Competitive Strategy and Sustainability

Studying this chapter should provide you with the knowledge to:

1. Create a strategic group map and a strategy canvas of a competitive landscape.
2. Analyze a company’s competitors to identify the likely ways they will respond to a company’s strategic moves using a competitor response profile.
3. Describe the different types of competitive strategies that can be deployed contingent on the environment in which a company operates.
4. Choose or create a competitive strategy suitable to a company’s competitive situation.

One cold January, facing increasing competition from low-fare carriers, Delta Airlines introduced a new pricing plan called sim- plifares that dramatically cut ticket prices across most of Delta’s domestic US routes. Paul Matsen, Delta’s chief marketing officer, stated, “We could sit back and wait for low-fare competition to force us to react, but we’re going on the offense.”1 The company cut ticket prices by as much as 50 percent and eliminated the Saturday-night stay requirement that had long helped airlines distinguish between leisure travelers and business travelers. Furthermore, it capped the price for a last-minute coach fare at $499 and a first-class fare to anywhere in the country at $599. Although the new pricing scheme would immediately create a drag on revenue, Delta expected that

over the long run the pricing move would be good for the airline by helping it take back passenger volume from the low-fare carriers. Business travelers, in particular, had been increasingly moving to low-fare carriers for their travel. In fact, near Cincinnati, where sim- plifares was first piloted, many business travelers preferred to drive to a smaller airport and pay the fares of AirTran or ATA rather than the higher fares of Delta. The new pricing structure was expected to bring these customers back to Delta.
Although Delta hoped for a new source of advantage from this pricing move, Delta’s main competitors—the full-fare carriers such as American and United—responded to simplifares by immediately matching Delta’s prices. Within days, business fares in the top 40 routes flown by major airlines were down by an average of one-third, and American Airlines’ fares were down by 44 percent.2 Perhaps as a way to slow the free fall, Northwest airlines warned the industry that “fare simplifications” would immediately and adversely affect indus- try revenues, but other airlines ignored the warning.3
By July, just six months later, Delta was already making upward price adjustments, citing a spike in the cost of fuel.4 The company abandoned the $499 cap and raised the ceiling by $100. Again, major carriers immediately followed suit. On the day of the announcement, a spokesman for Continental stated, “All I can tell you is that we did match Delta’s fare, and the match was effective today. Whatever Delta did, we did.”5 Meanwhile, the low-fare car- riers welcomed the move as evidence that full-fare carriers were burdened with cost structures that were simply too high to match their low ticket prices.

194

Despite the effort exerted to implement the new pricing strategy, within three years, Delta had completely abandoned the simplifares initiative, discovering that it provided no sustainable advantage. Delta’s CEO seemed to suggest that efforts to compete on price with the low-fare carriers had been misguided. Cutting prices for business travelers had disastrous effects on revenue because the expected

growth in passenger volume never materialized. This was largely because of competitive price matching. In a clear return to its previ- ous strategy, the CEO stated, “You really have to have a differential [between business and leisure travel]. We offer different products to different customers based on their attributes. That’s better for an inter- national carrier offering . . . different products on the same airplane.”6

Competition is a reality for business firms. Whether a company faces competitors that are actively striving to erode its market share or potential new entrants to its market, nearly all managers must grapple with how to compete. In some markets, competition is light because firms are highly differentiated or because they face few rivals. In other markets, competition can be very intense. In such markets, and as the opening case demonstrates, a company must acknowledge the reality that competitors are watching and are likely to react to its strategic actions. Had Delta realized how quickly its competitors would respond to its pricing moves, the company might have tried a different strategy to improve its performance against low- fare carriers.
One of the key challenges of the strategist is to capture profits in the face of competitors who want to steal them. A company might offer a unique value proposition in an attractive market delivered with the right resources and capabilities, but if a competitor can enter that market offering the same, or better, value proposition, then the advantage isn’t sustainable. Or, if competitors can simply copy a company’s strategic moves, any advantages are fleeting. The question of sustaining advantage—how to prevent other companies from offering the same value—is the fourth key strategy question that must be answered as identified in Chapter 1.
How does a company know which actions to take in the face of competition? What kinds of moves are most likely to provide sustainable competitive advantage for the firm? This chapter provides answers to these questions by identifying a set of tools for competitive analysis along with strategies for responding to competitors that are useful under a variety of market circum- stances. The overall objective is to help strategists understand how a company can improve and sustain its performance in the face of competition.
In order to effectively compete, a company must first know the competition and then it must launch strategies to win against the competition. The first two sections of the chapter, “Under- standing the Competitive Landscape” and “Evaluating the Competition,” address knowing the competition. The latter three sections, “Principles of Competitive Strategy,” “Competitive Actions for Different Market Environments,” and “Sustaining Competitive Advantage,” address winning against the competition and sustaining competitive advantage.

Understanding the Competitive Landscape
In order to compete effectively, a firm must understand the structure of the competitive environ- ment in which it operates. Most industries contain groups of companies that compete directly against each other but only indirectly against companies in other groups. This situation arises because of differences in customer needs and preferences, which give rise to various customer segments. As companies pursue these segments, they develop business models that are well- suited to serving one segment but not so well-suited to serving other segments in the market. Firms with similar business models cluster together by pursuing the same segments of customers.

Strategic Groups and Mobility Barriers
An analysis that breaks down the structure of a market or industry into these constituent groups is called a strategic group analysis. Visualizing this group structure is an important component of competitive analysis because it identifies the major arenas of competition and who com- petes directly with whom.

strategic group A set of companies that compete in similar ways with similar business models pursuing similar sets of customers.

In the United States, Delta, United, and American Airlines compete in the full-fare segment of the industry (see Animated Executive Summary, “Competitor Interaction”). Delta encoun- ters American or United on many of its routes between pairs of cities because these companies compete in Delta’s primary customer segment—business travelers. Among the companies in this group, airlines compete head-to-head and watch the moves of their competitors closely. They respond to one another’s competitive moves almost immediately in order to maintain a valuable competitive position. Other airlines, such as Southwest, JetBlue, Frontier, or Spirit, compete in the discounted or low-fare segment of the industry. They offer few frills, less popular airports, or no reserved seating. These companies compete head-to-head with each other more than they compete with the full-fare carriers.
Even though companies within groups compete head-to-head, and companies in other groups are less of a threat, rivals in other groups cannot be completely ignored. Rivals could begin targeting customer segments with new offerings or more favorable value propositions and eventually steal customers. This is exactly what happened in the case at the opening of the chapter. Low-fare carriers were gaining ground in the business traveler segment of the market when Delta launched its effort to compete on price with these carriers.
Strategic group maps are constructed by identifying the main differences in the ways in which firms in an industry compete to deliver value. These differences typically relate to value chain activities such as relative price, geographic placement, product line breadth, extent of vertical integration, niche or full-service offerings, and so forth. The factors that are relevant vary based on the industry in question. In the airline industry, for example, clues about the most important differences in how firms compete can be found in the opening case description. Two of the important factors mentioned are price and whether airlines are flying to primarily large or small airports (recall that Delta was losing business travelers to smaller airports near Cincinnati). Therefore, to draw a strategic group map of the airline industry, you would place these two factors on the horizontal and vertical axes of a simple two-dimensional chart and plot the companies relative to these axes as outlined in Figure 11.1. If you observe clustering of companies, you have identified strategic groups within the industry, at least along the dimen- sions chosen. The rule is to choose factors that are the most relevant in describing the differ- ences in how companies compete for customers. In other words, choose the dimensions that create the most distinctive clusters.

Large

Small

Low

Relative Fare Price

High

FIGURE 11.1 Strategic Group Map
Note: Company circle size relative to revenue

Companies find that switching strategic groups is difficult once they have built a history in one. The reason is that companies in specific strategic groups choose particular ways to con- figure their activities and these activity systems do not change quickly or easily. This creates a barrier to mobility between groups. After a firm is in a particular group, it is not mobile and can’t simply leap to a different group.7 For Delta to effectively compete with low-fare carriers, the company would have to acquire many of the business characteristics of the low-fare carriers. For example, the company would have to change its cost structure, airline fleet, routing, and airport locations, effectively abandoning much of its existing customer base. In the opening case, Delta attempted to compete head-to-head with the low-fare carriers by changing only its price. But the company would have had to change many more of its charac- teristics in order to be successful.
A strategic group map provides a basis for making competitive assessments not only because it defines who a company’s competitors are but also because it can help to analyze potential changes in the landscape. For example, it can indicate whether companies in one group are beginning to appeal to the primary markets of another group. Such was the case when low-fare carriers near Cincinnati began to steal business customers from Delta.
Relevant questions to ask include the following: Are firms in any group attempting to change the value they offer and the basis of competition? Is this leading to any changes in the boundaries of groups? Delta attempted to alter group boundaries when it launched a low-fare pricing strategy. Are new firms entering the industry with fundamentally different business models? Southwest certainly did when it first entered the Texas market in Dallas. Are there “empty spaces” on the strategic group map that may invite successful entry? In Figure 11.1, no firms currently operate with high fares at small airports, or with low fares at large airports. If this is the case, does this fact suggest possible alternative competitive approaches to the market? These types of questions can be asked and addressed effectively in the context of the strategic group map (see Strategy in Practice: A Real World Strategic Group Map).

Strategy Canvas
Another way to evaluate differences among competitors is to employ a strategy canvas. This idea was first introduced by W. Chan Kim and Renée Mauborgne as a way to assess relative competitive strengths and weaknesses against specific purchase criteria.8 By rating firms on various criteria that customers use to make purchase decisions, the analyst is able to quickly grasp similarities and differences in how companies attempt to offer unique value to customers relative to competitors.

barrier to mobility Any factor that limits the ability of a company to move between strategic groups.

High

Low

Price

Meals Lounges Seating
choices

Hub connectivity

Friendly service

Speed Frequent departures

FIGURE 11.2 Strategy Canvas of the Short-Haul Airline Industry
Source: Adapted from C. Kim and R. Mauborgne, “Charting Your Company’s Future,” Harvard Business Review (2002).

Strategy in Practice
A Real-World Strategic Group Map The chart provided a clear view of which companies were on the landscape, how the companies were competing with respect to price
Ivanti is a provider of enterprise software solutions for IT admin- and product capabilities, and which companies Ivanti primarily com- istrators who manage the many devices on corporate computer petes against. By examining the chart, it was also clear that some of networks. When Ivanti wanted to gain strategic insight into the the companies were well positioned to present threats to companies dynamics of its competitive landscape, the company created a stra- in other groups by changing products or pricing. For example, compa- tegic group map (see Figure 11.3). First, the company chose two fac- nies in the Alternative Delivery Providers and Small Business Segment
tors that seemed to distinguish the business models of firms in the Full Suites groups seemed to be the biggest threat for encroaching
industry: relative price and product capabilities, especially around on Ivanti’s market share. Meanwhile, companies such as Novell, HP, scalability, or the ability of the software to handle very large cor- and CA, which offered similar software, seemed to have fallen out of porate networks. All relevant competitors were placed on the chart Ivanti’s strategic group. Still other firms, such as those in High-Growth based on how they scored on these two dimensions. The circle size Niche Providers, seemed to be improving their product scalability. for each company was scaled to represent revenues. Clear strategic These dynamics are represented on the chart with arrows. The stra- groups emerged, and these were circled (dotted black) and then tegic group map successfully informed the development of targeted given a name for quick reference. Competitor bubbles were further competitive strategies, but also helped identify potential acquisitions, color coded with a proprietary Ivanti indicator. pricing, and product feature enhancements.

Full Suite–Large
Enterprise Revenues/
High Market Share IBM
Declining BigFix
High-Growth Niche HP Novell
VDI and Point Providers
Players CA
Absolute Symantec/ Microsoft
RES Lumension Altiris (SCCM)
Software
Ivanti

Medium AppSense
Bomgar Threats from
Dell/Kace Below Full Suite—Enterprise
Wanova
JAMF

Microsoft (InTune)
Matrix Numara
Kaseya 42 (BMC)
Low
Small Business Segment Full Suite
Alternative Delivery Providers (Primarily
Small Business Segment) Size of bubble reflects the size (revenue) of the organization
Product Capabilities/Scalability

FIGURE 11.3 Ivanti Software—Strategic Group Map and Competitive Landscape

For example, consider a strategy canvas analysis of Southwest Airlines and its unique value proposition relative to full-fare airlines and automobile travel (see Figure 11.2). Various features that customers care about when selecting among travel options are identified and placed on the horizontal axis. These features include price, meals, lounges, seating choices, hub connectivity, and so forth. Next, company performance is evaluated against these criteria and scored on the

vertical axis. This scoring can be based on rigorous quantitative scales, such as those obtained from surveys or other market research, or on estimates. The completed strategy canvas provides insight into how competitive offerings are differentiated.
In Figure 11.2, Southwest’s scores more closely resemble automobile travel than they do the scores for other full-service airlines. This analysis uncovers a key point about Southwest’s approach to the market. When Herb Kelleher founded the airline in 1971 at Love Field in Dallas to fly passengers to Houston and San Antonio, he set out not to compete with airlines but, rather, with automobile travel.
The strategy canvas is a useful tool not only for uncovering existing differences among competitors, but also for identifying new ways to beat rivals. Imagine Figure 11.2 without Southwest’s line drawn on it. If you were launching a new airline, or even if you were running an existing airline, you might be able to identify new opportunities for competitive positioning by studying the differences between how other airlines and cars are competing across relevant purchase criteria.

Evaluating the Competition

Now that we’ve explored how to look at the competitive landscape, we can turn to examining the motives and likely behavior of individual competitors. Anticipating the actions of rivals is an important skill for companies because it helps them evaluate their own competitive moves to identify those that will have the most advantageous effect. A useful way to examine a competi- tor is to develop a competitor response profile.9 A competitor response profile identifies char- acteristics of a competitor in order to assess how it might respond in the face of rival actions, as outlined in Figure 11.4.

competitor response profile A profile of a competitor that identifies its objectives and assumptions, its strategy, and its resources and capabilities in order to anticipate how the competitor might respond to rival actions.

Objectives Strategy

• Leverage the benefits of international scale for overall cost savings.
• Capture a greater share of market by providing home city to destination travel for international passengers.

Delta

• Position as an international travel choice to as many customers as possible by building an extensive travel network.

Assumptions
• Passengers want to fly the same airline domestically and internationally.
• Scale savings exist by having a global footprint, which permits competitive pricing on international routes.

FIGURE 11.4 Competitive Response Profile

Resources & Capabilities
• Locations in major cities
• Airline partners that provide global reach
• Fleet of large aircraft
• Reliable and service-oriented travel

Source: Adapted from M. E. Porter, Competitive Strategy (New York: The Free Press, 1980).

What Drives the Competitor?
To illustrate how to build a profile, let’s return to the airline industry. Let’s assume that Southwest Airlines wants to compete on international routes in Europe and is evaluating Delta as a comp editor.Thefirstquestiontoaskis,“Whatdrivesthecompetitor?”Withinthiscategory,objectivesand assumptions areidentified. Anobjectivefor Deltacouldbe,“Leveragethebenefitsofinternational scale for overall cost savings,” or, “Capture a greater share of market by providing home-to- destination travel for international passengers.”
What assumptions reinforce these objectives? One is that passengers want to fly the same airline domestically and internationally, possibly because of co-located terminals or easier bag- gage transfers. Another is that scale savings exist by having a global footprint, and that this per- mits competitive pricing on international routes (since scale savings lower costs). These kinds of assumptions often point the way to potential rival moves. For example, if Southwest theo- rized that the scale savings from Delta’s global footprint were small, or that Southwest’s own operating model gave it significant cost benefits, it could plan on using this as an advantage against Delta and contest some of its rival’s more popular international routes.

What Is the Competitor Doing or Capable of Doing?
After identifying the objectives and assumptions that drive the competitor, the next question would be: What is the competitor doing and capable of doing? Here is where a competitor’s strategy and its resources and capabilities are identified. What is Delta’s strategy? Put simply, Delta’s strategy is to position itself as an international travel choice to as many customers as possible by building an extensive travel network.
What resources and capabilities does Delta use to accomplish this? Resources include its locations in major US cities that are international gateways, such as New York, Atlanta, Seattle, and San Francisco; airline partners that provide coverage where Delta is weak; and a fleet of large planes that are characteristic of long-haul travel on international routes. Further, the airline has built a capability for reliable, timely, and service-oriented international travel. These resources and capabilities point directly to what Delta can do on a competitive basis, such as supplying international corporations with end-to-end travel services. These are the strengths that Southwest, in our hypothetical example, must acknowledge if it is going to challenge Delta.

How Will a Competitor Respond to Specific Moves?
After these four factors—objectives, assumptions, strategy, and resources/capabilities—are laid out for a specific competitor, a company such as Southwest can anticipate how the com- petitor might respond to specific moves. For example, given this profile, how would Delta respond to Southwest entering one of its existing city-to-city routes? Given that Delta dif- ferentiates, in part, by providing a broad set of international route options to customers, the company will probably not react strongly to Southwest entering a single city-to-city route or even several routes. Why? Think about Delta’s objectives, assumptions, strategy, and resources/capabilities. These include international scale, cost savings based on this scale, an end-to-end extensive travel network, and substantial global assets. Because Delta is add- ing value by being in as many places as possible and is building an extensive network, the company is unlikely to view the entry of a competitor without these objectives and resources as a threat to its broader strategy. In formulating its competitive strategy, Southwest can feel confident that entering into markets already occupied by Delta will be accommodated, at least while Southwest’s international travel network remains small. If it begins to grow large, Southwest could wind up moving into Delta’s strategic group, which could then invite inten- sive competition.

Using Game Theory to Evaluate Specific Moves
A competitive response profile provides an extensive look at a particular rival and also lends insight into how this rival might respond to specific strategic actions. When rivals are locked in intensive back-and-forth competition, such as that experienced in the airline industry, a struc- tured approach to analysis can lend even more insight. The tools of game theory provide such a structured approach. The word game in game theory refers to strategic interaction among com- petitors and the word theory refers to a set of predictions about how competitors play games.
In most games, rivals are expected to make moves that deliver the greatest profit, called a pay-off. Firms typically make their choices with this objective in mind. But rivals have choices, too. With both firms facing choices, each must consider what the other will do in order to reach their own best outcome. This logic of anticipating what is in a rival’s best profit interest before making your own move is central in game theory. Had Delta considered this in the opening case, the company might have anticipated how quickly rivals would respond to its price cut.
Game theory is especially useful in contexts in which only a few rivals exist (such as air- lines) and these rivals are considering such moves as price changes, capacity adjustments, or new product features, and are wondering how competitors are likely to respond. Let’s examine the logic of game theory to see how it can be used to anticipate and respond to rival actions.

Simultaneous Move Games To illustrate the basic logic, let’s consider a simple game with two players, each of whom has two choices. Assume the players make their moves simulta- neously and they play the game only once. This set up is called a simultaneous move, one-shot game. The most famous game of this type is the prisoner’s dilemma. The prisoner’s dilemma is as follows:10 Two individuals, prisoner 1 and prisoner 2, rob a bank of $2 million and hide the loot. They have been captured and are being held by police in separate cells. The police believe that the two robbed the bank but lack sufficient evidence to convict. So they decide to sepa- rately offer to each prisoner the following deal: “If you implicate your partner, we will give you leniency. But if your partner implicates you, you will get jail time.” The prisoners know that if neither implicates the other, they will both go free.
Now consider the following 2 × 2 matrix representation of the game shown in Figure 11.5. It shows that each prisoner has two choices. Prisoner 1’s choices are on the rows and prisoner 2’s choices are on the columns. The numbers in the cells are payoffs. The payoff on the left in each cell belongs to prisoner 1 while the payoff on the right belongs to prisoner 2.
To interpret payoffs, assume that one year of jail time is the equivalent of $1 million of the loot. If neither prisoner implicates the other, they go free and share the loot. If both implicate, they go to jail for one year each. If one implicates the other while not being implicated, he gets off and takes all the loot for himself, while the other goes to jail for two years. Assuming that the prisoners play the game only once, they either get off free and go their separate ways, or do so after they get out of jail. If they both go to jail, assume the loot is recovered by the authorities.

game theory A structured approach to analysis of competitor interaction that yields predictions about which strategic actions are most likely to be chosen by rivals.

Prisoner 2
Do not
Implicate implicate

Implicate

Do not implicate

FIGURE 11.5 Prisoner’s Dilemma

Nash equilibrium A set of moves in a game that simultaneously maximize each firm’s payoff, given the choices of rivals, and from which no player has an incentive to defect.

dominant strategy In game theory, a set of actions that is always played no matter what a rival chooses to do.

Since the prisoners are being held in separate interrogation rooms, they must make their choices (“implicate” or “do not implicate”) without knowing the choice of their partner. This is the simultaneous move aspect of the game. Assume both players know the structure of the game and the payoffs accruing to their respective actions.
What is the predicted outcome for this game? John Nash, a famous game theorist, devel- oped an equilibrium concept in games that has come to be known as the Nash equilibrium. The Nash equilibrium is represented by a set of moves in a game that (1) maximizes each firm’s payoff given the choices of rivals and (2) removes the incentive to defect in the sense that no player can improve his payoffs by changing his choice. The first component of the definition reflects that players are striving to achieve their best possible outcome while the second ensures that the outcome is stable (i.e., the players have no incentive to change their action). The Nash equilibrium is the solution concept used to predict the outcome of competitive interaction.11
To find the Nash equilibrium, think through what a player should do under each possible move of its rival. Let’s look at the game from prisoner 1’s perspective. Suppose prisoner 1 thinks that prisoner 2 might implicate (look at the implicate column for prisoner 2). Prisoner 1 has two choices. He can implicate and receive –1, or not implicate and receive –2. Which does he prefer? He prefers to implicate since we assume that players always prefer the better payoff.
Now let’s consider what prisoner 1 would do if he believes prisoner 2 will not implicate. Under this scenario, prisoner 1 receives a payoff of 2 if he implicates and a payoff of 1 if he does not implicate. Clearly, he prefers to receive 2 over 1, so he would implicate.
Notice that no matter what player 2 chooses to do, player 1 maximizes his payoff by choosing “implicate.” Doing the analysis from prisoner 2’s perspective gives the same answer. The intersection (cell) of any choices that are simultaneously preferred by the players of a game is considered a Nash equilibrium, as long as there is no incentive to defect. In this game, each player’s best choice is to implicate, and neither has an incentive to change this choice.
Implicate is also what is called a dominant strategy because it is the best choice under every alternative choice of the rival. Searching for a dominant strategy makes finding a Nash equilibrium easier in games where such strategies exist. In the prisoner’s dilemma, after discov- ering that “implicate” is a dominant strategy, the analyst can cross off both the row and column associated with “do not implicate.” This choice would never be employed because it is always dominated by the implicate choice.
Notice how the style of analysis that we used to solve the game resulted in the development of a strategy for play. In game theory, a strategy is a set of best responses to every possible rival action. We systematically analyzed prisoner 1’s prospects under each possible alternative action of prisoner 2 and selected the best outcome. In the real world as well, this is a useful approach for developing a competitive strategy. If the number of possible moves of a rival is small, a potential response to each one of those possible rival actions can be planned. Having done so, a company would have identified a competitive strategy.
The key lesson from the prisoner’s dilemma is that each player implicates and goes to jail when a much better outcome exists. If they both play “do not implicate,” they share 1, or $1 million each. However, the competitive risk, the lack of trust, and the worry that a rival will take advantage of the situation if he thinks the other will play “Do Not Implicate,” keep both players going to jail. The reason this is important in real markets is that it suggests a truth about com- petitive behavior. Namely, competitors will play with their own best interests at heart. Further- more, since in most markets cooperation between competitors is anticompetitive and illegal, coordination typically does not exist—and neither does trust. Therefore, the prisoner’s dilemma offers a compelling prediction about what happens in real markets when companies have opposing interests.
Now consider a prisoner’s dilemma game in the business world. Let’s return to the opening case and assume that Delta Airlines is playing a one-shot pricing game against American Air- lines (we’ll make the one-shot assumption for now and relax it in a moment). Let’s assume that in this game each firm has two choices. It can either maintain price or lower price. If both main- tain price, each earns a profit of 5, or $5 million. If both lower price, each earns a profit of 2, or

American
Maintain Lower

Maintain

Lower

FIGURE 11.6 Delta and American Play Out the Prisoner’s Dilemma

$2 million. But if one company lowers price while the other maintains price, the first company receives a profit of 10, or $10 million, while its rival loses 1, or $1 million. See Figure 11.6.
To solve this game, take the perspective of one firm and decide which move would be best under each alternative action of the other firm. If Delta believes that American will maintain price, it has a choice between payoffs of 5 and 10 for maintaining and lowering price, respec- tively. Clearly, Delta prefers to lower price. If Delta believes that American will lower price, then it has a choice between a payoff of –1 and 2. It prefers to lower price to receive the payoff of 2. The logic is similar from American’s perspective.
As in the traditional prisoner’s dilemma, both firms wind up with payoffs that are worse than they might have received. Specifically, if both companies would maintain price, they would each wind up with $5 million. However, in the one-shot game, the pull to try for $10 million is very strong. This leads both companies to a relatively poor outcome of $2 million. This game illustrates how the prisoner’s dilemma can affect firms in real markets. Rivalrous behavior can make both firms worse off than they might have been if they had been able to cooperate. The example also illustrates how a simple game structure can be used for insight into how players might respond to one another’s strategic moves.

Infinitely Repeated Games Now let’s relax the assumption that competitors interact just once as in the one-shot game. In the real world, most companies are in competition with rivals each and every day, month, or year with no certain end date. Game theorists call these games infinitely repeated games. Even though the games are not literally played forever, they are treated this way since the competitors repeatedly interact and the ending period is not known.
In infinitely repeated games, players always believe there is a future. This alters the way they play. Specifically, they look for opportunities to get a larger amount of profit over a longer period of time. In stable markets in which the players rarely change, firms play the game indef- initely. They know that they will be facing their rivals each and every period.
Delta and American play an ongoing pricing game in which they must decide whether to maintain, lower, or increase price each and every period. (In fact, pricing games are played on each and every route, often with multiple players). The companies do not know if or when the games will cease to be played so treating their rivalry as an “infinite horizon” game is sensible. To see how this affects the outcome of the game between Delta and American, consider again Figure 11.6. We already know what happens in a one-shot game—both players choose to lower prices, which makes them both worse off. However, both players know that they are not playing a one-shot game. They can lower prices this period, but they have many future periods to go. In this situation, we assume that the firms look at the payoffs and realize that they will be better off over the long run if they maintain prices. Firms reason that this type of collusion is in their mutual best interest, and they assume that their rival is thinking the same way. Therefore,
each decides to maintain price and expects rivals to do the same.

Ethics and Strategy

Is Collusion Ethical? On the one hand, by keeping profits high, these companies are able to invest in research and development and continue to
Companies that consistently do battle with the same set of com- come out with great products. Such products can even improve the petitors eventually develop norms of competition that help them quality of life. In the pharmaceutical industry, for example, com-
avoid low profits. Although the companies are not communicat- panies would not be willing to invest billions of dollars in research ing directly to develop these norms (which would be illegal), they and development without a reasonable assurance of recouping this
watch each other so closely that consistent patterns of behavior— cost through high prices.
norms—can quickly emerge. The norms can influence pricing, prod- On the other hand, high prices of drugs or other products limit uct or service features, or certain kinds of restrictions on customers access. Through collusion, many products are priced out of reach that all companies impose. of less-affluent consumers. As large companies use their power to For example, many people own a cell phone and have signed a raise prices, higher proportions of economic resources are directed
two-year contract for service with a telecommunications company. toward their products and away from other products or causes in
All of the major cellular providers in the United States, AT&T, Verizon, the economy. Some would say that this misallocates resources in and Sprint, offer this two-year contract. How did this situation ways that make consumers worse off and unfairly channels profits arise? Simply put, the major telecommunications providers tacitly to shareholders.
colluded to set the contract requirement at two years. Whether What do you think? Should the legal form of collusion prac-
it’s airline pricing, in which airlines collude to keep prices high ticed in markets by large firms be allowed? Should restrictions be and avoid price wars for themselves, airline service features such imposed? If so, how would such collusion be monitored and con- as charging for bags on flights; the price of gasoline at the pump; trolled? Are you willing to accept collusion in exchange for better- or the cost of an automobile or medication, large and powerful quality products in some cases? Does your view change if you are a companies—airlines, oil companies, auto companies, pharmaceu- shareholder of a company that practices collusion?
tical companies, and so on—often collude to keep profits high.

tit-for-tat strategy A strategy that responds in kind to the moves of rivals.

In effect, companies in this situation enter into a style of play called “tit-for-tat.” In a tit-for-tat strategy, companies watch each other closely and choose actions that mimic what their rivals are doing. As long as a rival is “cooperating,” the firm chooses to cooperate. If a rival defects from a cooperative stance, the firm responds in kind. In the game between Delta and American, each firm chooses to maintain price unless it observes its rival choosing to lower price. If at any time the rival lowers price, the firm will “punish” by lowering its own price. After a few periods of this kind of “punishment,” it’s possible that the rivals could return to collusion, but doing so could grow increasingly difficult in the presence of repeated defections (see Ethics in Strategy: Is Collusion Ethical?).
One question that arises in these types of repeated games is whether playing the one-shot Nash equilibrium is ever in a firm’s best interest. The answer depends on the differences in cash flows between collusion and defection (defection here means playing the one-shot action). The value of these cash flows, in turn, depends on the time value of money since payoffs are received each period in perpetuity. (See the Strategy Tool: When Does Defecting from Collusion Make Sense?) Typically, however, ongoing collusion is the best approach, and it is what most firms in long-standing stable competition practice. As explained in the chapter opening case, when Delta chose to lower prices, its rivals immediately followed suit. The logic of game theory that we have just reviewed shows why. In fact, rivals did not even wait for Delta to obtain a tem- porary advantage; they lowered prices immediately. They reacted quickly with their tit-for-tat strategies, refusing to allow Delta to use price as a competitive advantage.
Game theory is a useful tool for analyzing and predicting rival actions in any context in which discreet actions are clear and payoffs can be specified. Constructing a game scenario is useful even when it represents a simplification of a real-world setting. The reason is that solving a simple game can provide insight into how competitors are likely to play more com- plex games, as we saw in the games illustrated by Figure 11.6. To construct payoffs for game scenarios, conduct detailed financial modeling or simply rank the value of conditional actions for each competitor, with more valuable actions ranked higher. Even if conditional payoffs had been only ranked in Figure 11.6, the insights would have been the same. By setting up simple game scenarios, analysts can quickly predict the outcome of competitive interaction, and spe- cifically, how a firm’s rivals may react to specific moves. This can contribute to successful eval- uations of the competition.

Principles of Competitive Strategy
Now that we know how to evaluate the competition and to analyze the dynamics between competitors, let’s turn to identifying competitive moves that are most likely to be effective. Four general principles of competitive strategy should be followed as a company looks for suc- cessful competitive moves.12 These principles, when applied, strengthen a company’s ability to compete:

1. Know your strengths and weaknesses
2. Bring strength against weakness
3. Protect and neutralize vulnerabilities
4. Develop strategies that cannot be easily imitated or copied (go where the competitor is not)

Know Your Strengths and Weaknesses
The first principle is to know your strengths and weaknesses. A company’s strengths are the resources and capabilities that deliver unique value (see Chapter 3 for a detailed discussion about resources and capabilities). A company must work to develop these strengths through focus, investment, and effort. A key strength of Apple is product design. But it is the relentless focus on developing and investing in that strength that turns it into a strong and sustainable source of competitive advantage.
A company’s weaknesses are the resources and capabilities that are subject to rapid obso- lescence, easy imitation, or high cost not recouped by value. Apple has strengths in product design, but its products are subject to rapid obsolescence because of the rapid pace of techno- logical change. Similarly, Starbuck’s atmosphere is easily imitated so the company cannot rely on this alone as a source of competitive advantage.
A company must make a careful and accurate assessment of its strengths and weaknesses because these form the foundation of competitive strategy as the next two principles illustrate.

Bring Strength Against Weakness
Second, bring strength against weakness. After a company’s key strengths are identified, they should be targeted to competitor weaknesses. Bringing strength against weakness can have devastating effects on the competition. When Google launched Android in 2007 as a mobile operating system for smartphones, Microsoft was already limping along in mobile phones, having suffered rapid market share declines because of products from Apple and Research in Motion (RIM, now Blackberry). Google leveraged its formidable strength in software engi- neering innovation and then built a coalition of manufacturers who would adopt Android (the open handset alliance) to deliver a strong body blow to Microsoft, whose rapidly decaying resource investments and declining market share made the company vulnerable in this area. Sometimes competitor weaknesses may be masquerading as strengths, so any apparent competitor strength that can be undermined or eroded through direct competitive action can be considered a weakness. Therefore, in their hunt for competitor weaknesses, companies should not be afraid of attacking competitive strengths. As Kmart struggled to stay afloat amid bankruptcy, Walmart attacked what was considered one of Kmart’s few areas of success by introducing a knockoff of Kmart’s Martha Stewart product line.13 This strong blow contributed
to Kmart’s downfall.

Protect and Neutralize Vulnerabilities
Third, protect and neutralize vulnerabilities. A company’s own weaknesses, once identified, must either be strengthened or truly neutralized; that is, made irrelevant so that they don’t

become targets of competitors. Starbucks neutralizes the effect of an easily imitable atmos- phere by also introducing a large variety of great tasting coffee blends, food items, store con- venience, and brand positioning.
In the last story, Microsoft might have assessed its weakness in mobile earlier than Google did and made moves to strengthen this vulnerability by investing much earlier in a new mo- bile operating system. As another example, some regard Apple’s closed, proprietary mobile operating system, iOS, as a competitive vulnerability since other companies are not allowed to deploy it on their devices. This could limit its market potential. In fact, Google attacked this weakness by making Android an open platform. However, Apple has been highly effective at neutralizing this weakness through strong design of its products and development of an exten- sive developer network in which developers of applications share in the value of the proprie- tary system.

Develop Strategies That Cannot Be Easily Copied
Lastly, develop strategies that cannot be easily imitated or copied. This seems obvious, but often companies are so busy copying competitors’ moves that they fail to see how they could do something altogether different. The principle might be best captured in the idea of going to where the competitor is not. Sun Tzu, the great Chinese strategist, once said, “To be certain to take what you attack is to attack a place the enemy does not protect.”14 Whether a company is pursuing special market niches, reconfiguring the sequence of its activities along the value chain, or recombining and leveraging resources of themselves and partners in ways that deliver value, competitive strategy flourishes when companies are doing something unique.15
In fact, most long-time competitors have found a way to occupy distinctive positions in their markets so that they can coexist with other companies profitably. Returning to the air- line industry, even though American, Delta, and United compete in the same strategic group in the United States, each has carved out distinctive hubs within their nationwide hub-and-spoke system so that they don’t completely overlap as they compete. Delta has hubs in Salt Lake City and Atlanta. United has hubs in Chicago and Denver. American has hubs in Dallas and Chicago. So although there is some overlap between the cities to which they fly, each of the major com- petitors has staked out a somewhat distinctive position relative to rivals.
In summary, these four competitive principles may be used to develop strong and unique competitive positions that improve the likelihood of long-term competitive success.

Competitive Actions for Different Market Environments

market structure The way rivals in a market interact and bargain for advantage. In its simplest terms, it’s the number of rivals in a particular market.

Clearly, not just any competitive move will work against a target competitor. A firm’s circum- stances define which competitive actions are available and likely to be effective. Market context strongly influences the scope of competitive action. One particular aspect of market context, market structure, is highly influential. Think of market structure in its simplest terms as the number of rivals in a particular market. Market structures typically fall into one of three catego- ries: monopoly, oligopoly, or perfect competition (sometimes referred to as just “competi- tion”).16 Each of these market structures creates certain competitive conditions that lead to particular sets of strategy choices when facing competitors.

Competition Under Monopoly
A monopoly is a market of one firm or one highly dominant firm, such as Sirius XM in satellite radio or Microsoft in word-processing software for personal computers.17 The basic strategic objective of a monopolist is to reinforce its monopoly. It does so in several ways, such as by

(1) raising entry barriers, (2) limiting competitive access to scarce resources, (3) innovating and patenting, and (4) introducing new products frequently. If a monopolist has new competitors threatening to enter its market, these are among the competitive actions they should consider taking as a response. On the flipside, the competitor attempting to enter the monopolist’s mar- ket can expect these kinds of retaliatory actions from the monopolist.

Raise Entry Barriers A barrier to entry is any factor that increases the costs, lowers the profit margins, or limits the market share of entrants to a market. For example, a monopolist may choose to practice limit pricing, which means to set the market price of a product just low enough so that a new entrant cannot pay the cost of entry to come into a market and be profit- able. Investing in heavy advertising or advertising over long periods of time also raises entry barriers. Coca-Cola’s brand equity, worth billions, was built through long-term consistent advertising, and it is a formidable barrier to entry for any firm looking to get into the cola market.

Limit Competitive Access to Scarce Resources If a monopolist can place a lock on the resources that it uses to produce its product, it can effectively bar competition. The monopolist might hire the most valuable scientists or other experts; it might secure the most advantageous geographic or real estate positions; or it might procure all of the capacity avail- able in a market for some particular input. For example, when JetBlue launched its regional jet strategy, the company entered into contracts with Embraer, the Brazilian manufacturer of regional jets, to purchase all of Embraer’s planes for three years. This effectively blocked any other competitors from procuring the same regional jets and implementing the same strategy.18

Innovate and Patent To maintain its competitive position, a monopolist is often required to innovate and patent.19 Indeed, in many monopolies both the monopolist and would-be entrants are in an innovation race. Potential competitors can bring down a monop- olist by making the monopolist’s product obsolete through innovation, while monopolists can stay ahead of potential market entrants by innovating themselves. As already mentioned, Microsoft lost its hold on the mobile operating system market in 2008 after failing to innovate sufficiently.

Introduce New Products Frequently By introducing new products frequently, monopolists can maintain the customer demand associated with their products and stay ahead of potential entrants who are trying to get into their markets. Apple Inc. dominated the market for handheld music players (the iPod) in the early days. Other firms attempted to get into this market, and certainly other devices appeared, but these devices obtained only a small fraction of the total share of market. Apple kept would-be entrants off balance by consistently and fre- quently releasing new product upgrades and enhancements. As already noted, this was also a way for Apple to overcome a potential weakness of rapid obsolescence.

Competition Under Oligopoly
Oligopolies are markets of a few firms, typically two to five, though in some cases the number could be as high as 10. The upper bound is difficult to define because the oligopoly designa- tion depends on whether firms in these markets are monitoring and reacting to specific rival behavior. If there are few enough firms for each to monitor the others effectively, then they are probably operating in an oligopoly.
Because the firms in oligopolies are locked in tight competition with only a few other firms, they must make their moves carefully, knowing that rivals will detect their actions and respond accordingly. We saw this as we analyzed infinitely repeated games and looked at an illustration of the competition between Delta Airlines and American Airlines. From a competitive perspec- tive, oligopolists monitor and mimic rival behavior, particularly in price and product features, and they employ tit-for-tat strategies.

barrier to entry Any factor that increases the costs, lowers the profit margins, or limits the market share of entrants to a market.

Monitor and Mimic Rival Behavior Oligopolists try to avoid the negative effects of competition by monitoring and matching rival behavior. In this process, norms emerge in competition around particular approaches to the market. For example, pricing norms are very common. Companies know that they could dramatically cut their price and possibly pick up market share in the short run, but they realize that this move would be quickly detected and matched, leading to lower profits for all firms in the market.
We analyzed this scenario using game theory. In the opening case, Delta airlines violated the pricing norm of its strategic group by matching prices with the low-fare carriers. This led to immediate retaliation by rivals so that almost no advantage was obtained and the whole industry suffered. This is a clear example of how trying to beat the norm rarely pays. Thus, for the good of long-term profits, firms usually simply respond to one another’s pricing and prod- uct features at levels that are profitable for all (also see infinitely repeated games).
Although the firms in oligopoly almost always respond to one another’s pricing moves, they don’t always match price, since some companies position their products at a premium. Coke and Pepsi are oligopolistic rivals, but Coke has staked out a price position that is slightly higher than Pepsi. Even so, if Pepsi raises its price, Coke will too in order to maintain the differential.
Price is not the only area of mimicking and matching among oligopolists. The behavior can also be seen in product or service-feature competition. When one airline announces a new frequent-flier program or significant new upgrades to its existing plan, so do the others. When one hardware manufacturer, such as Apple, introduces a new touch-screen device, rivals quickly follow suit. When Chevron adds a new detergent additive to its gasoline, Texaco does the same (the two companies have now merged). By matching product and service features, oligopolists ensure that they do not fall behind. In this way, oligopolists protect their profits and command higher margins from the market overall.
Finally, oligopolists may tacitly respond to one another in ways that carve up the market so that all can profitably coexist. The airlines do this with major hubs in different cities as described above. But the behavior can also be seen in the ways that oligopolists sometimes choose to appeal to particular market segments, with one providing price leadership in one segment and another providing it in a different segment (see Strategy in Practice: Tacit Collu- sion Between AT&T and Verizon).

Employ Tit-for-Tat Strategies As previously discussed, tit-for-tat strategies are those that respond in kind to the moves of rivals, including the meting out of punishments for behavior that violates norms (e.g., price wars, lawsuits, etc.). Because of the threat of this type of pun- ishment, defections from tacit collusion are reasonably rare among oligopolists. When defec- tions do occur, they are often accompanied by a signal that communicates the parameters of the action, such as length of time, in a way that rivals can clearly read. For example, airlines may run sales discounts on certain city-to-city routes, but these discounts are almost always accompa- nied by specific dates for which discounted fares are available. This provides an explicit signal to rivals so that they can interpret the parameters of the discount and avoid a price war.

“Perfect” Competition
“Competitive” markets are markets with many firms. In competitive markets, firms are price takers rather than price setters because attempts to use price strategically, as is done in monopolies or oligopolies, are not effective and wind up hurting the firm that tries. The logic goes like this: Because a firm sells a homogeneous good in a market of many firms, raising price leads to a dramatic drop in sales as customers go elsewhere. On the other hand, lowering price can backfire because firms are assumed to operate at full capacity. If firms are at full capacity, dropping price reduces total margin by more than it increases sales, leaving the firm worse off. If firms are not yet at full capacity, then price will typically fall until they are, and further attempts by individual firms to cut price will have negative effects. This is why firms in per- fectly competitive markets set prices at the market prevailing price and largely avoid strategic manipulation of price.

Strategy in Practice
Tacit Collusion Between AT&T and Verizon
From 2007 to 2011, AT&T enjoyed a monopoly on the iPhone since it was the only cellular carrier that Apple, Inc. allowed to provide services for the phone. But in January 2011, Verizon was also finally permitted to carry the iPhone, setting up an oligopoly between AT&T and Verizon (Sprint was added in October of that year). Fol- lowing a short period of offering unlimited data plans, both AT&T and Verizon eliminated their unlimited data plans for new users.20
In addition to matching one another’s moves in this way, the companies’ pricing behavior took on a collusive flavor. AT&T priced slightly lower than Verizon for data plans up to 4 GB and Verizon priced slightly lower than AT&T for data plans above 4 GB. In addi- tion, the slope of the pricing curve (the rate at which price rises as

additional data is added to a plan) was almost exactly the same for the two companies at key GB levels (see Figure 11.7). In other words, as AT&T’s price rose, so did Verizon’s as the companies sought to maintain a consistent pricing differential. Notice in Figure 11.7 how the companies were not necessarily matching prices, but their pricing structures were very similar. An understanding seemed to exist between the two, in which AT&T, who historically served more business customers, would charge higher rates for customers using more data, while Verizon would charge higher rates for custom- ers using less data. The matching behavior of the cellular carriers in pricing and plan structure, and the different targeting of mar- ket segments, demonstrate how oligopolists collude to maintain profitability.

$120

$100

$80

$60

$40

$30 $30 $30

AT&T Cheaper

$50
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Verizon Cheaper

$60
$50
$65
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AT&T Verizon

0.2

1.0 2.0 3.0 4.0
Monthly Data (GB)

5.0 6.0 10.0

FIGURE 11.7 Smartphone Monthly Wireless Data Cost Comparison—AT&T Cheaper at the Low End, Verizon Cheaper at the Higher End
Source: Barclays Capital, company reports and websites.

Since a typical assumption of competitive markets is that products are largely homo- geneous, very little differentiation is assumed to exist in these markets. This leads to a very specific set of competitive strategies that are likely to be successful. The list includes (1) consolidate markets, (2) pursue low cost, or (3) pursue differentiation strategies.

Merge or Consolidate Markets Firms in competitive markets often suffer from the superior bargaining power of buyers or suppliers (forces that are part of Michael Porter’s five forces model discussed in Chapter 2). Because many firms in the market are selling a homoge- neous product, bargaining power is difficult to obtain. This feature of the market also creates intense rivalry among firms.
One strategic remedy to this problem is for firms in the market to merge. As they merge, the overall market consolidates, reducing the number of firms and strengthening the bargaining power between the firms’ upstream suppliers and downstream customers. This merger and consolidation process is the way that industries evolve toward oligopoly.21 Merging before a competitor might be a way to obtain advantages in cost (owing to scale) or bargaining power.
A competitive market of “mom-and-pop” video rental stores gave way to a consolidated oligopoly of Blockbuster and Hollywood Video stores in the 1990s and 2000s. Hollywood Video, in particular, began as a local video rental family business and, through the vision of its CEO, Mark Wattles, eventually expanded to 2000 stores nationwide. In the face of this consolidation, most of the mom-and-pop video rental stores disappeared.

In this example, the consolidators built new stores and the old stores disappeared, but with enough foresight, the old mom-and-pop stores might have merged in local markets and retained their hold on the business. This is a particularly good illustration of how firms in a competitive market can fail to anticipate the kinds of moves that could save them from obsolescence.

Pursue a Low-Cost Strategy Since companies in competitive markets are price takers, they have little control over price. Therefore, in order to realize profit, they must drive down their costs. In fact, it might be said that companies in such markets will live or die on their ability to get costs down. Especially in markets for which differentiation is difficult, rivals can expect other firms to aggressively lower costs. They must respond in kind in order to remain competitive. Chapter 4 details strategies for reducing costs, and any of those strategies can help the firm in a competitive market be successful.

Pursue a Differentiation Strategy When possible, companies in competitive mar- kets should pursue a differentiation strategy. To separate themselves from the pack, they can add product features, store locations, bundled services, or other variations to create unique value for customers. However, in markets with many firms selling homogeneous products, this is often easier said than done. Consider book selling on the Internet. For any given title, a book may be obtained from multiple different sources, including Amazon, Barnesandnoble.com, Walmart, Target, or a host of smaller sellers or even used booksellers such as eBay. The firms sell the same book. How can they differentiate? The product is the same no matter where it is bought. In this case, firms are left to differentiate on other aspects of the buying experience, such as the look and feel of the website, its ease of use, or the checkout process. Early in its his- tory, after realizing it could not make money on discounted bookselling, Amazon expanded its business into many other product lines. The fact that a customer can go to Amazon and buy not only a book but also many other items now helps Amazon differentiate its buying experience for books alone. Chapter 5 details differentiation strategies, and these may be especially useful for firms in competitive markets.

Dynamic Environments
The strategies discussed so far apply to stable market structures. However, some competitive environments are very dynamic, with competition constantly changing. Perhaps technology is changing at a very rapid pace; or new entrants with new technologies, products, or approaches are entering markets very quickly; or market consolidation is changing the landscape in unex- pected ways. In such environments, industry incumbents may not be able to raise entry barri- ers or limit access to scarce resources rapidly enough to stave off competition.
What companies must do in these environments is reconfigure their processes and capa- bilities to emphasize both innovation and speed. Imagine a company without these character- istics. Even if such a company were able to erect barriers to entry or secure access to scarce inputs, these advantages are likely to be fleeting because new competitors will rapidly innovate around them. Without capabilities of speed and innovation, companies in dynamic environ- ments are rapidly left behind. The smartphone industry provides an example. In an important growth era, the innovations and speed of Samsung, Google, and Apple quickly outpaced the market positions of companies such as RIM, Nokia, and Microsoft. To stay in the game, these companies too must be innovative and quick to market with value creating products. This will depend on their capacity to build effective internal processes.

Sustaining Competitive Advantage
Many of the above strategies can help a firm create and sustain a competitive advantage. Never- theless, the advantages offered by most strategies will almost always erode in time. What may be useful in various contexts are several additional tactics or mechanisms that can extend the time- frame of sustainability. Five specific sustainability tactics and mechanisms are illustrated below.

Create or Preempt Rare Resources The first tactic for sustaining advantage is to first possess and then preempt others from acquiring scarce resources. These could be raw materials, land, locations, or any other resource in limited supply. For example, DeBeers has sustained its advantage in diamond production by owning a large percentage of the world’s limited diamond mines. By controlling the limited supply of real diamonds, DeBeers is able to keep prices of diamonds high for jewelry like necklaces or wedding rings. Land can be a source of advantage in various industries like oil and natural gas. Energy companies that are able to locate energy resources and then purchase the land where they reside can sustain their advantage. Locations can also be a source of sustainable advantage. Walmart’s high profits in its early history was due in large part because it was the first discount retailer to put stores in smaller rural towns. It’s low prices and broad product variety was impossible for the smaller mom and pop stores to imitate. Its advantage was sustainable because large discount com- petitors like Target, Sears, and K-Mart rationally refused to enter the same rural towns since a second discount store would create substantial overcapacity. In similar fashion, when Star- bucks built a large number of stores in premium locations throughout downtown Seattle it cre- ated a barrier to imitation for other coffee houses. This strategy prevented other coffee shops from acquiring similar premium locations; moreover, if competitors tried to imitate Starbuck’s strategy of building multiple stores there would be too many coffee shops to make money. Companies that are the first to secure scarce resources are often described as benefiting from “first mover advantages.”

Secure Government-Sanctioned Barriers The second tactic is to secure government sanctioned barriers to imitation in the form of patents, regulations, tariffs, etc. For example, most pharmaceutical and biotechnology companies prevent imitation of their prod- ucts—at least for a period of time—through patents. In the United States, Blockbuster drugs like Adderall (for hyperactivity) and Viagra (for erectile dysfunction) were granted the standard 20 years protection from the date the patent application was filed. Government tariffs and other regulations can also protect certain companies. For example, US tariffs on imported steel help protect U.S. steel producers.

Create Buyer Switching Costs A third way to prevent imitation is to create buyer switching costs. One source of switching cost is investment or learning on the part of a buyer. For example, competitors of software companies like Microsoft have a hard time capturing Micro- soft’s customers because users have invested significant time in learning how to effectively use and navigate their Microsoft Office Suite (e.g., Word, PowerPoint, Excel). Buyers don’t want to have to learn a new software program. Another way to prevent buyer switching is through loyalty programs. Airline and hotel companies frequently get travelers to continually use their services because the traveler has accumulated “miles” or “points” with a specific company and they want to continue to build on their prior totals. Coke has long term contracts with key restaurant chains like McDonalds that prevent competitors from getting access to Coke’s business.

Leverage Network Effects A fourth way to prevent imitation is to offer a product or service that benefits from “network effects.” A network effect is a phenomenon whereby a prod- uct or service gains additional value as more people use it. For example, Facebook wasn’t par- ticularly valuable as a social media site when there were only a small number of users. But the value of Facebook increased as more people joined the community. This kicked in a positive feedback cycle whereby Facebook’s value increased exponentially as more users joined the community.
Markets characterized by network effects are sometimes called “winner take all” markets because the first mover to ignite the network effect often dominates the market. eBay (auctions), LinkedIn (professional networks), and Skype (Internet calls), all benefit from network effects. Companies that compete in “two sided markets” or “transaction platforms” also benefit from network effects. For example, Uber (ride hailing), Airbnb (lodging), and PayPal (money transactions) all benefit as more customers join their networks. Not surprisingly, a firm that benefits from network effects becomes hard to dislodge by competitors who cannot replicate the network effect.

Leverage Rare Intangible Assets Fifth, companies can prevent imitation through valuable intangible assets such as branding, loyalty, and customer habit. Customers buy Tide detergent because they know the brand and have just been using it for years. Former Procter & Gamble CEO A. G. Lafley refers to this as Cumulative Advantage, a reservoir of goodwill among customers that predisposes them to purchase new versions of Tide and not even look at com- peting brands.22 Competitors could create an iPhone knock off but due to the Apple brand, cus- tomer loyalty, and habit, Apple can effectively prevent imitation even if a competitor’s product is functionally equivalent.
Generating and sustaining profits is a key challenge in the face of competition. Companies should choose strategies and tactics that create long-term sustainability of their advantages.

Summary
• To effectively compete, a strategist should know the competition, including understanding the competitive landscape and how to evaluate specific competitors and their potential moves.
• The tools of game theory can lend insight into competitive interac- tion by helping the strategist think systematically about how a com- pany’s moves affect competitors, and vice versa.
• Principles of competitive strategy, such as knowing strengths and weaknesses, bringing strength against weakness, protecting and neutralizing vulnerabilities, and developing inimitable strategies, are useful for identifying successful competitive options.

• Competitive actions depend on the market environments in which firms compete, with some actions being more effective for certain environments than for others.
• Sustainability tactics and mechanisms can be used to extend the time horizon of sustainability of competitive advantage for com- panies.

Key Terms
barrier to entry 207 barrier to mobility 197
competitor response profile 199

dominant strategy 202 game theory 201 market structure 206

Nash equilibrium 202
strategic group 195
tit-for-tat strategy 204

Review Questions

1. Name two frameworks for understanding the competitive landscape.
2. What is a strategic group analysis, and how is it useful?
3. What factors might limit a company’s ability to switch strategic groups?
4. What is a competitor response profile, and how is it useful in evalu- ating competitors?
5. Define the Nash equilibrium used in game theory to predict the out- come of competitive interaction.
6. Identify the four general principles of competitive strategy.
7. What are the three types of market structures?
8. What are the strategies most likely to be useful for a monopolist?
9. What are the strategies most likely to be useful for an oligopolist?
10. Why do firms in an oligopolistic environment often hesitate to make moves that will take them outside of the status quo?
11. What strategies are most likely to be useful for firms in perfectly competitive markets?
12. What types of strategies are most useful for firms operating in dynamic markets?
13. Name five tactics that can be used to sustain competitive advantage.

Application Exercises
Exercise 1: Choose an industry and construct a strategic group map. Do this by identifying some of the major players and some of the key differences in how they compete. Select two factors for the two axes and plot the firms. Do you observe a group structure? Explain.
Using the same industry as above, identify three companies that sell a similar product. List some of the product attributes. Now evaluate each company’s product on those attributes (it’s OK to do this qualitatively) and plot the data using a strategy canvas view. What insights do you gain?
Exercise 2: Identify a company whose products you use frequently. Now identify one of its competitors. Imagine that you are the chief strategist for the first company. Using the principles of competitive strategy, list several strategic moves that you think could be effective against the competitor that you identified.
Exercise 3: Choose a competitive situation and model it as a game. Identify at least two players and two actions. Possible examples could include two banks that are considering whether to offer free checking; Google and Apple in the decision about whether to launch a self-driving

car; or two stores in a mall deciding whether to raise prices on men’s clothing. Sketch a game matrix. Estimate or rank the conditional payoffs (higher values more valuable) for each player for each choice. Treat the moves in the game as simultaneous and find the Nash equilibrium outcome if the game is played once (one-shot game). Now consider how the game would change if it is played repeatedly forever (infinite horizon game). What insights do you gain into the competitive situation you chose?
Exercise 4: Identify a company whose products you use frequently. Determine whether this company operates in a monopoly, oligopoly, or competitive market. What does this imply about the competitive strategies most likely to be successful? List some specific strategies the company could use against competition.
Exercise 5: Identify a company whose products you use frequently. Choose and apply one or more of the tactics of sustainability and explain how the company could employ the tactic to extend their competitive advantage.

Strategy Tool
When Does Defecting from Collusion Make Sense?
In long-standing, stable oligopolies, most firms repeatedly play the collusive outcome. (Collusion here is legal since the companies are not explicitly coordinating or price-fixing.) However, we can use the payoff structure to calculate the point at which firms would find defection to

knows it will be punished by its rival, and both firms will lower price in future periods. The value of the collusion stream is 10 + 2/ i. We want to know what discount rate on capital i will make cooperation a superior strategy. In other words, what value of i solves the following equation?
5 + _5 ≥ 10 + _2

be preferable to collusion. To do so, we simply compare the string of i i

payoffs under each alternative.
In the Delta and American game (Figure 11.6), maintaining price delivers a stream of $5 million in perpetuity. The value of this stream can be calculated as 5 + 5/ i (5 received now and a stream of 5s received in perpetuity). The value of defection can be calculated as $10 million received now, plus a stream of $2 million each year in the future. This is because if either firm knows that its rival will maintain price, it can initially grab a profit of $10 million by lowering price. But then the firm

Applying add and subtract operations to both sides and rear-
ranging yields
3 ≥ 5
i c 3, or 60%
Therefore, in this example, as long as Delta or American’s cost of capital or discount rate stays equal to or below 60 percent, the com- pany should continue to maintain prices.

References
1E. Perez, “New Pressure to Simplify Airfare; Delta Details Plan to Cut Some Prices by Up to 50%; Boston to Key West for $389,” The Wall Street Journal (January 5, 2005).
2E. Perez, “Business Fares Fall by One-Third; Delta’s Reductions Spread Beyond Its Flight Network Following Cuts by American,” Wall Street Journal (January 26, 2005).
3Perez, “New Pressure to Simplify Airfare.”
4S. W. Ames Bernstein, “Delta’s Prices Reach the Sky, Soaring Fuel Costs Force a Stunning $100 Fare Hike; United, Continental and US Airways Follow Suit,” Newsday (July 15, 2005).

5S. Warren and E. Perez, “Southwest’s Net Rises by 41%; Delta Lifts Cap on Some Fares,” The Wall Street Journal, Eastern edition (July 15, 2005): A.3.
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