WHY DO LEADERS LEAD?
by Donald V. Potter
Complexity is so prevalent that we view it as unavoidable and unyielding. We are so used to viewing the world in complex terms that we are suspicious of simple ideas and those who advocate them.
Yet a study of leadership companies shows that leaders respond to complexity in ways that are notable for their simplicity. Leaders lead because of their self-discipline, their awareness of limits, and their adherence to a very small number of factors. In a world that breeds clutter, the leaders strive to reduce the noise. The result is a set of simple precepts for dealing with a complex world. What the leaders are doing may seem simple, but it is anything but easy.
Who are the leaders? Their ranks include the likes of McDonalds, Boeing, IBM, The Price Club, Sony, 47th Street Photo, Compaq Computer, Toys ‘R’ Us, Bluebird Body Co., Marriott, and Toyota. These companies compete in various industries, but their patterns of leadership hold lessons for would-be leaders in all industries, service and manufacturing, new sectors and old, large companies and small, in high, middle, and low-tech product areas. Leadership is decided by only one determinant – the customers. And the customers, in turn, recognize leadership for only one reason – cost and value consistency.
Leaders teach us with their simple and concrete strategies. Strategy for leaders means cost and value consistency – deciding who you are trying to serve and what costs you are willing to have in order to provide that service. Once these decisions are made, leaders teach us to pursue them with single-minded resolve. Leadership also teaches us to live within our limits. Leaders know whom not to serve. They don’t feel sorry about saying no. And leaders teach us that the market richly rewards those who follow the fundamental rules, just as it punishes those who ignore them.
For the last few years, we have been studying the business strategies of more than five hundred corporations. Most of the research data has been drawn from the business press and other publicly available, non-proprietary sources. This research has helped us to find patterns revealing simple rules of economic success. These patterns cross industry lines because they result form fundamental economic forces of competition and from decision psychology common to all customers. Thus, a general manager in the steel industry can learn from leaders in the electronic components industry, and a bank can learn from a leader in the transportation business. Regardless of where they are found, leaders present themselves by their results. Their customers provide them with increasing market share and high returns on investment. (For more on how industry leadership was defined in our research, see end of article).
Customers tell us who the real leaders are. They tell us by the way they buy the leaders’ products rather than the competitors’ offerings. Real leaders grow faster than their industries, and make more money doing it, by having a persistent value or cost advantage in serving customers.
When they put their money down, customers make the final decision on who the leader is. No one else counts because no one else pays. The general manager must rely on the customer to identify his industry’s leaders, because the customer, and the customer alone, is objective. Claims of leadership from inside an organization are suspect; a corporate staff will deliver the descriptions that top management wants to hear. To one degree or another, the same holds true for suppliers and professional advisers. But customers don’t care. They buy what is best for them at a price that strikes them as fair in relation to their direct and indirect alternatives.
Leaders achieve their fine results by following one of four basic types of strategy, each of which combines a decision on cost level with one on breadth of value offered. Leaders deliver higher relative value and lower relative cost because they are disciplined and objective (meaning that they assume the customer’s viewpoint) when making their two decisions. The first decision is how broadly to define their value. The second is whether to have a high or low cost structure to deliver that value. The first decision, value, determines which customer segments the company will serve. The second, cost, determines the company’s relative cost levels, compared to the industry standard. These decisions are made at the level of the company’s products or product families, where strategy has its most concrete meaning.
In combination, the outcomes of the two decisions produce the Leadership Matrix (Exhibit One). Each position on the matrix represents a type of strategy; each leadership company falls into one of the four positions. Over time, any industry will develop competitors in each of the four positions (with the possible exception of Next Leader.) The leader in each position will be the competitor with the highest sales growth and above-average profitability, over a significant period of time.
EXHIBIT ONE: LEADERSHIP MATRIX
The first and foremost lesson from the leaders is this: a leader’s product can occupy only one position in the matrix. Each position is unique and is incompatible with any other position. The research demonstrates, again and again, that a company falters when it strays from its position, when it offers a pale imitation of a leader with insignificant cost or value differentiation, or when it tries to occupy two positions simultaneously. “Know thyself” may sound trite, but it proves to be indispensable for long-term success.
Understanding the precepts of leadership can help a company develop a product to compete and win against a leader. To attack a leader at his point of strength is usually an invitation for failure. However, there are elements of vulnerability inherent within each successful leadership approach that an able challenger can exploit. (Exhibit Two).
EXHIBIT TWO: VARIABLES OF THE LEADERSHIP MATRIX
|HOW DO YOU PRICE?
|HOW MUCH SHARE DO YOU EXPECT?
|HOW DO YOU WIN? (OFFENSE)
|WHERE ARE YOU VULNERABLE? (DEFENSE)
|At industry standard
|Moderate performance and price with good economies of scale
|Complacency allows value to slip or relative costs to rise opening way for other leaders
|25-50% below industry standard
|Low performance and even lower prices with very lean cost structure and little marketing
|Value drops too low for market or costs rise in futile attempt to achieve more share than market offers
|At a premium above industry standard
|Broader than standard solution to customer problem with careful attention to marketing and operating costs of value provided
|Costs rise too high for value offered so industry leader copies
|At or below industry standard
|Much more performance for a niche with much lower cost structure than industry standard
|High profits in early years breed sloppy organization with high costs in maturity
The single most useful way to judge where a company product stands in the Leadership Matrix is to look at its pricing. Pricing gives the customer the first clue as to how a company wants to be compared to others. If product pricing is at or near the industry standard, then customers will compare to the Standard Leader. Prices more than five percent above standard usually invite comparisons against the Performance Leader. A company will be compared to the Price Leader when its prices are more than 15 percent below industry standard. Next Leaders are unique. Most often their prices are well under industry standard for the market segments they are serving. But pricing is only the first way to characterize a leader. There are several more.
I. Standard Leaders
Standard Leaders set the standards for value in the marketplace. They are everyone else’s reference points in statements such as “cheaper than…” “faster than…” and “better than…” Standard Leaders set the prices, establish the levels of service, and serve as the functional benchmarks for the rest of the industry. One of the Industry Leaders enjoys the largest share of the market and low unit costs, although in some cases costs will fall out of line and result in high unit costs. Their prices set the industry standard, being neither the highest nor the lowest.
Many Standard Leaders are consumer and industrial household names: AT&T, Sears, Boeing, Caterpillar, General Electric, General Motors, IBM, Merrill Lynch, Safeway, and United Airlines. Others are relatively unknown outside their industries. Blue Bird Body Company is the nation’s leading marker of school buses. Quotron dominates the electronic stock quotation market. Club Corporation is the leading owner and manager of country and town clubs. Service Corporation International leads the nation in funeral and cemetery management.
The Standard Leader must constantly balance value and cost. He can be attacked on either front. If he lets his value slip, he loses some of his market to another Industry Leader or to a Performance Leader, such as the way IBM ceded some of the minicomputer market to Digital Equipment Corp. On the other hand, if the Standard Leader lets his cost drift too high, he is vulnerable to Price Leaders. IBM’s pricing levels for its personal computers are high enough that a large number of low-priced compatible equipment manufacturers can profitably sell under IBM’s umbrella.
On the broad value and cost front, a Standard Leader should by invincible. He sees the most markets and has the best known name. His unit cost for value delivered should be lower than any competitor’s. When a Standard Leader loses, it is usually because he has tried to take a shot he did not have. He tried to charge a price for value he did not deliver-and the customers, as usual, called “foul.”
An example is Computervision, which in its 1970s hey-days led the CAD/CAM industry with as much as 40 percent market share. But Computervision insisted on selling its product as a complete package, including its own minicomputer, display terminal and software. While Computervision had a distinct value advantage in its software, it had a cost disadvantage in hardware manufacturing. Eventually IBM introduced a software CAD/CAM product that ran on IBM equipment. Other CAD/CAM companies began writing software for DEC and Data General minicomputers. By the end of 1985, Computervision’s market share had fallen to 12 percent, a distant third to IBM’s 20 percent share and Integraph’s 15 percent. Computervision was losing money and rewriting all of its software to IBM standards. By then it had no cost or value advantage in software. Unless IBM makes an equally bad strategic mistake, Computervision will remain a follower.
The research shows that Standard Leaders are not as dominant as might be assumed. As a rough rule, the Industry Leader companies hold 80 percent of the market. Individual Standard Leaders who lead their industries average about 35 percent of the market. Some market leaders vary notably from this average. Cummins Engine Co. holds 60 percent share in the heavy-duty truck diesel engine market, and Boeing commands 60 percent of the commercial airline industry. Phillip Morris has nearly 40 percent of the cigarette market, and 40 percent represents the market shares of such well-known Standard Leaders as Coca Cola, GM, Anheuser-Busch, Kellogg’s, and Federal Express. The leader in the airline industry has less than a 20 percent share. But, some share of many industries is under the command of the Price Leaders and the Performance Leaders.
The Standard Leader’s peril is that success breeds complacency. Complacency destroys both cost advantage and value. For example, the offshore oil-drilling rig market was dominated for years by McDermott International and Brown & Root. Then the 1970’s oil boom created complacency and overhead – lots of it. In 1985, Shell Oil put out for bid the “Bullwinkle,” which at $200 million was the world’s largest and most expensive oil drilling platform. The two industry leaders submitted their bids – in vain. The winning bid came from little-known Gulf Marine Fabrications. This lilliputian firm, consisting of four executives and a secretary, literally brokered the Bullwinkle deal by subcontracting all the key functions to outside suppliers.
A strong, market-leading Industry Leader is hard to attack directly. A competitor’s small advantage on either value or cost can be imitated or surpassed by the Standard Leader, whose superior economies of scale and market share will usually win such confrontations. In order to successfully pull off a frontal attack on a Standard Leader, a competitor must offer the customer clearly better performance for an equal price. This feat is hard to accomplish unless the competitor enjoys a notably lower overall cost structure than does the largest Standard Leader. IBM overcame the Standard Leader, Computervision, by having a lower overall cost structure for its product package. Gulf Marine Fabrications surpassed the leaders of its industry by keeping overhead very low and by using subcontractors from industries with overcapacity, who were prepared to bid very low in order to get the work. The profitability of Ford, Chrysler and the Japanese auto factories in the U.S. compared to GM suggests that the auto Standard Leader has costs that are badly out of line for the value produced.
II. Price Leaders
Price Leaders have product offerings that meet the most basic needs of a broad part of the market. But their primary thrust is that they take on the world with very low prices. They do this by offering value that is below the industry standard – the lowest, in fact, that their customers will buy. They maintain a very lean cost structure with tightly-run operating and control systems.
Pricing is the Price Leader’s forte, his reason for being noticed by a customer. One finding of this research was how large a discount cost leaders must offer to be successful. They will commonly offer their products and services at discounts of 25 to 50 percent off the industry standard. For example, discount stockbrokers are 40-70 percent below the industry standard. Generic drugs sell for 30-70 percent off the branded equivalent. Most IBM compatible PC clones sell at 40-50 percent below IBM. Crown Books sells books at 40 percent off retail. Burlington Air Express advertises its air package delivery service at a price 50 percent below Federal Express. Epson established its personal computer printer business by offering prices 40 percent below standard.
The research suggests that if the discount offered is beneath this threshold, not only will the strategy fail but, curiously, it could wreak greater havoc on the entire industry than if a more dramatic discount were offered. In theory, small discounts can win customers; a customer will move for one percent, providing the product and service package offerings are exactly the same. The problem with the smaller discounts is that competitors will match them. And when the competition matches the discount, all competitors are back on the same footing, but with lower revenues all around. Customers get confused by all the discounting and delay their purchasing decisions to avoid making a mistake; this delay further raises the industry’s selling costs at the same time that its revenues are falling.
On the value side, the Price Leader leads by stripping the product down to bare essentials – no frills, no extras. Price Leaders offer distinctly different products from those of Standard Leaders. They offer much less performance in return for their much lower price. Earl Scheib will paint any car any color for $99.95, but don’t ask for any body work for that price. You can not buy top-of-the-line Carver stereo components from 47th Street Photo. Discount stockbrokers don’t give investment advice, and the Hyundai automobile company cannot sell you a station wagon. If you miss a Supersaver flight, you pay a penalty. Customers have to drive some distance and buy in bulk at the Price Club.
The Price Leaders offer a product that is less than industry standard, and that fact usually limits their potential market share to less than 20 percent of the total market. Discount brokers hold less than 20 percent of the retail brokerage business. Generic foods have less than 20 percent of the U.S. grocery market, while generic drugs hold about six percent of the market for prescription medicines. All of the long-distance phone discounters combined, including MCI, Sprint, Allnet and the others, have managed to capture only 20 percent of AT&T’s former monopoly position.
If Price Leaders took much more of the market, the Standard Leaders would imitate them and preempt their growth. In the case of the long-distance phone companies, their price advantage has shrunk to 10 percent due to AT&T’s aggressive counter-discounting and their share inroads have stopped. As long as the discounters strip down their product to achieve a defendable price advantage, they will, by definition, appeal only to a minority of the market place. And that minority is smaller than is generally assumed.
Price Leaders often win market share at the expense of someone other than the Industry or Performance Leaders. Price Leaders virtually never compete with Performance Leaders. Their customers are completely different. In fact, Price Leaders do not have much competitive overlap with the standard products of effective Standard Leaders, either. Their real products differ too much from one another. Most of the Price Leader’s market comes from new customers, rather than from customers switching allegiance within an industry. While the Price Leaders offer lower value and price than one Standard Leader, they may in fact offer higher value in another, lower priced, market.
Apple Computer has been fighting for several years to keep low-cost clones from copying its products. Today Apple clones hold less than 5 percent of the total market for Apple II-type machines. The few clones that do exist sell through completely different distribution channels than does Apple. They claim to be competing, not against Apple, but against Atari and Commodore on the low end side of the home computer market. Apple, in fact, might be missing a chance to use the clone makers as entry-level producers selling to customers who later could be persuaded to upgrade to a better-performing Apple-made system.
Price Leaders help, not hurt, their industries. Their discipline of low prices and low costs leads them to unconventional methods of design, manufacturing, sales and service. Astute competitors watch them carefully as if they were a laboratory for useful experiments. The “Courtyard” mid-priced suburban hotels of Marriott had their conceptual genesis in the late 60s and early ’70s with Price Leaders such as La Quinta Motor Inns, who developed mid-priced suburban hotels catering to travelling mid-level business people.
Price Leaders help expand an industry’s customer base. Airline deregulation and the advent of the discount airlines drove down ticket prices while passenger ridership increased at a rate three times faster than the growth of population. People who would otherwise not have flown – or not traveled at all – have taken to the air. Much of Greyhound Bus Lines’ current trouble can be laid at the feet of People Express and its more successful airline industry peers.
Successful Price Leaders have well-crafted control and management information systems. Their compensation systems may be tied to productivity, and their work forces rarely are underpaid or suffering from poor morale. They manage superbly the three generic costs of people, purchases, and net capital employed. United Parcel Service is the country’s largest employer of Teamsters. UPS drivers make more than other truckers. In the face of high labor rates, the company has meticulous human engineering that produces the industry’s most efficient work force. UPS sets and monitors standards for how fast drivers walk, how they should bring customers to the door quickly, for the number of packages a sorter should handle in an hour, and so forth. Quick & Reilly, the highly profitable discount broker, farms out every function possible to outside vendors, rents low-cost office space, and buys only used furniture. Worthington Industries prospers in the dismal steel industry by concentrating on employee productivity; about half of a Worthington employee’s compensation comes in a bonus tied to profitability. Total annual compensation packages well above the average of the highly-paid steel industry have become the norm at Worthington. In another trend counter to the industry, Worthington’s labor force continues to grow due to the company’s high productivity per dollar of labor cost. The electronic superstore chain Circuit City puts its large stores in out-of-the-way sites, uses a sophisticated computerized cash register system to turn inventories faster than the industry average, and keeps purchasing costs low by using co-ops.
In addition to lean operating structures, Price Leaders save on marketing costs. Customers find them because many of their customers are buyers only at low prices. Marketing investment, per unit of sale, is lower for a Price Leader than for the rest of the industry. The newspaper ads of 47th Street Photo are stark, showing only products and price quotes with no creative copy or expensive artistic effects. Service at the point of sale is minimal. Price Leaders get away with marketing murder by the standards of their more traditional competitors.
The Achilles heel of Price Leaders is value. That is why Price Leaders may take on a Standard Leader but rarely challenge a Performance Leader. Standard Leaders usually counterattack on the value dimension by emphasizing to the customer what he gives up by patronizing the Price Leader. Are you a long-distance caller? AT&T goes more places. Are you a business traveler? You can’t change your itinerary on a Supersaver plan. Do you enjoy the social aspects of shopping? You can’t see a live fashion show in a mail-order catalogue.
The research shows that when a Price Leader does get beaten, the defeat is usually self-inflicted. Once its rapid market penetration has reached its natural limits, the temptation is mighty for the Price Leader to upgrade, so he starts adding services. These new services add costs and soon the Price Leader begins to lose his major drawing card, low prices. He begins to look more like a Standard Leader. In the retail industry this is called “trading up,” sprucing up the store, adding a little more help, improving the quality of the merchandise. Bradlee’s, the large discount subsidiary of Stop & Shop, grew rapidly during the 1970’s by offering basic merchandise at rock bottom prices. Near the end of the decade, management felt it needed to differentiate itself and launched a trade-up program, upgrading both merchandise and service. Increased costs rendered the company uncompetitive on the prices of its basic merchandise, and profits plummeted as a competitor attracted the markets Bradlee’s was abandoning. Bradlee’s forgot to whom to say no.
A Price Leader must have the industry’s lowest cost structure to carry out its low priced mission. If an industry can meet or beat the Price Leader’s cost structure, the Price Leader is doomed. This explains why Price Leaders have such a difficult life in industries with substantial excess capacity. People Express offered substantial discounts on its flights. But the airline industry had far more capacity than it needed, and low marginal costs for adding another few passengers to a flight. Rather than give up market share to People Express, Standard Leaders like United and American used their low marginal costs and excess capacity to meet any price that People Express offered. The airline industry is an environment too hostile for a Price Leader’s survival.
III. Performance Leaders
As product and market innovators, Performance Leaders concentrate on a niche in the marketplace and employ a high cost structure to serve it. They serve their market with a broader view of the customer and his problem than is typical for the industry. They have to be the industry’s best marketers, because their costs and prices are above industry norms. Performance Leaders offer a premium product at a premium price. The PIMS research suggests that a customer perceives prices starting at five percent above the industry standard as being those of a Performance Leader.
The Performance Leader justifies these high prices by offering customers greater value. An Air Stream recreational vehicle, the “Silver Bullet” of the highways, sells at a premium that is 60 to 300 percent above its industry peers. Air Stream takes a broad view of what it needs to do for its customers. It builds in microwave ovens and cedar closets. Want a hickory writing table for your RV? Get one from the Wally Byam Store and Service Center (named after the company’s founder) that is located near the Ohio factory. Wondering what to do about with your RV once you’ve bought it? Join the Wally Byam Caravan Club International. The club is partially funded by the company and organizes caravans and rallies around the world. The Club members also buy more than half of Air Stream’s annual production.
Other Performance Leaders follow similarly broad dictates for serving their customers. Cross Pen sells “classic styling” in its silver and gold pen-and-pencil sets. Esprit de Corps offers to its young women customers a total “Esprit Girl” look – mix-and-match outfits, accessories, shoes, and make-up. The company controls this look down to the sales girl training, the displays of merchandise, and the advertising formulas used by its retailers worldwide. Dreyer’s Ice Cream ensures the freshness of its product and a changing variety of flavors by employing a direct store-door distribution system that is unique in its industry.
There are two components to value: performance and price. Performance covers the total solution to the customer’s problem. A product is not a device. A total solution is much more than the physical device or the service that the customer uses. A company has produced a device at the factory door. That device does not become a product until a customer uses the device. Between the factory door and the customer’s use come the marketing and selling costs that turn a device into a product. The performance part of value includes activities such as marketing and advertising, which let the customer know the product can solve his problem. Performance covers sales, the differentiation of the product from other potential solutions, and the delivery of the product to the customer through the distribution channel, with the attendant costs of inventories and receivables to make the product convenient. Under this broad definition of value, performance also encompasses any costs of keeping the product operating, such as warranties and service. So, in thinking about performance of its product, a company needs to consider not only the functions the product performs for the customer, but also the marketing and selling services performed on behalf of the customer.
Price is the second component of value. Since value cannot be measured absolutely, only relatively, price determines whether or not value is high or low compared to other products and solutions. The standard of performance is set by the price level paid by the largest part of a market.
The Performance Leader’s costs are higher than the industry standard. He is constantly at risk that his high prices will depress his volume further and make his cost position even worse. The best of the Performance Leaders compensate for this problem by becoming the best marketers in the industry and keeping a wary eye on costs, since higher costs mean higher prices and smaller volume. Piedmont Aviation builds its fleet around Boeing 737 aircraft so that most of its pilots can fly most of its planes. Esprit subcontracts all of its manufacturing to Far Eastern suppliers. Compaq puts together teams to pour over each of its complex models, searching for pennies to save out of their manufacturing costs.
Compaq’s marketing skills also help it control costs by keeping it focused on the technologies that its niche customers want – or, just as importantly, don’t want. By knowing whom not to serve, Compaq keeps its cost structure lean and preserves its value premium. The company grew on the back of its transportable IBM-compatible personal computer. Compaq had the technology for a laptop computer and was mulling the development of an entry-level machine for novice computer users. However, extensive market research indicated that Compaq customers were experienced computer users who had no interest in a system for beginners. So Compaq dropped that idea and, instead, focused entirely on a new generation of personal computer built around Intel’s state-of-the-art 80386 chip. Compaq’s “386 machine” led the market, and the company avoided the costs of producing machines with limited appeal for their market segments.
Another example of a Performance Leader’s marketing/cost efficiency is Marriott’s aforementioned entry into smaller “Courtyard” hotels. Marriott did its first round of market research by watching a Price Leader. Then came meticulous testing of prototype rooms with several hundred customers, during which Marriott learned that while customers didn’t mind rooms that had less depth, they were bothered by rooms that seemed narrower. Once Marriott was satisfied that it had its product value right for its customers, it ran the Courtyards with rigid attention to cost control.
As with their Price Leader cousins, Performance Leaders can control only a minority of the market. If they get much larger than 20 percent share the Standard Leaders will imitate them and take away business. Specialty stores, with a keen showman’s eye and distinctive merchandise, became the retailing stars of the ’80’s. Today the large department stores are copying that success by opening specialty stores within their stores. In another example, an innovative company called United Tote introduced a microcomputer-based machine for race track betting that had more value than the conventional minicomputer-based machine. So the top Standard Leader, American Totalisator, introduced its own microcomputer-based system.
As in the United Tote example, Performance Leader products usually have a competitive overlap on the Leadership Matrix only with the Standard Leaders. The customers of a Price Leader are so different that a Performance Leader rarely sees them. But a Standard Leader has the same relationship, and bears the same threat, to a Performance Leader that a Price Leader has to a Standard Leader. A successful attack on a Performance Leader is usually based on beating the Performance Leader on costs and pricing. The successful company will offer the similar performance at a lower price.
IV. Next Leaders
The last of the leadership paradigms are Next Leaders, companies that serve a market niche, at least in the early stages, and that have a significant cost advantage. Next Leaders are usually outsiders to the industry and their effect is so profound as to create what is essentially a new industry. Until their imitators catch up, the world belongs to the Next Leader because no one can beat him on value and cost. His pricing is usually well below the industry standard, even though he offers performance that is often higher than that of the Performance Leader.
The Next Leader usually starts with one product aimed at a niche, such as the original Apple computer. Atari, with its Pong game, was a Next Leader who created the electronic game industry. Other examples are Disney with animation, Federal Express with overnight air parcels, Polaroid with instant photography, Visicalc with mass-market PC software, and Xerox with plain paper copiers. But the high value product is only the start. The Next Leader also has the lowest cost structure in the industry for the niche he serves.
By its nature, the Next Leader is the hardest of the four leadership categories to conceptualize. The Next Leader offers higher performance than anyone else to a niche in the market, as well as a much lower cost structure supporting this performance. Since pricing is often driven by costs, the Next Leader’s price is often well below the industry standard even though his performance rivals or exceeds the Performance Leader.
Imagine the major players in the world automobile market on the Leadership Matrix. The Standard Leader products is GM’s Chevrolet, a broad market product with a medium cost structure that establishes standard pricing and functionality. The Price Leader would be Yugo, a bare-bones product selling at a big discount with little power, stodgy styling, uncertain reliability and limited dealer service. Priced at $4,000, the Yugo fits the Price Leader rule of thumb by discounting at about 60 percent below the average automobile sold in the U.S. A Mercedes Benz would stand as Performance Leader. In the position for Next Leader would be a Boeing 767 aircraft.
What does a plane have to do with the car industry? An airplane is a much cheaper and faster alternative to the automobile as a means of transport for distances over two hundred miles. The product appeals to the niche market of the long distance traveler. Its cost structure is very low – an airline has operating costs of about six to nine cents per seat mile. The average automobile has operating costs of about 40 cents a mile, not including the driver’s time. For the single long-distance traveler, especially where time is valuable, no conventional product in the automobile industry is competitive. The airplane becomes a Next Leader. The plane’s value is higher than that of the Performance Leader. Without other competitors, an airline could charge much more per mile than could Mercedes, but there is competition in the form of other airlines. As a result, airline pricing is low, an average of 11 to 13 cents a seat mile over the last few years.
Toys ‘R’ Us is a contemporary example of a Next Leader. It serves a niche market in the retail industry, toy buyers. It offers that niche better value in both performance and price. The range of merchandise it offers in its warehouse-sized stores is unmatched anywhere else in the retail industry. It operates on lower margins than its competition. The company supports this low price structure with a cost structure to match: low cost locations, top-of-the-line computerized inventory control, an inexpensive work force, and the industry’s highest volume-buying discounts. The result is that over the last ten years Toys ‘R’ Us has created the toy supermarket industry and the company, by itself, accounts for 14 percent of all toys sold in the U.S.
Once a Next Leader begins to breed imitators, it usually establishes itself as either a Standard Leader or a Performance Leader in the industry he has spawned. Toys ‘R’ Us, Federal Express, and Disney became Standard Leaders. So did Atari and Visicalc until they failed to adapt to a changing market. Apple and Polaroid became Performance Leaders.
The primary vulnerability of the Next Leaders is greed. His relative performance is so good that he could charge high prices and reap enormous profits – for a while. These very high profit levels make for sloppy organizations notable for their lack of concern for costs. These organizations are ill-prepared for the real world of cost competition when it hits in the guise of copy-cat competition.
V. Me-Toos and Siamese Twins
Earlier we said that the foremost lesson of the Leadership Matrix is singularity. A product leader must select one spot on the matrix and stay with it relentlessly, honing its skills ever finer within the definitions of its position. Otherwise the company product will most likely be a Me-Too or a Siamese Twin, neither of whom will win unless the Standard Leader has fallen asleep.
Me-Too competitors price at levels comparable to the Standard Leader, but they suffer because they have cost problems. Being smaller, they have fewer economies of scale. They try to distinguish themselves by offering better performance than the Standard Leader, but they lack the lower costs needed to sustain that performance. Amdahl had been vying for ten years against IBM in the plug-compatible mainframe market. With prices comparable to IBM’s, Amdahl’s computers perform 15-35 percent faster. Today Amdahl has 7 percent of the market to IBM’s 90 percent. Amdahl’s returns are low because its cost structure cannot profitably sustain its superior performance.
In October 1986, Pan Am began a shuttle service in the Northeast corridor to compete against the Standard Leader in this market, Eastern Airlines. Pan Am spent $80 million to acquire landing rights, lease aircraft, and construct a new terminal. Because the yield on the shuttle routes is so lucrative – three times the industry average – Pan Am doesn’t plan to gain share by reducing price. Instead, the company plans to compete on services, offering more leg-room, plusher seating, friendlier assistance, and an enhanced frequent flier plan. Same pricing, slightly better service – a Me-Too strategy. This appears to be an unsound risk, especially since Pan Am needs to win about 40 percent of the market, or half of Eastern’s share, in order to make a profit. It is offering similar value with a higher cost structure.
Siamese Twins try to occupy two positions on the matrix. They get caught in a straddle by attempting to combine low prices with superior performance. One head of the company offers customers products priced at some discount from the industry standard – sounding for all the world like a Price Leader. At the same time, the company’s other head makes eloquent promises about extra features or services that are not available from the Standard Leader – which means he is trying to be a Performance Leader. A company that reduces its prices below the standard and simultaneously offers above-standard performance has wrapped itself into a double bind.
Tandon, which made its name by supplying disk drives to IBM, introduced in 1986 a family of IBM compatible PC’s priced at a discount to IBM that ranged from 32 to 47 percent. Together with this Price Leader pricing, Tandon also announced that it would give dealers an added incentive: an additional discount of 5-10 percent, which was a higher distribution discount than the industry standard. This was a Performance Leader strategy – make your dealers more knowledgeable about your product so they can be more helpful to your customers. But a company cannot be in two places at one time. Either Tandon competes with other “clones,” and therefore keeps its cost structure leaner than those competitors to earn a good return, or it competes with the Performance Leader, like Compaq, and raises its prices to cover its greater customer support.
MCI is an example of a Price Leader that grew another head and became a Siamese Twin. In late 1986 the company, which thrived by offering discounts to standard long-distance pricing, announced a new 800 toll-free number service that would compete with Standard Leader AT&T. MCI planned to price its service 10 percent below AT&T’s service. In addition, MCI planned to offer features unavailable through AT&T, such as distance-sensitive pricing, the same number for in-state and out-of-state calls, and volume discounts. These features, which are standard with the MCI package, look more like something a Performance Leader would offer and charge for, and they will certainly add cost. MCI’s Siamese Twin approach can only succeed with the forbearance of AT&T.
Even a Standard Leader can deceive itself with a Siamese Twin strategy. B. Dalton bookstores grew to be the second largest bookstore chain. A few years ago discounters like Crown Books arrived on the scene offering bestsellers at 40 percent off. As these new entrants won share, B. Dalton responded by dropping its prices – seemingly a sensible decision, yet severely damaging because its cost structure did not change when its prices did. B. Dalton was a Standard Leader, carrying a wide assortment of books in convenient and expensive downtown and suburban mall locations. It tried adopt a Price Leader’s pricing structure, but a true Price Leader carries a more limited product line in less convenient locations. A Price Leader will win any low-price battle against a Standard Leader whose cost structure provides more value. The Standard Leader just bleeds to death. To compete, the Standard Leader would need to introduce its own price leader products.
Business is undergoing increasing complexity and an explosion in the quantity and diversity of services and products. At the same time there is massive industry restructuring as companies slash staff, close plants, sell off divisions, discontinue product lines and pare themselves down to core operating units.
What the Leadership Matrix shows is that, within this seeming paradox of more and less, many managements have learned from the leaders and seek to duplicate their successes. The proliferation of services represents an attempt to win along the value dimension, while the restructuring and cutbacks are strategies along the cost axis.
Either approach can be the path to one type of industry leadership, but once the choice is made it must be followed through unwaveringly. And it is a choice that must be made consciously, not by default. That is why leaders lead.
Our research on industry leadership tracked several hundred corporate strategies as they were reported in the major business press. Leadership was defined along three criteria: relative sales growth, relative profitability, and time,
The first test of leadership is that the leader’s sales growth be faster than his industry. For example, Federal Express has had sales growth nearly six times that of the air freight industry. Value is the key determinate of revenues. High sales growth says high value.
Relative profitability, the second test, is how the customer tells us that the leader has used his cost structure more efficiently than the competition in solving the customer’s problem. The leader makes a better return on investment than his industry peers. The return on investment is what is “left over” after the operating costs of providing value are subtracted from revenue. Cost, then, is the key determinate of relative profitability. The lower the company’s costs are in delivering value, compared to his competitors, the higher will be the company’s relative profitability and return. Good returns say low relative costs.
Time is the third test of leadership. A leader’s high growth and profitability, compared to other industry players, have to be persistent. Otherwise, the apparent value and cost advantage is illusory. Over the long term, there is no trade-off between growth and profitability. Real leaders get both, and real leaders stand the test of time.
(Note: This Perspective was written in the context of the economy in 1986. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)
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Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis.