in has an advantage, there are no barriers to entry. In unprotected and profitable markets, the return will be driven down to the cost of capital. Differentiation (where branding is the primary tactic) can prevent the product from becoming a commodity. Frequent entry and exit in a market lead to a more difficult analysis of the future.

“Without competitive advantages, investments will generally return the cost of capital, meaning they will not add any value for the existing owners. This is true for projects like expansions into new territory and the development of new product lines as it is for the entire companies. The only exception come from superior management, which can use resources more efficiently than other firms and so squeeze out higher returns”

THREE MAIN COMPETITIVE ADVANTAGES. The three main competitive advantages are: (1) supply advantage – own technology, experience, exclusive supplier agreements and other abilities to deliver [unique] products at a lower cost than competitors, (2) demand advantage – customer captivity based on things like habit, network effects, exchange costs or search costs and (3) economies of scale – the ability to reduce costs per unit when the volume increases, largely due to the spread of fixed costs over a larger number of units sold. Truly sustainable competitive advantages derive from the interplay between benefits between supply and demand, from the link between economies of scale and customer captivity.

“IN THE LONG RUN EVERYTHING IS A TOASTER”. The first player can achieve an advantage in terms of the learning curve, which then creates an economy of scale before competitors threaten. Sometimes, however, subsequent actors can have lower costs as they can learn by mistake. Technology benefits can be powerful but disappear. Polaroid increased sales from $6 million in 1950 to $98 million in 1960, and in 1975 sales exceeded $800 million. Operating profit increased faster. From 1950 to 1975, the operating margin was 19%. When the digital camera came in the 2000s, they got into big trouble.

DEFEND OR SURRENDER. A major player working within barriers must defend its position. The strategy for a company that is in the position of an ant should be to consider leaving the industry as painless as possible. If companies regularly take market shares from each other, it is unlikely that any of them are protected by competitive advantages – and vice versa. If no one has a competitive advantage (or can create one), no player will earn above average returns. One should then focus on operational efficiency. Reducing costs is the best way to improve returns.

FIRST ASSESSMENT OF THE MARKET. There are three scenarios to consider when assessing a market: (1) no one has a competitive advantage, (2) a competitor dominates the market, (3) several competitors have different competitive advantages. The strategies for each type of market situation are different. Greenwald and Kahn identify companies with a competitive advantage through lasting high market share and / or lasting high returns.

ECONOMIES OF SCALE. A company with a 75% market share in a small market has a greater advantage than a larger company whose market share is only 5% of a huge market. If average unit costs decrease as a company produces more, smaller competitors will not be able to match costs even if they have equal access to technology and resources. Market growth is usually the enemy of economies of scale. The best course is to establish a dominance in the local market and grow outward. This is how Sam Walton grew Wal-Mart from a small town in Arkansas. Small markets are more suitable than large markets to gain competitive advantages.

REMOVE THE NOISE. Finding out real earnings requires adjustment for any economic fluctuations. The simplest way is to calculate the average operating margin over a multi-year period and then apply the average margin to current sales. Margins tend to fluctuate more than sales. But if sales are also sensitive to the business cycle, they should also be adjusted to an average level. Also find out the level of investments made in maintenance and investments made for growth.

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