5
EXPLOIT INDUSTRY SHIFTS
SO FAR, you have looked for opportunities that lie in better understanding customers, in reconfiguring your offerings to various customer segments, and in changing the key ratios that dictate the profitability of a strategy. In this chapter, you’ll learn how firms have taken advantage of opportunities to capitalize on changes that affect all the competitors in their industries. The perspective here builds on a traditional preoccupation with industry-level phenomena, but instead of looking at them as relatively stable, we see them as dynamic. The idea is that when a major industry shift is in the works, the thundering herd will tend to move in the same direction. You can create significant advantages by playing the game differently.
In this chapter you will find many examples of companies that have done just that. The process is to first determine the potential for major industry-level change and then figure out whether you can do one of three things: (1) exploit your insights into a pending change through the action of an external force, (2) take advantage of second-order effects brought about by the change, or (3) introduce a disruptive change and benefit from it.
Consider a capital-intensive industry in which capacity utilization is a major driver for profitability. Competitive behavior in such industries is predictable. When demand exceeds supply, all players make a fortune, and that encourages them to expand capacity. As the new capacity comes onstream, demand is satiated, and everyone drops prices to try to maintain profitable volumes. Profitability across the industry sinks.1 Recognizing this pattern, astute players might capitalize on it by devising a way to eliminate the structural causes of cycles; exploit it by creating the capability to create capacity at the peak without being forced to preserve it during the low period; or benefit by becoming a second-order capacity broker.
A prepared firm might make a lot of money by, for example, locking up or securing capacity in times of shortage, or by incorporating the kind of flexibility that lets it respond quickly to short-term demand pressures in whichever markets they appear.2 Another approach is to provide products or services that help your customers cope with cycles in their industries. Examples include building modular factories, converting plants to use multiple fuels, and linking disparate producers to increase or decrease supply.3
This chapter describes ideas for marketbusters that can help you capitalize on insights into your industry that have so far escaped your competition.
Industry Dynamics
In the early days of any industry, firms experiment. Technologies, units of business, features, sales channels, marketing pitches, branding, and so on are up for grabs.4 Over time, players learn which approaches work better than others, and the variety in the industry begins to decline. Dozens or hundreds of new entrants also decrease to a few that have come up with a workable formula for competing in the new space. Eventually, certain practices, technologies, and ideas come to be regarded as legitimate and central to the industry. At this stage, these elements become taken for granted, and business as usual commences.5
Interestingly, when an industry starts to change, it often seems as though every strategist is reading the same recipe book, and soon firms are rolling out a horde of similar strategies. Typically the initial reaction to industrywide change is denial that there is a problem. This is followed shortly by resistance to the problem and attempts to reinforce the existing business model.6 If the change really is fundamental, the resistance period is typically followed either by begrudging acceptance on the part of the incumbents or a shift in players within the industry as those who are no longer competitive in the new space leave and others enter.
Thus, as of this writing the recording studios are all trying to put roadblocks in the way of digital music and video distribution. The pattern is familiar. When threatened with the incursion of mini-mill technology into their markets, all the incumbent steel companies retreated to higher-margin markets and attempted to cut costs. Faced with the nearly disastrous circumstances of 2002–2003, major airlines globally used the same cut-and-shrink-to-survive strategies to try to overcome years of overcapacity and inflexible route structures. Threatened by the Internet, globalization, and the presumed convergence in financial services, financial companies the world over have been buying their way into “diversified” financial services, believing that demand for one-stop shopping will offer substantial customer value. And the list goes on. Clearly, it is extremely hard for a firm to break away from the industry pack, and yet, equally clearly, this is where the greatest opportunities are likely to be found.
Thriving in an Industry Change
We found three distinctive strategies that characterize firms that were able not only to survive but to thrive in the presence of an industry shift.
The first strategy involved proactive anticipation and exploitation of the shift and its consequences. Intel, for example, perceived that chip speed was no longer the dominant criterion of choice for all but the most demanding users, meaning that some other requirement would become important. For Intel, it is critical that the other requirement not be price, because its model of high investment, R&D, and manufacturing capacity would put the company at a disadvantage in a price-driven world. With the introduction of the new Centrino laptop chip, Intel has anticipated and accelerated the rise of longer battery life and wireless connectivity, rather than raw speed, as the dominant marketing criteria for laptops. Using its position as industry leader, Intel can initiate this shift and exploit it to the fullest. Of course, even mighty Intel is not immune—challenger AMD has made significant inroads, particularly in those lower-end segments that Intel is more reluctant to serve.
A second pattern we observed occurred when firms took advantage of second-order effects of a change in conditions. An expensive labor agreement that leads incumbents to suffer cost increases might lead to the second-order consequence of competitive players moving resources to areas not affected by the increase—as in greenfield developments. This shift can then create opportunities for service companies that can shorten the time to construct such a plant, for lobbyists who can ease local regulatory constraints, and for engineers and architects who have plans at the ready.
A similar second-order motivation can often be detected in firms that relocate their operations. By moving to a different institutional environment, companies can create advantages if competitors are locked into an existing one, creating a second-order opportunity. Citibank, for example, relocated its credit card operations to South Dakota from New York to escape usury laws that limited the interest it could charge to customers on revolving credit card debt.
A third approach is to disrupt things in a way that favors your capabilities and ideally disadvantages others. Hewlett-Packard is aligning itself to do this in the market for photographic printing. Many HP printers come with slots for the memory chips used in digital cameras and with software that allows users to easily copy, print, and store their images. HP makes its money on the printers, the paper, and the inks. This model is enormously threatening to the industry, which has grown up around film and the production of pictures from film: the small photo print shops, the multinational manufacturers of chemicals and paper, and of course the manufacturers of film-based cameras, such as Kodak. Allied with HP are companies such as Sony (nontraditional camera manufacturers) and traditional camera companies such as Olympus and Canon, which are seeking to move their business models into the digital age. If they succeed, the advent of digital imaging is likely to make huge inroads into what was a stable, successful industry by rendering entire functions obsolete.
The Framework of Industry Shifts
The essential feature of an industry shift is that the power held by various parties shifts. Porter long ago pointed out that an industry can go from being attractive for investment to being unattractive to the extent that its structure changes in a way that favors buyers or suppliers, that encourages substitution, or that limits barriers to entry.7
One way this occurs is through industry cycles, as mentioned earlier. Another is when a constraint that has kept power relations in balance shifts—as when regulations, technology, or industry standards change. Another type of change occurs through the natural process of industry evolution; as a new industry goes from a startup situation to a more mature one, predictable shifts in power take place. And of course innovations, by changing the cost or logistical routines that have become standard, always have the potential to reconfigure the way current value chains are constructed.
Where to start? Begin by assessing the likelihood of a major change in your industry. Table 5-1 provides some indicative questions you might use.
By combining these four patterns with the three approaches to taking advantage of industry change, we have developed a simple framework, shown in table 5-2, that you can use to structure your thinking about possible industrywide shifts. The result is twelve possible strategic moves. We’ll list them here, numbering consecutively with the previous chapter as before:
TABLE 5-1
Industry Shifts Framework
Move #21: End-run predictable industry swings
Move #22: Capitalize on second-order effects of industry cycles
Move #23: Launch a disruptive response to cycles
Move #24: Exploit shifts in industry constraints or barriers
Move #25: Capitalize on second-order effects of shifts in constraints
Move #26: Use a shift in a key constraint to disrupt the industry
Move #27: Exploit your industry’s structure for the next life cycle stage
Move #28: Understand the second-order effects of the next stage
Move #29: Redirect, disrupt or alter the evolutionary trajectory
Move #30: Exploit a shift in the value chain
Move #31: Exploit second-order effects of shifts in the value chain
Move #32: Reduce costs or abolish bottlenecks to disrupt the value chain
If you have concluded that one of these four change patterns is happening in your industry, you should consider where you have opportunities to make an end run around the change, benefit from second-order effects, or disrupt things for the competition by accelerating the change.
TABLE 5-2
MarketBuster Prospecting by Exploiting Industry Dynamics
Let’s walk through each of the four industry change patterns and look at examples that might help trigger your own thinking about industry dynamics. At the end of the discussion we provide a list of provocative questions you can ask to see whether a marketbusting opportunity may be present for you.
MarketBuster Prospecting Within Predictable Industry Cycles
The great advantage of cyclical industries is that they are to some extent predictable. The great danger of such industries, however, is that individually rational behavior can lead to collectively absurd results—one of the reasons that cycles persist.8 Thus, if everyone invests to increase capacity, excess is likely to create incentives for predatory pricing and increased competition. At the same time, no red-blooded executive wants to defer investment in the next-generation plant or in the next great opportunity and then watch helplessly as competitors that benefit from occasional scarcity walk away with the profits. Real estate, semiconductor manufacturing, and insurance are all industries that are heavily cyclical.
Move #21: End-Run Predictable Industry Swings
One way that firms have end-run the opportunities of cyclical surplus and scarcity is to figure out how to create capacity at the peak and maintain low carrying costs at the trough. This suggests an options-oriented approach to capacity creation. If you can think of a creative way to capture some of the peak demand without being stuck with excess capacity in a downturn, you can create considerable value. The option, in such a case, is to address peak demand— creating the capability, without necessarily the obligation, to maintain that level of production capacity over the long term.9
Example: Inefficient Peaking Plants Kick in When Prices Rise. The energy industry provides an example of how some firms took advantage of sharp shifts in available demand and supply and subsequent steep changes in prices. Competitors in this industry invested in so-called peaking plants, which were relatively inexpensive to build although less efficient than the state-ofthe-art facilities that would be in normal use. Peaking plants are brought online only when prices spike sharply upward, giving the owning firms the capability, but not the obligation, to generate energy from them as the economics of the situation demand. In an industry in which unit prices can shoot up to several thousand times their normal levels, such a response to capacity constraints can create considerable benefits. Together with the peaking plants, many energy companies (including the now-discredited Enron) engaged in sophisticated forms of options-style contracting, giving them the capability to trade units of energy under various combinations of future circumstances.
Example: Partner with Others to Gain Capacity. Other firms have found ways to end-run cycles by combining production resources. Members of cluster manufacturing circles in Italy have been known to compete aggressively for contracts but to cooperate simultaneously in delivering on those contracts. This behavior is premised on the idea that all players benefit when the incentives to create systemic excess capacity are muted. The key principle here is to capture the capability, but not the obligation, to gain capacity if and only if it is needed.10
Example: Betting the Company in Semiconductors. As of this writing, a huge marketbuster gamble is playing out in the semiconductor industry. Globally, several huge players are investing to build the next-generation semiconductor fabricating facilities, involving huge sunk investments (on the order of $3 billion per plant).11 Others, having decided that the fixed investment and cyclical nature of semiconductors create a game they don’t wish to play, are betting instead that they will be able to acquire capacity if they need it from contract producers. The gamble concerns which side will retain more power. Those with the fabricating plants run the risk of excess capacity and pressure on prices, and the others run the risk of a lack of capacity, high prices, and the possibility of being shut out or rationed in meeting their needs. Should those building the plants prove right, they stand to make substantial profits on their bet.
Move #22: Capitalize on Second-Order Effects of Industry Cycles
Among the more interesting consequences of cyclical industries is that as an industry moves from cycle to cycle, second-order bottlenecks often emerge. Without competing directly within a cyclical industry, some clever firms have benefited from the second-order consequences cycles create.
Example: Capitalizing on Internet-Driven Demand for Packaging. New Jersey–based Sealed Air Corporation manufactures a wide range of food and protective packaging materials and systems that reach some 80 percent of the world’s population. Sealed Air has taken great advantage of a second-order scarcity created by the emergence of Internet-based retailing. Unlike conventional retailing, Internet-based retailing includes the crucial value chain element of packaging goods for shipment. If the packaging doesn’t work, the rest of the offering doesn’t work.
Sealed Air has used two main strategies to capitalize on the new primacy of packaging for entire industry segments. The first approach focuses on providing a full packaging solution, which includes the launch of www.e-packaging.com. This interactive Web site walks business customers through their entire shipping and packaging processes, evaluates their current shipping and packaging systems, and even recommends superior packaging solutions. Additionally, the site includes a handful of useful resources (articles and studies) to aid the business customer.
Sealed Air’s second strategy concentrates on developing superior packaging products. Two flagship Sealed Air products are Instapak foam packaging and Bubble Wrap cushioning. Consider the Web-based firm EasyClosets.com. EasyClosets offers a Web site where a consumer interactively designs a contemporary closet using the company’s modules; the company then assembles a kit of materials and ships it on order. The dilemma facing EasyClosets was that its model involved shipping closet materials directly to customers. Any damage en route not only resulted in a dissatisfied customer but also triggered an expensive return and resend cycle. By using Sealed Air’s packaging products, EasyClosets reduced its packaging time from four hours to one hour and virtually eliminated damaged merchandise. By introducing innovative products and providing clients with full packaging solutions, Sealed Air was able to exploit second-order effects of the Internet boom.
Move #23: Launch a Disruptive Response to Cycles
A final way to benefit from industry cycles is to introduce innovations that mute or eliminate the impact of cycles. This is a major driver behind the adoption of flexible manufacturing systems, in which entire factories can fairly readily be converted from the creation of one sort of output to another. Although introducing flexibility can be expensive, it reduces the pressures that lead to much dysfunctional competitive behavior in cyclical or uneven-demand industries by limiting the sunk costs of overcapacity situations and allowing firms to capture the benefits of tight-capacity ones.
Example: Creating a Production System That Is Cycle-Resistant. Electronics provider Agilysys (formerly Pioneer-Standard Electronics) has invested significantly in combining its assembly, distribution, and computer component storage operations into a new distribution and value-added center. Although many of the components of its innovation are fairly standard—such as the use of just-in-time information to route components between processes—the company’s efforts are distinct in terms of its consciousness of the negative impact of cycles on its economic performance. Among the benefits it cites is the ability to build more complex units while using 20 percent fewer workers. According to Jeff Levine, the company’s vice president for operations, the new system “has created a more stable workforce able to handle the peaks and valleys that come,” without the need for disruptive hiring and dismissal of part-time employees or scheduling changes.12 Among the results of the shift have been a reduction in turnaround time to three days (from the former seven to ten days), better pricing power, and far greater levels of customer satisfaction.
Prospecting Questions for Exploiting Predictable Industry Cycles
Examine your industry’s sales over at least the past decade, looking for cyclical patterns. Some industries tend to follow the business cycle. Others, such as retailing, have additional seasonal cycles, and still others, such as real estate, have much longer cycles. Your task is to identify the particular cycles that impact your industry.
With this information in mind, brainstorm answers to the following questions:
What bottlenecks are likely to occur in the cyclical peaks?
What surpluses are likely to occur in the troughs?
Are there ways to end-run swings in the industry by positioning your firm to exploit bottlenecks during peak demand and to avoid troughs?
What second-order effects will cyclical swings have on the industry?
What second-order demands or surpluses will be created? For you? For members of the industry value chain, such as suppliers and distributors?
Are there opportunities to introduce innovations that mute or eliminate the impact of cycles?
MarketBuster Prospecting During Shifts in Industry Constraints or Barriers
It may be possible to identify marketbusting opportunities by exploiting a significant shift that has changed or will change an industry constraint or barrier. For example, in regulated industries the players often focus more on how to appease regulators than on how to compete with one another; when the regulatory climate shifts, opportunities often arise. Any major change in regulations or other legal constraints can create a marketbusting opportunity. The same thing applies to changes in technology, major social shifts, changes in transportation and distribution systems, and so on.
Move #24: Exploit Shifts in Industry Constraints or Barriers
One of the most obvious chances to create a marketbuster occurs when a fundamental change in an industry environment poses an opportunity for exploitation.
Example: Expanding from Regulated to Unregulated Parts of Your Industry. The Viridian Group PLC of Northern Ireland successfully capitalized on the deregulation of electricity through a strategy of selectively entering deregulating markets while preserving the integrity of regional electric company Northern Ireland Electricity (NIE). NIE provides power to about seven hundred thousand homes and businesses in Northern Ireland. Viridian’s unregulated businesses include business process outsourcing (Sx3), financial services (Open + Direct), power marketing (Energia), and high-voltage electrical infrastructure contracting (NIE Powerteam). Its Nevada telecom joint venture with Energis provides voice, data, Internet, and e-commerce services.
Anticipating further increases in deregulation, NIE is building an underwater interconnector that will give NIE customers access to electricity from Great Britain. The company has also entered the Republic of Ireland’s electricity market, which is opening up to competition. Its Energia subsidiary markets retail and wholesale electricity in the Republic of Ireland as well as Northern Ireland. Through its Huntstown Power unit, Viridian is building a gas-fired 340-megawatt power plant north of Dublin. The key point about Viridian’s success is that it proactively built competencies ahead of the industry-transforming event and thus was able to move quickly when deregulation occurred. Viridian has shown steady growth in revenues, from $908 million in 2001 to $1.5 billion projected for 2004.
Example: A Failed Attempt to Capitalize on Industry-wide Changes. Such opportunities can also prove to be dangerous, however, if implementation is not carefully thought through. Indeed, the recent history of deregulated or globalizing industries from telecom to energy suggests that such conditions will tend to attract investment from many overly optimistic would-be victors. The case of the Asia Power Group’s attempt to create a marketbusting strategy in the domestic energy market of the Republic of China is a cautionary tale.
The industry’s prospects were set against a backdrop of dramatic domestic growth; GDP growth in the ROC exceeded 10 percent throughout most of the 1990s, with the trend expected to continue. At that time, 35 percent of homes had little or no access to electricity, and the Chinese government’s own projections indicated that it would cost $500 billion to create the energy infrastructure needed to modernize the country. In response, in 1994, China changed restrictive regulations to permit foreigners to form joint ventures with provinces and municipalities to create build-operate-transfer plants. The plants were to be built by the foreign firms, operated at a price determined by the Chinese government, and then transferred to the joint venture partner. The deals were structured to be lucrative for the foreign firms, which could earn a return greater than 20 percent. So far, it sounds like a great opportunity, doesn’t it?
In October 1993, three Canadian power companies—Ontario Hydro, Hydro Quebec, and Power Corporation of Canada—formed an alliance to capitalize on China’s untapped energy market. The venture became known as the Asia Power Group, and its primary purpose was to invest in energy opportunities in Asia. Although the opportunities were indeed bright, the partners ended up not achieving their goals for dramatic profit growth. This was because, among other reasons, they underestimated how much competition they would encounter and overestimated how easy it would be to quickly establish themselves as trusted partners in an environment in which relationships are critical. The partnership was disbanded in 1996, with its failure attributed to divergent objectives on the part of the partners and with unexpected competition.
Example: Creating the Right Context Before You Leap In. A better example is offered by a large contract that was bid in 1996 for a 700-megawatt coal-fired plant in the Guangxi Zhuang region of southern China. A European consortium composed of Electricite de France International and GEC Alsthom won the $800 million project. The consortium had not only thought through the technical requirements for capturing the contract but had also proactively been developing strong ties with members of the Chinese government for years. Thus, although many firms saw the opportunities in China—six consortia bid on the Guangxi Zhuang project—relatively few proactively created the conditions that would allow them to capture the opportunity in a changing industry.
Move #25: Capitalize on Second-Order Effects of Shifts in Constraints
As with industry cycles, major shifts in industry constraints can create a host of second-order opportunities for those players having insight into the likely consequences. Changes in rules regarding national competition often create opportunities across many industries.
Example: Taking Advantage of Pending Changes in the Italian Insurance Market. One of our research collaborators, Clive Mendes, used insight into European Union trends in regulation to dramatically reposition personal insurance in Italy. He described it to us this way:
Royal Insurance was the fruit of a strategic review which I carried out in 1994 for Lloyd Italia Spa which was at the time the largest Italian subsidiary of the British Royal Insurance Group. Royal Insurance, like all large groups was looking out for opportunities for profitable development in its various markets. In Italy, at the time, there was a lot of changes going on in the legislative and cultural framework of the nation and I believed that an opportunity was developing to change the way personal lines insurance, particularly motor [auto] insurance was transacted.
I knew, though, that the European Union was about to require all European governments to “liberalize” their motor insurance markets. This would mean that individual companies would be free to set their own prices and conditions. I guessed at the time that most Italian companies would not be ready, after many years of simply administering a government tariff, to make a rapid transition to a more advanced, personalised form of pricing. My view was that in many cases they lacked the knowledge, they lacked the in-depth statistical analyses necessary and, most importantly, there was an inherent cultural conservatism or mindset which would make it difficult for most insurers to achieve the radical changes that would be necessary in the short term. They would get there eventually, but, in the meantime, there would be a few years for a creative first-mover to re-draw the playing field.
Mendes set about creating an entirely different kind of insurance company in Italy, capitalizing on the second-order effects of the deregulation trend and his parent company’s sophisticated capabilities. He created the first direct distribution model for insurance in Italy, emphasized customer satisfaction in an industry in which that had not been a primary criterion, and also leveraged his company’s capabilities of insurance risk analysis and operations. In January 2002, Royal Insurance was purchased for £12 million by Direct Line.
A somewhat more diffuse trend than shifting regulation, but one that creates enormous second-order opportunity, has to do with the emergence of new concepts or even fads. One example was the emergence of the concept of “best practice” study for major corporations in the early 1980s.
Example: The Corporate Executive Board Capitalizes on the Hunger for Companies to Compare Themselves to Other Companies. Corporate Executive Board (CEB) created an entire business model around the concept of benchmarking. David Bradley, CEB’s founder, started the company in 1979 to do esoteric business research. That didn’t work very well, but in the course of pursuing this business, CEB developed the concept of keeping companies from reinventing the wheel every time they have a problem.
Now CEB collects solutions to various business problems from its large corporate customers. Relevant problems might include boosting employee retention or minimizing government regulatory costs. It then assembles this management wisdom, adds its own insights, compiles it all into reports, and sells it to subscribers, which are usually other large corporations. This model has worked so well that it has placed CEB into “hot growth” company lists of both Business Week and Fortune.13 From 1998 to 2000, revenues grew at an average annual pace of 35 percent, and profit growth averaged 153 percent annually. CEB’s average return on capital over those years was 61.4 percent. CEB’s stock, a split-adjusted $9.50 at initial public offering in 1999, recently closed at $33.
Move #26: Use a Shift in a Key Constraint to Disrupt the Industry
Often, an industrywide shift can be traced to the emergence of a technological innovation that changes customer expectations. Sometimes directly, sometimes indirectly, new ways of doing things can send ripples across an entire industry and dramatically shift the power dynamics within it. New approaches can also cause the stable structure of an industry to fragment, making room for smaller players or players with different strategies.
Example: Allergan Creates a Revolution in Wrinkle Treatment. Allergan, founded in 1951, is a California-based niche provider of health care solutions for neuromuscular skin and eye care. The company’s initial product, an antihistamine eye drop called Allergan, was its first innovation. Its growth (greater than 20 percent annual revenue growth for much of its history) continued to be driven by innovative solutions in niche markets, primarily in eye care in the early stages. In 1988, Allergan acquired the rights to a botulinum toxin product called Oculinum, which would later evolve into a product called Botox.
Botox is a purified protein toxin derived from clostridium botulinum bacteria. In the late 1970s, researchers used small amounts of Botox to treat muscle disorders such as facial twitching and muscle spasms, and in 1989 the Food and Drug Administration (FDA) approved Botox for the treatment of eye muscle disorders. In the same year, a Canadian professor using Botox to treat a patient with eyelid muscle twitching noticed that the wrinkles around the area improved, and that sparked a revolution in the world of cosmetic treatment.
Cosmetic specialists have since aggressively marketed Botox to their clientele as an alternative to surgery. What the clients don’t necessarily realize is how much business sense it makes for providers to use Botox rather than perform surgery. Surgery requires high malpractice insurance, a longer procedure, and a longer recovery period. Since surgery is permanent, patients seldom repeat their visits. Botox, in contrast, is not permanent, so patients come back. It’s also not covered by Medicare or most insurance plans, so patients who want the treatment pay in advance. Rather than wait around for reimbursement, doctors have the cash in hand immediately. Doctors get between $400 and $1,000 per patient every three to four months for a five-minute procedure. In addition, doctors recover the cost of the vial on the first patient because Allergan charges $400 for a vial that will treat five patients. Moreover, patients are released thirty minutes to two hours after the procedure, increasing patient turnaround.
From the consumer’s point of view, Botox offers a minimally invasive procedure that is cost effective, painless, and convenient.
Prospecting Questions for Exploiting Shifts in Industry Constraints or Barriers
List the most important constraints or barriers that have bounded the competition in your industry. Identify those that are or likely will be under pressure to change. Brainstorm those constraints and barriers for answers to the following questions:
Is there a way of capitalizing on this shift by exploiting the new competitive opportunities that it creates?
What are the second-order effects that this shift will create in your industry? In the value chain that supports it?
Can you exploit these second-order effects by making a marketbusting move?
Can you exploit this shift to disrupt the way competitors compete?
Patients avoid spending time in an expensive hospital bed recuperating from invasive surgery. The convenience of the treatment is a key attribute. To paraphrase one consumer, “Getting a Botox shot takes less time than a haircut.” The treatment requires virtually no effort on the part of the consumer aside from the commute to the physician’s office. The treatment shows results immediately, as opposed to surgery, which requires a convalescence period. Botox sales are projected to grow at 20 to 30 percent per year for the next few years, and Allergan’s Botox revenues are projected to reach $808 million by 2005.14
MarketBuster Prospecting to Exploit Industry Evolution
Like products, industries go through several life cycle stages, beginning with early experimentation, continuing through growth and maturity, and finally ending up in a slow- or no-growth endgame of decline.15 Preparing for the evolution of an industry allows the insightful firm to stake out positions that can convey intriguing advantages as the industry matures. Research has consistently identified certain patterns. They include the predominance of product innovation in the early days of an industry, with process innovation becoming more prominent as it matures; the tendency of maturing industries to undergo consolidation; and the tendency for the products offered in mature industries to become commoditized.16
Marketbusting opportunities emerge for those firms that anticipate life cycle trends in product categories, such as the transition from feature innovations to process innovations. Manufacturers of mobile telephones, for example, have shifted from innovating in features and attributes to innovating in fashion and services. Mike Zafirovski is president and chief operating officer of Motorola, Inc. When Zafirovski was president of Motorola’s personal communications sector, he redesigned both the products and the manufacturing system to anticipate this industry trend. Previously, the company had offered many phone models that required various hardware and software parts. With the design of the newer models, Motorola’s phones had 40 to 45 percent of their parts in common at the end of 2001 compared with the previous 10 to 20 percent.
Move #27: Exploit Your Industry’s Structure for the Next Life Cycle Stage
One pattern of exploiting evolutionary industry paths is an industry roll-up. Roll-up involves consolidating some aspect of the value chains of a fragmented industry. A familiar example is the invasion of big box retailers into industry segments that were formerly occupied by momand-pop small businesses. Office suppliers such as Staples and Office Max, huge home entertainment stores such as Circuit City and HMV, and home improvement centers such as Lowe’s and The Home Depot have all employed a variant of the defragmenting strategy.
By exploiting volume, technological, and pricing advantages, these retailers are able to provide goods at much more competitive prices than their smaller rivals can achieve. Although their service tends to be less personal than that in a locally owned shop, for many items customers simply don’t care. Instead, the variety, long hours, low prices, and selection offered by the large suppliers creates real value for the customer.
Of course, the conditions under which a roll-up will succeed are not infinite. There must be enough underserved customers to merit the investment, and the differentiation offered by a superstore must be sufficiently compelling to persuade customers to change their shopping habits. In the U.K., for example, entrepreneurs tried to copy The Home Depot’s model with DIY (do it yourself) stores in the 1980s. Unfortunately, even though smaller competitors were driven out of business in large numbers, too many large chains entered, trying to chase too few customers on price competition alone. Only when retailer Boots entered did competition shift from price to differentiation, product variety, and customer service.17
Another example and a bit of a cautionary tale is Service Corporation International (SCI). Hoover’s online Web site (www.hoovers.com) observes that “SCI is to death what H&R Block is to taxes.” SCI is the largest funeral company in the world. It owns 3,125 funeral homes, cemeteries, crematoria, and flower shops in eleven countries, primarily in the United States and Canada. Robert Waltrip, the author of the company’s current strategy, inherited the business at the age of twenty in the early 1950s. He decided to grow the funeral business by mimicking the growth strategies of service companies such as Holiday Inn and McDonald’s. This unconventional strategy allowed SCI to grow (primarily through acquisition), even though the conventional wisdom at the time was that the funeral business could never be national because of local ties, local regulations, and the highly personal nature of the business.
By colocating its facilities (funeral homes, florist shops, and so on), SCI shares personnel, vehicles, and preparation services, making it possible for it to operate more cost effectively than competitors having only one location. SCI has also preserved the individual nature of the businesses it bought in order to remain a trusted source for different religious and ethnic groups.
SCI has also taken advantage of some other techniques for marketbusting. It changed the payment stream in its industry, for example, by allowing customers to purchase funerals in advance, thus locking in preinflationary prices. SCI’s 2001 sales totaled $2.5 billion, and it has arranged future business of $4.6 billion in prepaid funeral contracts.
Growth has not been without its difficulties. Accusations of poor management of some funeral operations and overly ambitious international acquisitions have been troublesome in recent years. In addition, the spending by the company to pursue its acquisition-oriented growth strategy has left it burdened with debt at a time when trends are going against it. Nonetheless, the performance of the company in what may well be the ultimate mature industry has been historically remarkable.
Move #28: Understand the Second-Order Effects of the Next Stage
In developing industries it’s common for vertically integrated companies to exit certain noncore businesses as the industry matures. This is particularly true of high-technology businesses, which find it extremely difficult to remain at the state of the art in every technological aspect of the industry compared with players that focus on only one.18
Example: DuPont Creates Efficiencies by Specializing in Photomasks. DuPont capitalized on the second-order effects of industry development with its photomask offerings. Photomasks are quartz or glass plates that are used to etch microscopic circuitry onto semiconductor wafers. Several years ago, chip manufacturers (Intel, Texas Instruments, and so on) would have their own photomask divisions transfer their chip design onto their chips. However, technology for photomasking equipment rapidly improved, and costs for making, inspecting, and repairing the equipment skyrocketed from the low seven figures to $10 million and up. Chip manufacturers began to focus on their core competency of making chips and not masks, creating the opportunity for DuPont to acquire masking operations of major chip manufacturers. DuPont’s strategy has allowed the firm to integrate its operations into those of the chip manufacturers and also grow its revenues substantially. In 2000, DuPont Photomasks, Inc., saw revenues grow almost 25 percent, from $264 million in 1999 to $328.1 million in 2000.19
Move #29: Redirect, Disrupt, or Alter the Evolutionary Trajectory
When an industry has reached a certain level of maturity, many of the characteristics of its offerings become standardized. In the language of attribute mapping (see chapter 3), the offerings acquire a great many nonnegotiables, and it becomes more difficult to introduce new exciters or differentiators. Standardization, however, offers several benefits. It becomes easier to communicate what an industry’s offerings are, and as customers gain experience there is less need for continual education and training. In addition, many activities can become routine, and thus players avoid the need to invent processes from scratch.
But a subtle vulnerability can become manifest among leaders in a mature industry: As their offerings become increasingly standardized, new entrants may seek to divert that stable trajectory by creating a disruptive offering. Disruptive offerings, in the sense coined by Clayton Christensen, are those that appeal to a different (often less demanding) user set or are cheaper, simpler, or less complex for new groups of users to adopt.20 They are disruptive because incumbents seldom see the threat coming. New entrants often compete in places and with vehicles that are not readily visible, often because they grow in product or market environments that the incumbents have not addressed. If the upstart succeeds, the incremental evolution of an industry can again change to one of flux.
Example: Ticketmaster Versus Tickets.com. Ticketmaster is the dominant player in the ticketing industry, with approximately 80 percent of the market. Ticketmaster fully handles the ticketing needs of venues, but at a hefty price per ticket. The cost of the service includes staffing call centers, taking online sales, selling at box offices, and processing ticket fulfillment, in addition to other services at events. For these services, Ticketmaster receives, on average, $7 per ticket.
Tickets.com offers a cheaper alternative. One of the most important distinctions between Ticketmaster and Tickets.com is the latter’s dual product offering. In addition to the commonplace ticket-selling and distribution services, Tickets.com offers software that allows clients to control their own ticketing programs in-house. By simplifying the ticketing program and giving control to the venues, Tickets.com allows them to run their own ticketing operations and thereby save money compared with the cost of the Ticketmaster package of services.
Tickets.com offers three main software products for in-house ticketing: Prologue, Pass3 for Windows, and TicketMaker Professional. All three products offer significant telephone support and the option to purchase additional integrated modules. Furthermore, the products are tailored for venues of various sizes. One can anticipate that Tickets.com’s tailored offerings for smaller venues will be particularly disruptive, because these clients are often overlooked by major ticketing providers.
Tickets.com has set its sights on unseating Ticketmaster as the leading ticketing service provider and disrupting the evolution of ticketing services. Tickets.com was founded in 1996 and went public in the heady days of 1999. Over the three months ended May 31, 2002, total revenues rose 20 percent, to $17.9 million. Although it is not yet clear that Tickets.com will prevail, it provides a useful illustration of an attempt to shake up a settled industry by disrupting at the low end.
Prospecting Questions for Exploiting Industry Evolution
Examine the evolution of your product life cycle, and identify the ways competitors have converged in the current stage of the industry’s evolution. Look for indicators that this convergence is vulnerable to a competitive format that will move the industry into the next life cycle stage. Have your team begin to probe whether there are opportunities to capitalize on life cycle shifts:
Are there places (proliferation of product models, emergence of dominant design, preemptive roll-up, or consolidation) where you can anticipate and capture first-mover advantages by preemptive evolutionary moves?
Can you anticipate second-order effects of industry evolution by pinpointing places where industry fragmentation, disintermediation, or concentration creates marketbusting opportunities?
Are there ways you might be able to move boldly to redirect, alter, or disrupt the current course of the industry?
MarketBuster Prospecting When the Value Chain Shifts
The final industry pattern we have observed to be a source of opportunity arises when something changes, causing shifts in the structure of existing value chains. Unlike the often dramatic changes that influence an industry by shifting a constraint or regulatory barrier as discussed earlier, the changes here refer to innovations that ease bottlenecks or reduce costs. These innovations can also affect existing value chains by adding new components to them or by decreasing the value of or need for certain portions of the chains.
Move #30: Exploit a Shift in the Value Chain
One way to make money in these circumstances is to capture control of resources that are suddenly more scarce, expensive, or important than before, or to innovate to reduce the scarcity, cost, or importance of those resources. One approach is to automate, routinize, or standardize processes that were once complex and required high levels of skills. What happens then is that the control of the value chain shifts to some other component.
Example: Standardizing Construction Elements to Radically Reduce Cost. BT Building Systems is a Connecticut-based company that creates preassembled walls to specifications provided by its customers. The key value for customers is leverage: Rather than build framing for a construction job on-site using skilled workers, BT’s system uses specialized computer-aided design and computer-aided manufacturing (CAD/CAM) techniques to create walls in a factory setting.
Although the CAD/CAM system is complex and expensive (as of this writing, only four companies offer a similar process), after the process is running at scale BT can offer customers significant advantages compared with the old approach. For one thing, weather and other on-site impediments don’t delay the schedule. In addition, the system can kick in when needed, avoiding the inefficiencies of unpredictable construction schedules. And of course, builders using the system require fewer highly skilled framers on-site, something that saves cost and increases flexibility. Initial customers are expected to be those for whom cost is a major consideration (such as low-income housing projects), but after the technology improves it has the potential to influence the entire value chain of the building and construction business. BT’s senior executives passionately believe that as many as 80 percent of future construction sites will use this technology.
Example: Importing and Exporting Business Methods from One Environment to Another. Value chain shifts can also occur when firms with origins in different institutional environments seek to expand, thus changing the value chains in their target arenas. South African Breweries (SAB) enjoyed a dominant position (98 percent market share) in the beer business in South Africa. Apartheid prevented SAB from making overseas investments throughout the 1980s, leading it to diversify in domestic businesses. For many years, export restrictions and international disapproval limited its ability to expand, and volatile economic conditions and home and currency instability forced the company to become an extremely efficient operator. Then in the early 1990s, sanctions against South African companies were lifted. SAB’s management decided that its lean operating model could dramatically change value chains in the international beer business, and the firm set about expanding globally.
SAB now has major operations in Africa, China, India, Central Europe, and Central America. One of its most visible recent acquisitions was the 2002 purchase of Miller Brewing to create SABMiller PLC, making the new company the world’s second-largest brewer. In what others might consider a mature market, SABMiller produced 23.5 percent net income growth in 2002 on the basis of only 3.6 percent growth in sales—clear evidence of its ability to make the entire value chain in which it operates more efficient.
Firms seeking to exploit a shift in the value chain can also use a strategy that we term linchpin alliance. You can use this approach when your firm has developed capabilities that have very wide application potential and that you can license or sell to be incorporated into the products of a large number of alliance partners for whom the capability delivers a critical functionality. The marketbusting opportunity is to create alliances with all the beneficiaries of your capability and end up as the linchpin.
Move #31: Exploit Second-Order Effects of Shifts in the Value Chain
Strong trends or step changes are another major cue to begin probing and thinking about second-order causes and consequences of the dynamics of your current view of the world. So if you are experiencing or riding a trend it might be insightful to ask, “What trend (or change) could be causing this trend?” or “What trend (or change) could this trend cause?” Then begin to think through the opportunities that might flow from this.
Example: Turning Sand into a Valuable Scarce Commodity. An entrepreneur we know learned of the pending development of a huge open cast copper mining project in the African bush. He pursued the following line of logic: “To build a huge mine in the bush will require the development of housing for the workers and roads, buildings, and bridges for the mine and township. To build houses, buildings, roads, and bridges will require megatons of concrete. To make concrete will require megatons of sand. Transporting sand is very expensive.” So he drew a 100-mile circle around the proposed site, went to all the farmers who owned river property in that circle, and took out options on the rights to their river sand. Then he sat and waited for people needing sand to mix into their concrete. Eventually, they found him and he was able to lock in a generous profit from the sales of a commodity product that was suddenly scarce.
The kinds of opportunities to look for here are chances to eliminate gaps or glitches in existing value chains, to attain a position of power in a reconfigured value chain, or to help customers and clients maneuver in reconfigured value chains.
Example: Helping Customers Respond to Value Chain Upheavals. SAP is a premier provider of enterprise resource planning (ERP) software, which lets different parts of an organization, as well as other parties in its value chain, work from the same information, which is kept in common formats. The underlying need for such systems is often caused by value chain or competitive pressures that threaten the configuration of existing supply relations in an industry.
Recently, for example, German pharmaceutical manufacturer Bayer AG encountered an extraordinary spike in demand for its Cipro product, an antibiotic, stemming from the discovery of anthrax-tainted letters sent to victims in Florida, Maryland, New Jersey, New York, Virginia, and Washington, D.C. Historically, pharmaceutical manufacturing has been a process of forecasting demand and then manufacturing in batches to meet demand by carrying inventories; the same production plants are used for different products and must be certified for the manufacture of only that product for each production run. Coping with the unexpected demand for Cipro led Bayer to assign nonmanufacturing personnel to factories, to allow around-the-clock manufacturing, and to initiate arduous communications by telephone, e-mail, and fax to make sure that other value chain partners (particularly suppliers, wholesalers, and large pharmacy chains) were coordinated.21
Such experiences have created second-order demand for ERP systems such as those made by SAP. With an ERP-type system, organizations can quickly detect and address shortages and glitches. In addition, the system can provide the capacity to rapidly run alternative scenarios and help its clients develop the most appropriate response in an automated manner. Ultimately such systems have the potential for creating a competitive edge for companies that use them and a disadvantage for companies that don’t. As Garnet Group analyst French Caldwell recently observed, what drives demand for systems such as SAP’s is “to have better insight and be able to integrate the data it’s getting from inventory and supply chain management and from market and business intelligence with internal intelligence to improve its product development process.” The long-term bottlenecks addressed by systems such as SAP’s are those that affect product development time.
Move #32: Reduce Costs or Abolish Bottlenecks to Disrupt the Value Chain
Often, existing ways of competing coincide with existing value chains. When there is a shift, you may be able to benefit from the instability in a value chain to improve your position with respect to the rest of the industry. Your industry may, for example, have settled into relatively predictable patterns of competition. Such strategic lockstep occurs when competition has been dominated for some time by a few, largely identical providers competing in much the same way. An opportunity may exist for a new competitive model to be introduced by a marketbuster that the incumbents are reluctant to copy.
Example: The Explosive Growth of Affinity Cards. Started in 1982, MBNA uses affinity programs in which organizations endorse its credit cards. In exchange, MBNA imprints the organizations’ logos on the cards and gives them a percentage of the revenues generated. Through such partnerships, MBNA has created an earnings juggernaut, with $98 billion in loans, 15 percent of the U.S. credit card market, and the second-lowest rate of bad loans in the industry.
MBNA began its business by focusing on high-quality professional groups through trade shows, telemarketing, and direct mail. The company increased its market share of low-risk card users and concentrates almost exclusively on upper-market, free-spending borrowers. MBNA banks on customers to carry a balance from month to month in order to make money from interest payments.
Because of MBNA’s rigorous screening process, the company keeps its credit card loss rate below the industry’s average. In 2001, the company wrote off only 4.7 percent of its loans, well below the industry average of 6.9 percent. Its screening process includes computer models, and a person reviews every account. MBNA’s low-risk customer base has also helped the company to weather the weak economy better than most creditors.
With four thousand seven hundred affiliate organizations, MBNA has become a credit card giant, with annual earnings gains of 25 percent or more for the past nine years. MBNA is also moving its operations into Canada and Europe, where it has almost two hundred member corporations.22
Example: Kinder Morgan Energy Partners. In 1997 Richard Kinder and William Morgan paid $40 million for Enron Liquids Pipeline, L.P. At the time, the conventional wisdom was that the oil and gas pipeline and storage industry was profitable but slow growing. Kinder, a former Enron executive, saw a huge opportunity by rethinking the way business was done in the industry. He left Enron to form Kinder Morgan Energy Partners, L.P. By cutting $5 million in costs, largely by eliminating headquarters staff, the company increased cash flow and boosted the dividends to the limited partners by more than 50 percent in less than six months.
Kinder Morgan’s pipelines move gasoline, diesel, jet fuel, and natural gas from petroleum refineries to regional markets and can do this with dependable revenues. The company has more than thirty thousand miles of pipeline. Kinder Morgan also operates some thirty-three bulk terminals that handle 55 million tons of materials such as coal and petroleum coke. By accumulating pipelines and terminals, the company has acquired the assets that are central to the energy infrastructure of growing markets.
Kinder Morgan has also leveraged its Master Limited Partnership (MLP) financial structure, which allows it to capitalize on tax advantages. The company pays no corporate income tax as long as it distributes most of its earnings as dividends. It also avoids the double taxation of dividends that most companies face. As a result, its entire pretax earnings go to shareholders, whereas most companies would endure federal, state, and local governments skimming off 40 percent or more of that earnings stream. Kinder explains the advantage: “When I was president of Enron, I would have thrown people out of the room if they came in with a proposal that had anything less than a 15% aftertax return. We can make acquisitions all day as long as we’re over 8.5% pretax.”
Prospecting Questions for Reordering or Relocating Your Space on the Value Chain
Examine the value chain of your industry, reviewing how it has changed and how its value-capture patterns are shifting. Use your insights to seek marketbusting opportunities to capture value or relocate your participation at emergent shifts in the chain:
Can you spot places to exploit shifts that are occurring or will occur in the value chain structure?
Can you pinpoint second-order consequences up and down the chain where you can reposition your participation?
Can you spot places where you can disrupt the current value chain and change it in ways that suit you?
Since its formation in 1997, Kinder Morgan has grown through acquisitions of pipelines and terminals, including a $1.4 billion acquisition of Santa Fe Pacific Pipelines and a $1.15 billion purchase of the U.S. terminals and pipeline assets of GATX Corp. The company has also grown through expansion projects.
Kinder Morgan’s sales (in millions of dollars) were 323, 429, 816, and 2,947 in 1998, 1999, 2000, and 2001, respectively.23
Action Steps for Exploiting Industry Shifts
Step 1: With your strategy team, use the questions in table 5-1 to determine whether there is evidence that some kinds of dynamic changes are occurring at an industry level. Depending on the evidence, conduct the analyses we suggest for the specific pattern. There may be evidence that more than one pattern change is under way or imminent. So much the better! What you are trying to figure out is whether there are early indicators of the opportunities created by transforming industries.
Step 2: If you have concluded that there may be opportunities at an industry level, apply the prospecting questions that we suggest for each level to see whether there is a chance to make one of three possible moves:
- Can you capture an advantage because you are among the first to spot and exploit a new pattern of industry change?
- What are the likely second-order effects of a change that is clearly occurring? Can you capitalize on these?
- Are you in a position to disrupt or provoke a change in the industry?
Step 3: For those ideas you deem to be most attractive, put together a short feasibility overview. What are the main assumptions you are making about how you will succeed? What are the skills and competencies you must have for this to work? What is the step-by-step path forward?
Step 4: Consider the timing and implementation challenges of executing a strategy for exploiting industry shifts.