Success Under Fire: Policies To Prosper in Hostile Times
by Donald V. Potter
Headlines like these became commonplace in the place 1980’s:
“Computer Firm Pares Staff 17%, Cites Price Cutting,” “U.S. Banks Slip Further Behind Rivals,” “Borden Plans To Shrink Dairy Business,” “Xerox to Take Revamp Charge of $275 Million,” “Todd Changes Strategy as Losses Mount,” “Securities Firms Mull a Major Restructuring.”
The headlines tell of hostile times. Hostile times bring low margins, intense competition, and management turmoil. Few companies survive these times; even some of the best known fall by the wayside. At one time, RCA led the color television market, Schlitz was a key factor in brewing, and International Harvester was an important competitor in the farm equipment industry. A few years ago, Triumph was a class act in the motorcycle market. And, at one time or another, most of us have ridden on Firestone tires. These companies were well-known leaders, but none survive today as an independent company. What went wrong? Management polices.
The world of the 1990’s sees a few players winnings where these companies and many other failed. Matsushita leads the world in color television production. Anheuser-Busch dominates the domestic beer market. John Deere leads in farm equipment, Honda in motorcycles, and Goodyear in tires. What did these companies do differently than their peers? The answer is not one thing, but many things. These companies operated with better policies because they had superior understanding of hostility and of how to prosper during hostile times.
An industry experiencing hostile conditions typically goes through predictable phases. The phases are always the same though their sequence and timing may vary from one industry to another. Over the last several years, we have studied more than forty industries that have confronted hostility.
The Research Base
In 1985, we began a research project to track the evolution of several hostile industries. Overcapacity had plagued each of these industries for more than 10 years. The purpose of the project was to identify the policies of the few companies that really succeed in tougher times, and to compare those policies across the industry to highlight repeating patterns of success.
In our industry analyses, we concentrated on the critical strategic policies each key competitor used to confront its difficulties marketplace. How did the company position itself with customers? On what aspects of the product and services package did the company focus its performance efforts? How did the company price its product compared to those of its competition? How did the company achieve a low cost position?
The research drew on both public and private sources of information. We analyzed financial reports and industry economic studies. We conducted extensive interviews with current and retired executives in the industry, with long-time customers, and with industry analysts and consultants.
The research began with a handful of industries. However, as patterns of success and failure began to reveal themselves, the scope expanded to include more than 40 industries and several hundred companies. The research documents a long period of development in each industry and covers periods ranging from 15 to 30 years.
These industries cover a broad spectrum of products and services — from air express to automatic test equipment, beer to baby diapers, copper to color televisions, and tires to trucking. By observing and analyzing this evolution, we have seen that, while most companies fare poorly in hostile markets, a few perform admirably. The best performers seem to have a longer-term view of how to prosper in tougher times – a view undoubtedly developed from watching how other firms and other industries, confront and overcome economic adversity.
The purpose of this article is to outline those actions a company might take to increase the odds of prospering during those tougher times. This article will describe the causes of hostility, the phases in the evolution of hostility, and the policies of the companies that prosper during hostile times. Hostility is not the Black Plague of the Middle Ages. It is not a hopeless condition that no company survives. For some companies — providing they have astute management and an informed awareness of how an industry develops during hostile times — hostility can be an opportunity.
In summary, the primary cause of hostility is that industry leaders allow, perhaps even encourage, the entry of new competition or rapid expansion of existing competitors. They do this by holding price umbrellas over competition. The sources of those umbrellas are high costs. The disease usually comes from within the industry.
Once hostility has begun, it normally evolves through six phases. Phase One begins with very low margins. These low margins result from predatory pricing as competitors try to win share. Phase Two sees market shares begin to shift, at first due to price and, later, due to other factors. To counter this price discounting and shifting share, companies resort in Phase Three to a game of product proliferation in search of life-sustaining niches in the market. This product proliferation is expensive, especially in the face of falling margins. Every company in the industry reduces costs. Inevitably, some of the competitors in the market undertake self-defeating cost-reduction programs. The programs are self-defeating because the companies reduce their costs at the expense of their customers, and further weaken their ability to succeed. This is Phase Four. Phase Five brings consolidation. Consolidations and shakeouts take place in waves. In each wave, the companies in the hostile market reduce their overhead. Unfortunately, these shakeouts and cutbacks do not do what most of us believe they do. They do not usually improve margins, nor do they often carry the remaining companies out of hostility. Ironically, the majority of shakeouts actually intensify margin pressure rather than restore health to the industry. Phase Six takes the industry out of hostility. Most industries that emerge from hostility do so because an increase in demand rescues them from their plight.
Most companies fail, withdraw, or become acquisitions before this evolution is complete. They fail because their management policies were not effective. The few who survive and prosper do so by making decisions which follow two rules: attract customers and discourage competition. Losers lose by not following the second rule.
Causes Of Hostility
Hostility has two primary causes: a fall in demand and the expansion of aggressive competition. Expansion of competition is by far the more common cause. But it sounds ample warning, so it is also the more preventable.
- Demand Fall.
Fall-off in demand happens when something, often an external event, affects an industry’s customers. Government policy shifts often underlie the most important of these external events. The truck manufacturing, construction machinery, and farm equipment industries each fell into virulent hostility because their customer demand fell precipitously. Federal deregulation of the trucking industry in the late 1970’s drastically reduced the demand for Class 8 trucks. The demand for large construction machinery fell when both foreign governments and the United States decreased their investments in large infrastructure building projects like road, airports, dams, and power facilities. And the crisis in farm equipment resulted from a change in government farm policies. The changes ultimately reduced U.S. farmers’ international competitiveness.
- Competitive Expansion.
In this instance, several competitors see an industry as much more rewarding for expansion than do other competitors. These competitors expand much faster than the market demand grows, and this throws the industry into overcapacity and, usually, hostility. During the 1980’s, the semiconductor, airline, minicomputer, and orange juice industries went into hostility due to the expansion of one group of competitors at a rate that exceeded the growth of industry demand.
Of the two causes, the expansion of aggressive competition is, by far, more important. Expanding competition accounts for more than twice as many examples of hostility as does a fall-off in demand. Hostility, then, is more commonly seen in growing than in shrinking industries. The real cause of tough times is too many competitors, not too few customers.
But why would one group of competitors find an industry more attractive than another group? Because of differences in costs. The new entrants, and the rapidly expanding current competitors, see the current price structure in the industry as very attractive. This price structure allows such companies to earn good returns with their present cost structure. The cost structures of the remaining firms in the market do not allow them to make returns they find attractive. The Korean color television manufacturer, whose plants are peopled by hard-working ex-farm hands at a fraction of U.S. average wages, sees a color TV set price of $250 as very good. His American competitor, building sets in the United States, might feel he was giving his sets away at $250 apiece.
Sometimes these cost differences among competitors are more perceived than real. The perception problem happens when one firm or group of companies has been earning high returns in an industry and expects these returns to continue. When returns drop due to price competition in an early phase of hostility, the companies that had been earning high returns might find the market less attractive than do new entrants. Returns may not even have fallen that far, perhaps only from high to average, but the drop appears monumental to the company that suffers it. One copier company executive explained disdainfully that his company did not produce low-end machines because his company could not make enough money there. That is a dangerous statement. The company’s operating cost structure might be good enough to produce a successful competitor, but management’s return expectations are too high.
Returns cannot be managed directly. Only revenues and costs can be managed. Returns happen after customers and competitors have had their say. Returns are high when a company has a low cost structure for its industry. They are low when company cost structure is high. In a hostile industry, high returns like those of McDonald’s and Anheuser-Busch result only when a company’s unit cost is much lower than its competition. In such an industry, returns ought to be thought of as one of the costs of doing business. A management demand for higher-than-average returns is equivalent to saddling the company with higher-than-average labor costs or with expensive sources of raw material. Returns above average attract more competition.
An industry that is not hostile faces an irony, then. Almost all industries where profits are high will attract competition. These competitors will add capacity faster than demand will grow, such that almost all industries must endure hostile periods. In very fast growing industries, managers cannot avoid these. Today’s vigorous high-profit, high-growth industries stand a good chance of being tomorrow’s sick businesses. Yesterday, air express, airlines, calculators, and copiers were hot markets. These became hospital cases. Today, the credit card and computer workstation businesses enjoy terrific markets. Are they likely to avoid the disease of hostility?
The expansion of competition has one advantage over demand fall as a cause of hostility. It lets everyone know of its coming. Falloffs in demand tend to sneak up on industries. Not so with competitive expansion. Customers do not stampede from one supplier to another in herds. They straggle. Our research suggests that even a relatively fast shift in share moves only three share points from one group of companies to another group in a year. Industries that turn hostile due to expansion of competition have several years of warning that trouble is coming.
Anything a company can do to discourage the competitors it faces will reduce the intensity and length of hostility. That is well worth doing because the phases of hostility bring extreme pain and dashed hopes. It must be so because these phrases have as their primary purpose the discouragement of competition, as we are about to see.
Phase One: Margin Pressure
The dominant characteristic of every hostile industry is very low margins. Margins fall because of predatory pricing — many companies discount to seize share from others. Prices and margins fall until at least a few, and often many, companies in the industry reduce output.
The prime beneficiaries of the price discounting that produces low margins are the industry’s largest customers. Goliath usually gets a better deal than David. Large corporate buyers get better discounts than smaller corporate or retail buyers in every hostile market. Airlines and hotel chains negotiate lower rates for large-volume customers than for the average business traveler. Large homebuilders pay far less for their dishwashers than do household customers shopping at even the lowest-priced retail chains. Replacement tires are more than twice the cost of original equipment tires. Discounting to these large buyers by companies in search of large and stable volume can easily reach the point where these large customers are not profitable when viewed on a fully allocated cost basis.
Eventually, these large customers become the “commodity market” from which many industry competitors flee in the hope of finding healthy refuge in serving higher-margin, smaller customers. This is a difficult escape to execute, however, because all competitors can eventually be attracted to the higher margins of the smaller customers. The infection simply spreads to the niche markets. For example, as Honda and other Japanese motorcycle manufacturers invaded the U.S. market, European motorcycle makers responded by discontinuing smaller bikes and moving upscale with even larger machines. Predictably, most failed as the Japanese followed them into the large touring bike niche. Most large semiconductor manufacturers in the late 1980s found the expected safe haven in high-end application-specific integrated circuits to offer equally poor shelter from the turbulent commodity memory chip market.
Phase Two: Share Shifts
Each hostile marketplace experiences a major shift in market shares during the course of hostility. Our research indicates that share typically moves from one group of competitors to another group at the rate of one to five share points a year. These share shifts trigger a chain-reaction of fundamental changes in the market.
This is especially true when one company is the principal recipient or key loser of share. During the 1980’s, for example, Anheuser-Busch became the dominant brewer in the U.S. by gaining at the rate of two percentage points per year, while its competitors either maintained or lost share. Companies like Schaefer, Blatz, Hamm’s, Schlitz, Olympia, and many others gradually faded. As a result, Anheuser-Busch became much stronger than all of its competitors. It has now reached the position where it makes a good return on investment without regard to the hostility that plagues the remaining companies in the U.S. brewing industry. Conversely, Xerox lost its dominance of the copier industry by losing share at more than two percentage points a year over a 20-year period. It became just one of several contenders for market leadership. Once, the Xerox franchise produced stellar returns due to its overwhelming size compared to competition. After losing market position, the firm’s returns were considerably less cosmic. The competition could match Xerox’s economies of scale.
Three separate factors account for the share shifts in hostile markets: first, a leader’s trap, where a leading company will not match discounting in its market; second, a flight to quality, where customers shift their purchases away from weaker companies to better competitors in a market; and, third, acquisitions, where one company buys another in order to obtain more customers.
- A leader’s trap
moves share quickly, and happens most frequently to the biggest (and often the best) company in the industry. This leading company has a high margin position to protect when a discounting competitor invades its turf. Often, the discounting competitor is relatively unknown, offers a lower-quality product, or both. The biggest company decides to tolerate share losses in order to keep its prices and margins high, despite industry discounting. The leading company usually believes its superior product and the loyalty of its customers will enable it to keep prices high.
This rarely works. Usually, the leading company loses share and its prices fall anyway. The company is much worse off because it could not stop the competitive inroads. It loses customers who will be expensive to regain. Its margins fall for two reasons: first, because of the volume loss as share shifts away from it, and second, because it inevitably must follow the industry’s declining price move. In the process, it often loses the trust of some of its most important customers, who feel they had to drag lower prices out of the leading company. This loss of trust eventually increases selling costs.
A leader’s trap tends to occur in the first two to four years of hostility. During this time, price discounting can move significant share if not quickly copied. IBM held prices too high in the first few years of its competition in the personal computer business and lost nearly half of its market share to clone manufacturers. However, once the leading company decides to meet any significant discounting in the market, relatively little share will move due to price discounting. For instance, price discounting moves very little share in today’s domestic airline industry. Once the large competitors begin matching prices of discounting competitors, shifts in market share are a consequence of two other factors: a flight to quality and acquisitions.
- A flight to quality
moves share more slowly but also more permanently. Customers leave one company to buy from another because the new supplier offers better performance for the market price. Often this better performance comes through superior reliability or more accessible distribution. Federal Express continues to gain share in the air express industry because it offers a service at each major price point, because it meets its delivery schedules most consistently, and because it has more distribution than any other competitor.
also shift shares. Acquisitions in hostile markets are not purchases of companies or cash flows. They are purchases of customers and market shares. After hostility has proceeded for a few years, it is often cheaper to buy a company in order to obtain its customers than it is to try to win those customers with price discounts or additional services. As hostility proceeds, many companies will complement internal growth with an acquisition program to increase or create a presence in a market. Despite paying premiums over book value for their acquisitions, both American Airlines and Delta gained strong western footholds less expensively by buying Air Cal and Western Airlines, respectively, than if they had tried to woo those customers away with superior performance or price discounting.
Phase Three: Product Proliferation
As pricing settles to a low but stable level, companies continue their quest for share by changing performance. Most often this change in performance takes the form of product proliferation, where companies compete with one another by altering the features of their products. The changes in features are the result of either bundling or unbundling of product benefits.
Bundling of benefits is an attempt to upgrade the product by adding additional features or functions. A frequent flyer program, a suite hotel room, projection color television, color-tinted cement and not-from-concentrate orange juice with pulp are all examples of product benefit bundling. In each case, the inventor added a feature or function to the basic product in order to make it more attractive to customers. In the minority of cases, this bundling brings with it a higher priced, higher margin product, as in projection color television. More often, the intent of the bundling is to hold product price stable in a declining price market, and to gain share at the same time. The disposable diaper competition has added gender-specific shaping, imprinted cartoon characters, elastic bands, and refastenable tapes to diapers without the innovator raising relative prices.
Bundling can create an advantage for the larger competitors in the market by using up shelf space or distribution that would have gone to smaller companies. Gender-specific disposable diapers forced retailers to increase the diaper shelf space for Procter & Gamble and Kimberly Clark diapers, and to reduce the space available for the private label brands manufactured by smaller firms. Tropicana and Minute Maid’s product bundling in the orange juice market have had a similar chilling effect on smaller orange juice producers.
At the other extreme of product proliferation is unbundling. Here the innovator removes some customer benefits from the industry standard product in return for a much lower price. Maxsaver air fares, private-labeled products, and Marriott’s Fairfield Inn chain are examples of benefits unbundling. In each case, the innovator has stripped some customer benefits away from the industry standards product in order to reach a highly price-sensitive segment of customers. Maxsaver air fares carry cancellation penalties, private label tires or appliances carry no advertising and more limited warranties than their branded cousins, and the Fairfield Inn chain has a lower quality construction standard than does the standard hotel. Each product, though, has a distinct following among a group of customers who could not, or would not, use a higher priced product alternative. Unbundling often increases the total size of the market itself, and hastens the end of hostility.
Product proliferation via bundling or unbundling does not produce the eventual winners in a hostile market. Product proliferation does raise the ante for all competitors, though, and is an important precursor to the next evolutionary stage.
Phase Four: Self-Defeating Cost Reduction
As hostility continues, many customers demand that their suppliers offer the latest in product features and benefits. These benefits can be expensive to create and maintain in a low margin environment. Inevitably, some competitors destroy their chances for eventual success, perhaps even for survival, with a series of self-defeating cost reduction programs. The programs are self-defeating because they almost invariably reduce the company’s ability to serve customers as well as the rest of competition can. These self-defeating cost reductions fall into three typical categories: failure to match current features; quality slippage; and distribution conflicts.
- Feature Failure
The decision to delay matching popular new product features in the marketplace often causes the company’s products to lag behind those of the best competitors. In the late-1970’s and early 1980’s, the residential roofing industry made a massive conversion from organic felt shingles to glass fiber shingles. The glass shingles were cheaper, lasted longer, and had a better fire rating. Nevertheless, some shingle manufacturers refused to make the switch from organic to glass shingles until after they had lost significant market share.Eventually, feature failure will cost the company serving the broad part of the market a minority of its share. It could cost a niche player the majority of its share. However, for the larger company this decision is more survivable than a decision that jeopardizes product quality.
- Quality Slippage
A decision not to keep pace with improving industry quality standards or unilaterally to allow quality to decline is very damaging. Once People Express Airline and Yugo automobiles earned reputations for poor quality and service, recovery became a long-shot. The maintenance of high quality standards in hostile markets is particularly difficult for service firms. It is too easy to assume that the customers will not notice the small things like worn carpeting in the hotel or old paint in the fast food restaurant.The longest lasting of the self-defeating cost reduction is the decision to let quality fall. Customers seem to talk more about failures than about successes. So, selling costs rise disproportionately on failure. And, as General Motors has learned in a very painful way, customers are very slow to forgive quality problems. Market share lost on quality is the hardest to recover.
- Distribution Conflicts
Another self-damaging cost reduction program is the decision to pass some or all of the pain of a hostile environment on to the channels of distribution, including the inside sales force as well as outside distributors. An industrial equipment maker milked his key product by pricing it high and by allowing competition to match or exceed its operating capabilities. Demand stagnated. Profits fell while sales costs rose as a percentage of revenues. Management “solved” the cost problem by reducing sales commission rates and by charging salespeople for transportation costs previously paid by the company. Within a year, some of the company’s best salespeople left. These salespeople went to competitors, and were replaced at the company by new salespeople who were unknown to their customers. Relationship bonds between the company and some of its customers broke. Sales and profits then fell further as some customers shifted to other suppliers.
In each case, the nature of the cost-reduction decision is the same – to make it more difficult for the distributor to earn the same income. The company restricts territories, cuts back cooperative marketing programs or other forms of support, raises sales and bonus compensation targets, and, in the case of distributors, forces them to take more inventory than is ideal for them. This type of decision, if not initiated or matched by other industry competitors, usually damages the company. The best salespeople leave. The best distributors either change franchises or diversify into other products. The company loses important contacts with its customers, and accelerates its downward spiral.
Companies that cut costs at the customer’s expense are prime candidates for early shakeout. But before shakeout, the industry usually sees various other forms of consolidation, all of which share a common theme: the reduction of the overhead cost built into the product. And this industry cost reduction usually means that price pressure, and its resulting margin squeeze, intensifies. Consolidation happens in three waves: rationalization, national takeover, and international combination.
The first wave is internal — the company consolidates facilities, withdraws from unrelated businesses, and reduces overhead. This overhead reduction may also come in steps, with early efforts targeting a 10 to 25 percent overhead cost reduction, and later stages aiming for 25 to 50 percent reductions from the original base. The domestic automobile industry offers multiple examples of this kind of effort. During the 1980s, each of the three major domestic automobile manufacturers announced and began implementation of overhead reduction programs to reduce white collar employment by at least 25 percent at the same time as unit sales volume grew. Overhead costs embedded in the product dropped for each company and break-even volumes declined apace.
- National Takeovers
The second wave of consolidation is external. This wave sees mergers and acquisitions in the industry. Larger companies buy smaller niche players — for example, Northwest Airlines buys Republic. Or, stronger large firms buy weaker large firms — for example, GE buys RCA. Overhead savings result as the acquiring company lops off a good part of the newly acquired senior and functional staff management, and rationalizes the rest. These takeovers are rarely a single domino falling. Instead, several takeovers involving multiple competitors happen within a one- to two- year time frame. Industry costs per unit of product sold decline.
- International Combinations
The third wave flows across national borders as the surviving large firms in global industries buy one another, or form joint ventures to reduce functional costs. Bridgestone’s purchase of Firestone Tire, Komatsu’s joint venture with Dresser in construction equipment, and Volvo’s joint venture with GM in truck manufacturing, are examples of such consolidation. Industry overhead costs are reduced in this wave as well.
All of these consolidations are shakeouts of a sort. But these shakeouts do not relieve the price and margin pressures. In fact, they often increase the pressure on the smaller remaining competitors because the industry capacity remains. Capacity does not go away easily because product prices rarely reach a point low enough that no one can make an operating profit on the going concern. As long as a business can produce an operating profit, some investor in today’s capital-rich global economy is likely to buy and operate it. The new owner will try to reduce costs further and, because he often acquired the business for a bargain price, he already has a lower capital carrying cost than his predecessor. Industry costs fall again.
The truck manufacturing and semiconductor industries offer examples in International Harvester and Fairchild Semiconductor. International Harvester, burdened by too many ancillary businesses, failed as a company and entered bankruptcy proceedings. A much smaller, stronger and more focused company emerged, though, in the form of Navistar. Navistar has reasserted its former claim to the leader’s position in the U.S. truck manufacturing industry, and today runs neck and neck with Paccar for the title. Fairchild Semiconductor spawned several of the leaders of today’s semiconductor industry before it failed. The U.S. Government prevented the Japanese from buying the failing company. But National Semiconductor did take over Fairchild, at a fraction of its asset replacement value. In neither case did industry capacity fall. It rarely does. Rather, failed capacity was recycled to a stronger player, and margin pressure remained.
Phase Six: Rescue
The international combination, and even the national takeovers, do not happen quickly. These developments take years to evolve. But the average industry as it turns hostile will have many years to evolve. Hostility lasts a long time in most industries. The average industry will spend more than five consecutive years in tough times, and some will spend more than ten years in this harsh environment. Truck manufacturing has been hostile for more than 10 years. So have the airline, beer, copier, and cement industries. But hostility does eventually end. It ends either when the industry has consolidated down to three or four key players or when demand finally grows faster than the industry can add cheap capacity. Since it can take 15 to 20 years for consolidation to reduce an industry to only only three or four players, demand rescues most industries from hostility.
- Few Players
Some industries emerge from hostility by consolidating down to three or four key players who each give up trying to win share from one another through price discounting. These three or four key competitors will control more than 80 percent of the total market. If there are smaller competitors in the market, these smaller firms have learned to avoid direct competition with the larger companies and to stress performance rather than price in their product packages.
The disposable diaper industry serves as an example. Procter & Gamble and Kimberly Clark control over 80 percent of the U.S. market for disposable diapers. These two companies beat out six other larger companies to achieve their positions. Several small companies also serve the market. However, each of these smaller firms is either a private label producer earning marginal returns or a focused purveyor of expensive products, such as special biodegradable diapers. Price competition is very limited.
By itself, the reduction of the industry to only three to four key players is not enough to end hostility. Each of these key players must view price competition as futile as well. The farm equipment industry had only a few competitors by the late-1980’s, but hostility continued as price continued to move share. This share movement on the basis of price can be stopped only when the industry leader decides to meet any discount that moves share.
Relatively few industries come out of hostility due to consolidation. The process takes too long, lasting 15 to 20 years. The large appliance industry is out of hostility, with only four companies controlling 90 percent of the market. But that consolidation took 20 years.
- Demand Growth
When an industry breaks out of hostility, growth in demand is the underlying reason in most instances. After several years of bad times and low levels of investment, demand catches up to and exceeds the physical ability of the industry to supply product. Industry prices and margins rise. Margins rise to the point where a company can justify investment in additional physical capacity. At that price level, capacity already operating in the industry usually earns attractive returns. The industry comes out of hostile times because customers have fewer choices than previously.Surges in demand regularly yank the semiconductor industry out of the worst slumps in its long-term hostile market. Trucking emerged from hostility in the late 1980’s with the wind of the increased demand at its back. In both cases, an increase in demand raised prices in order to provide industry competitors enough margin to bring on additional capacity. These increases in demand resulted from an increase in the markets of these industries’ customers.Some increases in demand are due less to growth of customer markets and more to shifts in international currencies. Many of the metal markets of the late-1980s are examples. In 1987, the dollar devalued by an average of 40 percent compared to the currencies of America’s major trading partners. This currency shift made U.S.-produced goods less expensive on world markets, and made many foreign products more expensive in America. One obvious group to benefit from this devaluation, and its consequent changes in relative costs, was the metal production sector. In the late-1980s, the aluminum, copper, and steel industries all escaped the pain of hostility. These industries recovered largely because their domestic demand increased with the changes in the dollar exchange rate.
These six phases of evolution happen in all hostile markets. The ordering of the phases, however, is not ironclad. While the progression described here is the most common, the sequence and timing of the middle phases can vary from industry to industry.
Hostility is certainly not over. Many of the industries that were hostile in the 1980’s will suffer a recurrence during the 1990′. Many other industries that avoided hostility’s destructive path with high growth rates will have to contend with it in the next few years. The continuing emergence of the Pacific Rim and a revitalized Europe will make it so. But there is time now for preparation. And it is easiest to prepare for hostility before, not after, it exists. Good preparation is a matter of changes in policies.
Most companies fail in a hostile marketplace. An industry starts out with many competitors and ends up dominated by a few big ones. Failure is rarely due to bad luck. Most share loss is voluntary. Nor is failure usually the result of poor execution. Most companies are amply stocked with capable, hard-working people trying to do things well. Failure is usually the price a company pays for bad management policies.
As a general proposition, bigger is better in all hostile markets. Size is an advantage not only because of traditional economies of scale, but also because of the natural cost advantage that accompanies ownership of the customer relationship. Customers change suppliers only when someone new offers notably better performance or lower price — either of which implies a much higher cost structure than that of the incumbent supplier. As in boxing, all ties go to the champ. Whatever a company does, it would prefer to be the biggest at doing it. It is not that small firms cannot survive, it is just that the odds are against them. Spud Webb, at 5-feet/5-inches, is a fine guard in professional basketball, but you would much rather be 6-feet/5-inches if you want to try out for the NBA. The same holds true for companies that face hostility. Big is beautiful and small is vulnerable.
Despite the odds against them, though, some small companies do survive and even prosper in hostile times. Cooper in tires, Samuel Adams in beer, Cypress Semiconductor in semiconductors, and J.B. Hunt in trucking are examples of smaller firms competing nicely in very tough markets. These companies prosper by focusing their organizations very tightly on particular groups of customers, forsaking all others. They win because they beat the standard industry performance package for their products, and because they avoid all costs not specifically targeted on their chosen customer groups. They steer clear of all forms of competition based on price. The discipline and clarity of purpose of all smaller companies that succeed in tough markets is much to be admired.
Among the more general population of companies, though, those who win in hostile markets adopt management policies that make them bigger than as many of their competitors as possible. Among these policies are the following:
- Grow faster than the market. This seems obvious, but it takes a conscious decision that proves hard to face when returns in the industry are abysmal.
- Shut the marketing window. The key barrier to entry in any hostile market is a satisfied customer, not the cost of physical capacity. If competitors try something that moves share, winners copy it.
- Offer products at each key price point. If customers migrate, the winners want to offer them a pathway. If customers buy multiple products, winners offer one-stop shopping.
- Stress reliability over features and convenience. Most features are easily copied, so they cannot offer much in the way of permanent share gain. The most reliable company ends up with high convenience as well. Customers and distributors search them out. Reliability is also very hard to copy.
- Match but do not initiate price discounts. After the first few years of hostility, discounting moves little share. But it does destroy industry margins. Still, companies that price high by refusing to discount lose share quickly as discounting becomes widespread.
- Price to discourage competition. The only role price plays in a hostile market is to discourage a company from competing for someone else’s customers. Winners do not compete on price directly by predatory discounting. They price at the market but ensure that the market price is low enough to make anyone else’s discounts very painful to maintain.
- Build cost structure around price, not the other way around. Winners use a “design to value” mentality that sets the benefits and price structure the customer needs, and then designs the company cost structure to meet those targets.
- Cut costs not benefits. Losers cuts costs by cutting customer benefits. Customers leave and the company gives up the lowest cost position in the market, the ownership of the customer relationship. Winners maintain their customer benefits. They reduce the cost of providing benefits while offering the best value in the market.
- Reduce unit cost over total cost. Winners usually win by having the most productive cost structure rather than lowest cost structure. In many cases, winners add to total costs in order to gain more customer volume over which to spread a somewhat fixed cost structure. This reduces unit costs, and units are what customers buy and competitors discount.
In short, winners follow different policies than losers. They obey the Two Great Commandments of hostile markets. One, do what will be attractive to customers because customer ownership is the key to a low cost position. Two, do what competitors will find hard to copy because low returns are due in the main to too many competitors. It sounds a lot easier than it is. That seems to be the way of all commandments.
(Note: This Perspective was written in the context of the economy in 1991. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)