Strategic Innovation

Description
In todays fast-changing business environment, those firms that want to remain competitive must also be innovative.

Strategic Innovation
In today’s fast-changing business environment, those ?rms that want to remain
competitive must also be innovative. Innovation is not simply developing new
technologies into new products or services, but in many cases ?nding new
models for doing business in the face of change. It often entails changing the
rules of the game.
From the late 1990s to today, the dominant themes in the strategy literature
have been strategic innovation, the impact of information and communications
technologies on commerce, and globalization. The primary issues have been
and continue to be how to gain a competitive advantage through strategic
innovation using new game strategies, and how to compete in a world with
rapid technological change and increasing globalization. Strategic Innovation
demonstrates to students how to create and appropriate value using these “new
game” strategies. Beginning with a summary of the major strategic frameworks
showing the origins of strategic innovation, Afuah gives a thorough examin-
ation of contemporary strategy from an innovation standpoint with several key
advantages:
•
Focus on developing strategy in the face of change.
•
A wealth of quantitative examples of successful strategies, as well as
descriptive cases.
•
Emphasis on the analysis of strategy, not just descriptions of strategies.
•
A detailed, change-inclusive framework for assessing the pro?tability
potential of a strategy or product, the AVAC (activities, value, appropri-
ability, and change) model.
•
Emphasis on the aspects of strategy that can be linked to the determinants
of pro?tability.
•
Consideration of how both for-pro?t and non-pro?t organizations can
bene?t from new game strategies.
Allan Afuah is Associate Professor of Strategy and International Business at the
Stephen M. Ross School of Business, University of Michigan.
Strategic Innovation
New Game Strategies for
Competitive Advantage
Allan Afuah
Stephen M. Ross School of Business
University of Michigan
First published 2009
by Routledge
270 Madison Ave, New York, NY 10016
Simultaneously published in the UK
by Routledge
2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN
Routledge is an imprint of the Taylor & Francis Group,
an informa business
© 2009 Allan Afuah
All rights reserved. No part of this book may be reprinted or
reproduced or utilized in any form or by any electronic, mechanical
or other means, now known or hereafter invented, including
photocopying and recording, or in any information storage or
retrieval system, without permission in writing from the publishers.
Trademark Notice: Product or corporate names may be
trademarks or registered trademarks, and are used only for
identification and explanation without intent to infringe.
Library of Congress Cataloging-in-Publication Data
Afuah, Allan.
Strategic innovation: new game strategies for competitive
advantage / by Allan Afuah.
p. cm.
Includes index.
1. Strategic planning. 2. Originality. 3. Resourcefulness.
4. Technological innovations. 5. Competition. I. Title.
HD30.28.A3473 2009
658.4?063—dc22
2008034812
ISBN10: 0–415–99781–X (hbk)
ISBN10: 0–415–99782–8 (pbk)
ISBN10: 0–203–88324–1 (ebk)
ISBN13: 978–0–415–99781–2 (hbk)
ISBN13: 978–0–415–99782–9 (pbk)
ISBN13: 978–0–203–88324–2 (ebk)
This edition published in the Taylor & Francis e-Library, 2009.
“To purchase your own copy of this or any of Taylor & Francis or Routledge’s
collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.”
ISBN 0-203-88324-1 Master e-book ISBN
To my grandmother, Veronica Masang-Namang Nkweta, and the
Bamboutos highlands which she tilled to feed me.
To every family that has been kind enough to welcome a foreign
student to its home.
Contents
List of Figures ix
List of Tables xi
List of Exhibits for Cases xiii
Preface xv
Acknowledgments xix
PART I
Introduction 1
1 Introduction and Overview 3
2 Assessing the Pro?tability Potential of a Strategy 35
3 The Long Tail and New Games 67
PART II
Strengths and Weaknesses 89
4 Creating and Appropriating Value Using New Game
Strategies 91
5 Resources and Capabilities in the Face of New Games 117
6 First-mover Advantages/Disadvantages and
Competitors’ Handicaps 145
7 Implementing New Game Strategies 178
PART III
Opportunities and Threats 197
8 Disruptive Technologies as New Games 199
9 Globalization and New Games 223
10 New Game Environments and the Role of Governments 252
11 Coopetition and Game Theory 275
PART IV
Applications 301
12 Entering a New Business Using New Games 303
13 Strategy Frameworks and Measures 323
PART V
Cases 371
Case 1 The New World Invades France’s Terroir 373
Case 2 Sephora Takes on America 377
Case 3 Net?ix: Responding to Blockbuster, Again 383
Case 4 Threadless in Chicago 391
Case 5 Pixar Changes the Rules of the Game 393
Case 6 Lipitor: The World’s Best-selling Drug (2008) 401
Case 7 New Belgium: Brewing a New Game 405
Case 8 Botox: How Long Would the Smile Last? 411
Case 9 IKEA Lands in the New World 417
Case 10 Esperion: Drano for Your Arteries? 422
Case 11 Xbox 360: Will the Second Time be Better? 434
Case 12 Nintendo Wii: A Game-changing Move 442
Notes 447
Author Index 469
Subject Index 473
viii Contents
Figures
1.1 Business System and Options for New Games 8
1.2 Components of a New Game Strategy 18
1.3 Types of New Game 24
1.4 Flow of the Book 30
2.1 Components of an AVAC Analysis 39
2.2 Drivers of the Components of an AVAC Analysis 41
3.1 A Long Tail Distribution 68
3.2 Impact of the Internet on a Long Tail Distribution 71
3.3 Value System of Long Tail Potential Coopetitors 71
4.1 Value Creation and Appropriation 92
4.2 A Book Value Chain 98
4.3 New Game Activities and Value Creation and Capture 110
5.1 The Role of Complementary Assets 125
5.2 Strategies for Exploiting Complementary Assets 126
6.1 Types of Player 163
6.2 Different New Game Product Strategies 167
6.3 Player Types in Different Countries 167
6.4 A Firm’s Evolution from Explorer to Exploiter 168
7.1 Strategy, Structure, Systems, People, and
Environment (S
3
PE) Framework 179
7.2 What Should a Firm Do? 186
8.1 S-curves Showing Physical Limits of Technologies 201
8.2 PC versus Mainframes and Minicomputers 204
8.3 Disruptive Technologies and Value Creation and
Appropriation 211
8.4 Disruptiveness of Disruptive Technologies 219
8.5 Examples of Degrees of Disruptiveness 219
9.1 Who Appropriates How Much from Nigerian Oil? 228
9.2 Effect of Taxes on Value Appropriation 229
9.3 Effect of Subsidies on Value Appropriation 230
9.4 Who Appropriates More Value than It Creates? 231
9.5 Types of Multinational 233
9.6 Different Global Strategies 239
10.1 The Macroenvironment 253
10.2 Determinants of Environments that are Conducive to
Pro?table New Games 257
10.3 A PESTN Analysis 271
11.1 A Payoff Matrix 277
11.2 Dominant Strategy 278
11.3 Nash Equilibrium 279
11.4 Prisoner’s Dilemma 281
11.5 A Sequential Game 282
11.6 Players in a Value Creation and Appropriation Game 290
11.7 For Question 1 300
13.1 SWOT Framework 326
13.2 Elements of a PESTN Framework 329
13.3 BCG’s Growth/Share Matrix 331
13.4 Illustration of Growth/Share Matrix 333
13.5 GE/McKinsey Matrix 335
13.6 Porter’s Five Competitive Forces 337
13.7 Components of Porter’s Five Forces 339
13.8 Business System for a Technology Firm 344
13.9 An Automobile Maker’s Business System 345
13.10 A Generic Value Chain 346
13.11 A Value System 347
13.12 A Value Network 349
13.13 A Value Shop 350
13.14 Elements of the Balanced Scorecard 351
13.15 Elements of the S
3
PE 358
13.16 Elements of the 4Ps 359
13.17 Components of an AVAC Framework 362
x Figures
Tables
1.1 Competitive Consequences of New Game Strategy 19
1.2 Costs, Retail, and Wholesale Prices 21
1.3 Forecasted Console and Games Sales 21
1.4 Estimates of the Pro?tability of Three Different Strategies 22
2.1 Applications of AVAC Analysis 52
2.2 Selected Financials 54
2.3 Customer Service for Year Ending March 2005 55
2.4 Industry Leading Margins for Year Ending March 2005 55
2.5 Back-of-the-envelope Estimates of the Contribution
of Some Activities to Low Cost and Revenues 58
3.1 The Activities Component of an iTunes AVAC Analysis 81
3.2 The Value Component of an iTunes AVAC Analysis 82
3.3 The Appropriability Component of an iTunes AVAC
Analysis 83
3.4 The Change Component of an iTunes AVAC Analysis 85
3.5 Strategic Consequences of an AVAC analysis of
Apple’s iTunes Activities 86
4.1 Some Estimated Costs for the iPhone in 2007 99
4.2 October 2005 Top 8 Most Expensive Components/
Inputs of a 30GB iPod 116
5.1 Rank Ordering Resources/Capabilities by
Competitive Consequence 129
5.2 Strategic Consequence for Google’s Search Engine
Capabilities 135
5.3 Rank Ordering Complementary Assets 136
5.4 Is a Strength from a Previous Game a Strength or
Handicap in a New Game? 137
5.5 Sample Values of Intangible Resources (all numbers,
except rations, in $ billion) 140
6.1 First-mover Advantages (FMAs) 146
6.2 Rank Ordering First-mover Advantages 158
6.3 Lipitor’s Projected Sales 173
6.4 NPVs for the Different Revenue Flows 173
7.1 Is an S
2
P Component from a Previous Game a
Strength or Handicap in a New Game? 191
8.1 The New Replacing the Old: A Partial List 200
8.2 The Disrupted and Disruptors? 205
8.3 To What Extent is Technological Change Disruptive
to an Established Technology? 207
8.4 Are Previous Strengths Still Strengths or Have they
Become Handicaps in the Face of a Disruptive Technology? 211
9.1 June 2007 OECD Gasoline Prices and Taxes 225
9.2 Oil Joint Ventures in Nigeria 225
9.3 What Each Player Gets 226
9.4 How Much Does each OECD Member Appropriate
from a Gallon of Gasoline? 227
9.5 What Each Player Appropriates 251
11.1 A Mapping of Coalitions into Value Created 288
11.2 Coalitions (submarkets) and Value Created 292
11.3 Value Added and Guaranteed Minimum 293
12.1 Type of New Game to Pursue When Entering a New
Business 319
13.1 Elements of a VIDE Analysis 355
13.2 Strategic Management Frameworks: A Comparison 365
13.3 Summary of Some Financial Measures 368
xii Tables
Exhibits for Cases
1.1 Hierarchy of French Wines 374
1.2 World Wine Exports in 1999 and 2007 376
2.1 Comparison of Industry Competitors in 2007 381
3.1 Summary of Net?ix’s Income Statements
($US millions, except where indicated) 385
3.2 Summary of Net?ix’s Movie Rental Plans 386
3.3 Summary of Blockbuster’s Income Statements
($US millions, except where indicated) 388
3.4 Summary of Blockbuster Total Access Movie Rental Plans 388
5.1 An Animation Movie Value Chain 395
5.2 Pixar Full-length Animation Movies 399
5.3 Top 12 Grossing Animation Movies 400
5.4 Competing Animation Movies 400
6.1 US Market Shares of Cholesterol-lowering Drugs,
January 1997 402
6.2 The Drug Development Process in the USA 403
6.3 Statin Average Prescription Pricing Structure 404
6.4 1997 Lipitor Worldwide Sales Projections 404
7.1 Average Cost of Goods Sold for United States Brewery 405
7.2 Cost Implications of Generator Purchase 408
8.1 2008 Plastic Surgery Fees 413
8.2 Allergan’s Product Areas 415
8.3 Allergan’s Products in 2008 415
9.1 IKEA Sales 417
9.2 Purchasing 419
9.3 Top Sales Countries in 2007 419
9.4 Where the Money Goes 421
10.1 Selected Disease Statistics—USA 2003 423
10.2 Drug Development Process 425
10.3 Drug Trial Expenses per Approved Compound 426
10.4 Total Hypolipemic Market Sales and Expectations 426
10.5 2002 Select Pharmaceutical Company Financial
Information ($000s) 427
10.6 Nominal and Real Cost-of-Capital (COC) for the
Pharmaceutical Industry, 1985–2000 427
11.1 Microsoft’s Financials
($US millions, except where indicated) 438
11.2 Xbox 360 Sales Projections 438
11.3 Playstation 3 Sales Projections 439
11.4 Sony’s Summary Financials
($US millions, except where indicated) 440
11.5 Game Sales Information 441
12.1 Xbox 2001 Forecast Sales, Costs, and Prices 443
12.2 Costs, Retail, and Wholesale Prices 445
12.3 Forecasted Console and Games Sales 446
xiv Exhibits for Cases
Preface
The ?rst question that potential readers might be tempted to ask is, why
another book on strategy? Strategic Innovation: New Game Strategies for
Competitive Advantage has many of the same features that existing textbooks
have. It draws on the latest research in strategic management and innovation, it
is peppered with the latest examples from key business cases, it is easy to read,
and so on. However, it has six distinctive features that give it a unique position
vis-à-vis existing strategy and innovation books.
Distinctive Features
First, Strategic Innovation: New Game Strategies for Competitive Advantage is
about change. While existing textbooks acknowledge the importance of
change, especially in an ever-changing world, they devote very little or no atten-
tion to the subject of change. All the chapters in New Game Strategies are about
change and strategic management—about how to create and appropriate value
in the face of new games. Second, existing strategic management texts tend to
have very few or no numerical examples. This lack of numerical examples does
little to reinforce the growing consensus that strategy is about winning but
rather, it might be promoting the “anything goes in strategy” attitude that is not
uncommon to students who are new to the ?eld of strategic management. Nine
of the thirteen chapters in the book have numerical examples that link elements
of the balance sheet to components of the income statement. Of course, the
book is also full of case examples. Third, while other texts are more descriptive
than analytical, this book is more analytical than descriptive. It is largely about
the why and how of things, and less about the what of things. Fourth, the book
includes a detailed framework for assessing the pro?tability potential of a strat-
egy, resource, business unit, brand, product, etc. Called the AVAC (activities,
value, appropriability, and change), the framework is distinctive in that it
includes not only both ?rm-speci?c and industry-speci?c factors that impact
?rm pro?tability, but also a change component. Fifth, the book’s emphasis is on
those activities that can be linked to the determinants of pro?tability; that is, the
book focuses on those aspects of strategy that can be logically linked to elem-
ents of the balance sheet and income statement. Sixth, the book summarizes the
major strategic management frameworks that are otherwise scattered in other
texts. This is a useful one-stop reference for many students.
The Dawn of Strategic Innovation
To understand why a book with these six features is needed today in the ?eld of
strategic management, it is important to take a quick look at the evolution of
the ?eld. In the 1960s, the dominant theme in the ?eld of strategic management
was corporate planning and managers were largely concerned with planning for
the growth that had been spurred by reconstruction of Europe and Japan, and
the Cold War, following World War II. The SWOT (Strength, Weaknesses,
Opportunities, and Threats) framework became popular as the tool of choice
for identifying and analyzing those internal and external factors that were
favorable or unfavorable to achieving ?rm objectives. In the late 1960s and
early 1970s, the primary theme had shifted to corporate strategy and the issues
of the day were dominated by diversi?cation and portfolio planning. Tools such
as BCG’s Growth/Share matrix, and the McKinsey/GE matrix enjoyed a lot of
popularity as analysis tools. In the late 1970s and early 1980s, the theme shifted
to industry and competitive analysis, and the primary issues became the choice
of which industries, markets, and market segments in which to compete, and
where within each industry or market to position oneself. Porter’s Five Forces
and business system (value chain) were the analytical tools of the day. In the late
1980s and early 1990s, the theme had evolved into the pursuit of competitive
advantage and its sources within a ?rm. Professors C.K. Prahalad and Gary
Hamel’s core competence of the ?rm and the resource-based view of the ?rm
emerged as the dominant themes.
From the late 1990s to today, the dominant themes have been strategic
innovation, globalization, and the impact of information and communications
technologies on value-adding activities. The primary issues have been and con-
tinue to be how to gain a competitive advantage through strategic innovation
using new game strategies, and how to compete in a world with rapid techno-
logical change and increasing globalization. A strategic innovation is a game-
changing innovation in products/services, business models, business processes,
and/or positioning vis-à-vis coopetitors to improve performance. A ?rm’s new
game strategy is what enables it to perform well or not so well in the face of a
strategic innovation. Thus, to perform better than its competitors in the face of
a new game, a ?rm needs to have the right new game strategies. This book is
about the new game strategies that ?rms use to exploit strategic innovations. It
is about change. It is about how to create and appropriate value using new game
strategies. These new game strategies can be revolutionary or incremental, or
somewhere in-between. This book is not only about a ?rm using new game
activities to offer customers new value (from new products/services) that they
prefer to that from competitors, but also about how the ?rm can better position
itself to appropriate the value created in the face of change or no change, and to
translate the value and position to money. It is also about some of the more
recent issues about the digital economy such as the Long Tail, and the not-so-
recent issues such as disruptive technologies. Firms that initiate new games, and
are therefore ?rst movers, can make a lot of money; but so can ?rms that follow
the ?rst movers. It all depends on the new game strategy that each ?rm pursues.
xvi Preface
Some Strategic Innovation Questions
New game strategies often overturn the way value is created and appropri-
ated. They can create new markets and industries, destroy or reinforce exist-
ing product-market positions, and most important of all, they can be very
pro?table for some ?rms. This raises some very interesting questions. What
exactly are new game strategies? What do we mean by creation and appropri-
ation of value? Which new game strategies are likely to be most pro?table for
a ?rm—to give a ?rm a competitive advantage? If resources are really the
cornerstones of competitive advantage, what is the role of resources during
new games? Since, in playing new games, ?rms often move ?rst, what really
are ?rst-mover advantages and disadvantages, and how can one take advan-
tage of them? What are competitor’s handicaps and how can a ?rst mover
take advantage of them? How can the pro?tability potential of a strategy—
new game or non-new game—be analyzed? Is entering a new business using
new game strategies any better than entering using non-new game strategies?
Does game theory have anything to do with new game strategies? What is
likely to be the reaction of competitors when a ?rm pursues a new game
strategy? Given competitors’ likely reaction, what should a ?rm do in pursu-
ing new game strategies? Does implementing new game strategies require
more precaution than implementing any other strategy? What are the sources
of new game strategies? What is the role of globalization and a ?rm’s
macroenvironment in its ability to create and appropriate value using new game
strategies? Are some environments more conducive to new game strategies
than others? What is the role of government in new games? How many of
the new game concepts and tools detailed for for-pro?t ?rms applicable to
nonpro?t organizations?
This book explores these questions, or provides the concepts and tools to
explore them. The book takes the perspective of a general manager who has
overall responsibility for the performance of his or her ?rm, for a business unit
within the ?rm, or for any organization for which performance is important.
Such a manager needs to understand the basis for the ?rm’s performance in the
face of change. The manager needs to know what determines the performance,
what other change might erode that performance, and when and what the ?rm
could do to gain and maintain a competitive advantage. The manager must then
use the ?rm’s resources to formulate and implement a strategy that will give it a
competitive advantage. Thus, the book should be useful in courses whose goal
is to challenge students to think strategically when confronting day-to-day
activities. It should also be useful to managers who want to challenge them-
selves to think strategically, irrespective of their functional role within their
organization.
The seeds of the book were sowed in the period from 1997 to 2006 when I
taught the Strategy Core Course at the Stephen M. Ross School of Business at
the University of Michigan. During that time, I also taught an elective in Innov-
ation Management. In 2003/2004 when I was on academic sabbatical leave
from Michigan, I also taught the core course in strategy at The Wharton School
of the University of Pennsylvania in the USA, and at INSEAD, in Fontainebleau,
France. The ideas that most of my students in these schools found fascinating
had a common theme—changing the rules of the game. Students could not have
Preface xvii
enough of the concepts and cases about strategic innovation, and the associated
new game strategies for a competitive advantage.
Intended Audience
The book is written for courses in strategic management, entrepreneurship, or
marketing that emphasize strategic innovation or change in a graduate or
undergraduate curriculum. It should also be useful to managers who want to
challenge themselves to think strategically, irrespective of their functional role
within their organization. Managers and scholars who are interested in explor-
ing any of the questions raised above would also ?nd the book useful; so should
those managers who are in positions that have a direct impact on ?rm pro?t-
ability, or who are in consulting, entrepreneurship, or venture capital. It should
also be of interest to those functional specialists (?nance, marketing, HRM,
engineering) who must participate in game-changing activities.
xviii Preface
Acknowledgments
I continue to owe a huge debt of gratitude to my Professors and mentors at the
Massachusetts Institute of Technology (MIT); in particular, Professors Rebecca
Henderson, James M. Utterback, and Thomas Allen. They introduced me to the
subject of strategic innovation, and to the virtues of patience and tolerance.
When I arrived at the University of Michigan from MIT, I was lucky that the
Dean of the Business School at the time, B. Joseph White (now the President of
the University of Illinois) had created an environment in which we could thrive
as researchers and teachers. That meant a lot to me and I am forever grateful! I
would also like to thank three anonymous reviewers for their suggestions and
help in reshaping this book. Some of my students at the Stephen M. Ross School
of Business at the University of Michigan gave me very useful feedback when I
pre-tested the concepts of the book, at the formative stage. Some of the cases in
Part V of the book were written by some of these students under my super-
vision. I am grateful to all of them. I would also like to thank Joseph Lui, who
read through some of the chapters and gave me useful feedback. Katie Chang
provided me with dependable research assistance. Finally, I would like to thank
Michael and Mary Kay Hallman for the funding that enabled me to explore the
topic of strategic innovation with a little more freedom.
I would like to thank Nancy Hale, Routledge editor for business books,
whose professionalism convinced me to work with Routledge.
Allan Afuah
Ann Arbor, Michigan
July 29, 2008
Introduction
Chapter 1: Introduction and Overview
Chapter 2: Assessing the Pro?tability Potential of a
Strategy
Chapter 3: The Long Tail and New Games
Part I
Introduction and Overview
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
De?ne strategy, new games, new game strategies, value creation and value
appropriation, and strategic innovation.
•
Understand the characteristics of new games and how a ?rm can exploit
them to gain and prolong a competitive advantage.
•
Begin to understand how to use an AVAC analysis to evaluate the pro?t-
ability potential of a new game strategy.
•
Describe types of new game (regular, resource-building, position-building,
and revolutionary).
Introduction
Consider the following business performances:
With a market value of over $160 billion for most of 2008, Google was one
of the most valuable companies in the world. Its net income in 2007 was
$4.2 billion on sales of $16.6 billion, giving it a net pro?t margin of 25.4%,
one of the highest of any company of its size. This was a remarkable per-
formance for a company that only four years earlier, in 2002, had revenues
of $439 million and a net income of $99 million in a struggling dotcom
industry.
In 2006, Threadless, an online T-shirt company founded in 2000, had
pro?ts of $6 million on revenues of $18 million, from T-shirts that had been
designed, marketed, and bought by members of the public.
1
This made the
?rm one of the most pro?table in the clothing retail business.
In 2007, P?zer’s Lipitor was the world’s best-selling drug with sales of
$12.7 billion, more than twice its nearest competitor’s sales (Plavix, with
$5.9 billion). This was the third year in a row that Lipitor had topped the
best-seller list. One of the most remarkable things about Lipitor is that it
was the ?fth cholesterol drug in its category (statins) in a pharmaceuticals
industry where the third or fourth product in a category usually has little
chance of surviving, let alone of becoming the best seller in the industry.
During the 2007 Christmas season, demand for the Nintendo Wii was so
strong that Nintendo was forced to issue rain checks to customers. On eBay,
bids for the $249 machine were in the thousands of dollars. What was even
Chapter 1
more remarkable was that each Wii console was sold at a pro?t, unlike
competing consoles from Microsoft and Sony that were being sold at a loss.
Goldcorp, a Canadian gold mining company, offered prizes totalling
$575,000 to anyone who would analyze its banks of geological survey data
and suggest where, in its Red Lake, Canada, property gold could be found.
2
Fractal Graphics, an Australian company, won the top prize of $105,000.
More importantly, the contest yielded targets that were so productive that
Goldcorp was said to have mined eight million ounces of gold worth more
than $3 billion in the six years following the launch.
3
Between 1994 and 1998, Dell’s sales increased by ?ve times, its pro?ts
increased by ten times, its stock shot up by 5,600%, its revenue growth was
twice as fast as that of its rivals while its operating earnings were greater
than the combined operating earnings of all of its major rivals.
4
From 2000 to 2005, Ryanair posted after-tax pro?t margins of 20–28%
in an airline industry where most ?rms were losing hundreds of millions of
dollars. These record high after-tax pro?t margins made Ryanair not only
the most pro?table major airline company in the world over that period, but
also one of the most pro?table European companies!
Definitions
New Game Strategies
At the core of each of these remarkable performances are strategic innovations,
and new game strategies. A strategic innovation is a game-changing innovation
in products/services, business models, business processes, and/or positioning
vis-à-vis coopetitors to improve performance. A new game strategy is a set of
activities that creates and/or appropriates value in new ways.
5
It is what deter-
mines a ?rm’s performance in the face of a strategic innovation. It entails per-
forming new value chain activities or existing ones differently from the way
they have been performed in the past, to create value and/or position a ?rm to
appropriate (capture) value.
6
It is about not only creating value in different
ways, but also about putting a ?rm in a position to pro?t from the value cre-
ated. It is often about rewriting the rules of the game, overturning existing ways
of creating and appropriating value. For example, rather than keep its data-
banks of geological survey data on its Red Lake, Ontario property secret, and
struggle to ?nd where gold might be located, Goldcorp made the data available
to the public and challenged it to locate the gold. Goldcorp was looking to the
public, rather than to its employees or a contractor, to solve its problem. Only
the winners, those who produced desirable results, would be paid. Contrast this
with employees who would be paid whether or not they succeeded in locating
gold. Rather than design and market its own T-shirts, Threadless had members
of its registered users design and submit designs to the ?rm each week. Mem-
bers of the community then voted for the best design, and winners were
awarded prizes. The winning design was then produced and sold to members of
the community. Effectively, the ?rm did not perform many of the activities that
T-shirt companies traditionally performed, or did so differently.
The winner of a new game can be a ?rst mover or follower; that is, the winner
of a new game can be the ?rm that moved ?rst to change the rules of the game,
4 Introduction
or a ?rm that came in later and played the game better. The important thing is
that a ?rm pursues the right new game strategy to create and capture value.
Google was not the ?rst to introduce search engines but it played the new game
very well—it was better at monetizing search engines. Its new game strategy in
the early 2000s included undertaking paid listings rather than pop-ups or
banner advertising for monetizing searches, developing those algorithms
that delivered more relevant searches to its customers than competitors’
search engines, and placing the paid-listing ads on its website as well as on
third-party sites.
New games are not always about product innovation. In fact, some of the
more interesting cases of new games have nothing to do with new products or
services. Rather, they have been about changing the rules of the game in getting
an existing product to customers or in positioning a ?rm to appropriate existing
value better. Take the case of Dell. It introduced direct sales to end-customers,
bypassing distributors. It also established build-to-order manufacturing and
business processes in which each customer’s computer was built to the cus-
tomer’s speci?cation and only after the customer had ordered and paid for the
computer. Both activities gave Dell some advantages over its competitors. By
bypassing distributors, for example, it was moving away from having to con-
front the more concentrated and powerful distributors to dealing directly with
the more fragmented end-customers where it could build switching costs, brand
identity, and identify other sources of revenue such as services.
New games do not always have to be about leapfrogging competitors with
products that have better product characteristics than competitors’. In fact,
some of the more interesting new game strategies are those in which ?rms cut
back some product/service characteristics that had come to be considered sac-
red cows, but at the same time, they add a few new features. For example, when
Nintendo offered its Wii, it deliberately used much cheaper three-year-old
microprocessor and graphics technologies, rather than trying to outmuscle
Microsoft and Sony, which used the latest and fastest but much more expensive
technologies which many avid gamers had come to expect in each new gener-
ation of game consoles. The Wii had other features that appealed more to
nonavid gamers, such as the ability to play games that enabled people also to get
some physical exercise.
Both ?rst movers and followers can also make money during new games. For
example, Merck revolutionized the cholesterol-lowering drug market when it
pioneered the statin cholesterol drug category, and made lots of money. Warner
Lambert, which came into the new game late when it introduced Lipitor (a
statin), was able to make even more money using its own new game strategies. It
entered an alliance with P?zer to gain access to P?zer’s large sales force and
marketing might, to sell the drug to doctors and conduct direct-to-consumer
(DTC) marketing.
Finally, what is a new game in one industry or country, may not be a new
game in another. Take the case of Ryanair. In addition to performing some of
the activities that had set Southwest Airlines apart from its US competitors—
such as ?ying only one type of airplane model (Boeing 737s for Southwest and
A320s for Ryanair) and operating largely out of secondary airports—Ryanair
went further. It sold snacks, advertised inside as well as on its planes, and
collected commissions on the proceeds made from hotel and car rental sales
Introduction and Overview 5
made through its website. It also forged lucrative relationships with local
authorities of the secondary airports where it established operations.
Usually, a new game strategy entails some type of commitment that is made
by the ?rm pursuing the strategy.
7
It also involves tradeoffs.
8
For example,
Google invested a lot of money in research and development (R&D) to keep
improving the relevance of its searches; and by committing to paid listing ads, it
was foregoing banner and pop-up ads and associated bene?ts and costs.
Value Creation and Appropriation
Since we have de?ned a new game strategy as the set of activities that creates
and/or captures value in new ways, it is only appropriate that we de?ne value
creation and value appropriation. A ?rm creates value when it offers customers
products or services whose perceived bene?ts to customers exceed the cost of
providing the bene?ts.
9
A ?rm appropriates (captures) value when it pro?ts
from it. For example, if a musician writes, composes, and produces a song that
customers want, the musician has created value, provided that the cost of offer-
ing the music does not exceed the bene?ts perceived by customers. The pro?ts
that the musician receives from his or her music are the value that he or she
captures. As the case of many a musician would suggest, value captured is
not always equal to the value created. Before the Internet, recording studio
managers and distribution channels usually had the bargaining power over
musicians and therefore captured more value from each record sold than they
created. Musicians usually appropriated less value than they created, ten cents
of every dollar.
Cooperating to Create Value and Competing to
Appropriate it
When a customer buys a product, the value that it perceives in the product is not
only a function of the value created by the maker of the product, it is also a
function of the components that go into the product, the complements that
work with the product, and of what the customer puts into using the product.
Effectively, the value that a customer perceives in a product is a function of the
contribution of coopetitors—of the suppliers, customers, rivals, complemen-
tors, and other actors with whom a ?rm cooperates and competes to create and
appropriate value. For example, the value that a customer perceives in an
iPhone is not only a function of what Apple puts into designing and getting the
product produced, but also a function of the contribution of the suppliers of
the chips, LCDs, and other components that go into the product. It is also a
function of the quality and availability of the type of phone service on it, of the
music and other content that can be played on the machine, and of how well
the user can use the product.
Thus, ?rms cooperate with suppliers, customers, complementors, and some-
times rivals to create value and compete with them to capture the value.
Cooperation can be direct as is the case with strategic alliances, joint ventures,
and long-term contracts; but often, “cooperation” is indirect as in suppliers
contracting with ?rms to supply products to a ?rm’s speci?cations. “Competi-
tion” exists not only when a ?rm has to select a supplier and bargain with the
6 Introduction
supplier but also when the ?rm has to bargain with buyers over the price of its
products. More importantly, competition also exists in an indirect way during
direct cooperation. When ?rms are in an alliance or joint venture to coopera-
tively create value, they also have to compete to determine who incurs what
costs and who will capture what fraction of the value created. Thus, where
there is cooperation to create value, there is nearly always competition to
appropriate the value; and where there is competition to capture value, there is
probably some cooperation to create the value. Even competition among rivals
often has elements that could bene?t from cooperation. For example, rivals
stand to bene?t when their market grows and therefore can cooperate to grow
the market where such cooperation is legal. They also stand to pro?t when
they do not get into unnecessary price wars, or get entangled in government
overregulation or taxation.
New Games
New Game Activities
Recall that a new game strategy is the set of activities that creates and/or cap-
tures value in new ways. The cornerstones of this set are new game activities. A
new game activity is an activity that is performed differently from the way
existing industry value chain activities have been performed to create or capture
value.
10
The activity can be completely new or it can be an existing activity that
is being performed differently. The important thing is that, (1) the way the
activity is performed is different from the way existing value chain activities
have been performed, and (2) the activity contributes to creating or capturing
value. For example, recall that Google’s new game strategy in the early 2000s
included undertaking paid listings rather than pop-ups or banner advertising
for monetizing searches, developing those algorithms that delivered more
relevant searches to its customers, and placing the paid-listing ads on its website
as well as on third-party sites. Undertaking paid listings was a new game
activity to ?rms in the search engine industry. So was developing the
algorithms to deliver more relevant searches to customers; and so was placing
paid listing adds on third-party sites. Because a set can have only one member,
there will be times when a ?rm’s new game strategy consists of one new game
activity, thereby making the activity a strategy. In fact, very often people refer to
a new game activity as a new game strategy. Finally, strategic innovations are
new games.
Value Systems and Options for New Game Strategies—
Which, Where, When, What, and How?
To understand the options that each ?rm has for pursuing new game strategies,
consider the business system (value chain) of Figure 1.1. At each stage of the
chain, a ?rm has many options for performing the activities needed to add value
at that stage to create and deliver products to end-customers.
11
For example, at
the technology stage, a ?rm has many options for sourcing the technology. It
can develop the technology internally using its own R&D resources, license the
technology from another ?rm, form a strategic alliance with partners to develop
Introduction and Overview 7
the technology, or decide to wait for the next-generation technology. If it
decides to develop the technology, the ?rm can patent aggressively to protect its
technology, or give away the technology. Suppose ?rms in an industry develop
their technologies internally and keep them proprietary; then a ?rm that gives
away its own technology to anyone who wants it is pursuing a new game
strategy. That is what Sun Microsystems did when it gave away its SPARC
workstation computer technology in the early 1990s. Of course, a ?rm is
also pursuing a new game strategy if it decides to use a radically different
technology.
At the distribution level, a ?rm also has many choices. It can use all the
channels available to it for distribution, or use only a few. It can also decide to
sell directly to customers or depend completely on distributors. It can decide to
build products and warehouse lots of ?nished goods inventory, or have a build-
to-order system with little or no ?nished goods inventory. Again, suppose ?rms
in a market all depend on distributors to deliver products to end-customers. A
?rm that decides to sell directly to end-customers is effectively performing a
new game activity. This is what Dell did when it decided to start selling directly
to end-customers. At the manufacturing level, a ?rm can be vertically integrated
into producing its components or buy the components; it can produce the
components at home or in foreign countries; it can locate all its plants in one
country or in different countries; it can perform its own purchasing or have an
agent do it, etc.
Effectively, since there are many options for performing value chain activities
at every stage of the value chain, there also exist options for performing new
game activities at all stages of a value chain. Thus, the opportunity to gain a
strategic advantage is not limited to product innovation (new game strategies
at the technology and product design stages). Opportunities for a strategic
advantage through new game strategies exist at all the stages of a value chain—
manufacturing, marketing, distribution, and service included. They also exist in
vertically integrating backwards to supply one’s inputs, integrating vertically
forwards to dispose of one’s outputs, and integrating horizontally into com-
plements or other related segments.
Moreover, options also exist as to which activities to perform, when to per-
form them, how to perform them, where to perform them, and what to expect
as the output. At the R&D stage, for example, a ?rm may decide to perform
basic R&D and not applied R&D while its competitors perform both. It might
Figure 1.1 Business System and Options for New Games.
8 Introduction
decide to perform that R&D in the USA, China, and South Africa while its
competitors do so only in Europe. It might decide to be the ?rst mover rather
than a follower in the R&D activities that it performs. It might also decide to
patent religiously while its competitors depend on trade secrets.
In any case, new game activities can create new customer value for existing or
new customers, address newer and more valuable market segments, better pos-
ition a ?rm to capture value created in its value system, or generate new rev-
enues from existing or new revenue sources. They constitute the cornerstones of
new game strategies.
Finally, note that although new game activities are the cornerstones of new
game strategies, the latter often contain some non-new game activities. For
example, not all the activities that Google performed to be pro?table were new
game; but the cornerstones of its new game strategy are new game activities.
From Activities to Profits
How do activities become pro?ts? When a ?rm performs business systems activ-
ities, (1) it produces a product with bene?ts that customers value, (2) it better
positions itself vis-à-vis its coopetitors, or (3) it does both. The product, or the
position attained then has to be converted to pro?ts. Although each category of
activities sometimes takes a different path to pro?ts, activities often comple-
ment each other. Let us examine both.
Product with Benefits that Customers Value
Many ?rms perform activities to offer products that customers want. R&D,
product development, purchasing, and manufacturing are examples of activi-
ties that are designed largely to add value along a value chain so as to offer
customers products that they value. If a ?rm’s product offers bene?ts that cus-
tomers perceive as unique—e.g. low-cost or differentiated products—customers
are more likely to gravitate towards the ?rm rather than its competitors. Offer-
ing customers low-cost or differentiated products is just one step, albeit a very
important one, for a ?rm to pro?t from performing value-adding activities. The
?rm must also price the product well since too high a price drives away some
customers while too low a price leaves money on the table. It must seek out as
many customers as possible, since customers usually do not come knocking at
a ?rm’s door. It could also seek different pro?table sources of revenue that
exploit the product. For example, many US car dealers make more money from
servicing cars than from selling new ones. A ?rm could also locate its product in
a market with few or no competitors such as a new market segment, a different
region of a country, or another country.
Effectively, when value-adding activities produce low-cost or differentiated
products, the products must still be translated into money—they still have to be
priced well, the number of customers that perceive value in the products
increased, pro?table sources of revenues sought, and the product also posi-
tioned in the right market spaces to pro?t more fully from it.
Introduction and Overview 9
Better Positioning vis-à-vis Coopetitors
A ?rm can also perform activities to position itself better vis-à-vis its coopetitors
in order to pro?t from the value that the ?rm or its coopetitors have created. A
?rm has a superior position vis-à-vis a coopetitor if the coopetitor needs the
?rm more than the ?rm needs the coopetitor. For example, when a ?rm pur-
chases its rivals, it increases its power over customers since there are now fewer
?rms (competitors) for a customer to play against each other. Buyers now need
the ?rm more than they did before the ?rm purchased its rivals. Such a ?rm can
use its increased power to raise its prices, or extract other concessions from
customers. This is a practice that Tyco International pursued pro?tably for
many years. If a ?rm integrates vertically forwards to sell directly to consumers,
it is bypassing the more concentrated distributors to deal directly with the more
fragmented consumers. In addition to saving on the sales commissions that are
usually paid to distributors, such a ?rm can also build switching costs at cus-
tomers (see Chapters 4 and 6) and seek other sources of revenues. It also has the
freedom and ?exibility to introduce more innovative products to customers. If a
?rm instead integrates vertically backwards to produce its own critical inputs, it
increases its bargaining power over suppliers. The ?rm can use such power to
encourage suppliers to provide second sources for its inputs. Doing so can allow
a ?rm to extract concessions from suppliers, including lower prices and higher
quality, both of which can increase the ?rm’s pro?ts.
Value Creation and Better Positioning
Some activities result in value creation and better positioning vis-à-vis coopeti-
tors. For example, by offering a differentiated product, a ?rm is not only
creating value but also positioning better itself vis-à-vis customers, rivals, and
potential new entrants since differentiation reduces rivalry, power of suppliers,
and the threat of new entry.
12
By marketing a product in a location with no
competition, one is introducing value to customers in the location. At the same
time, since there are no competitors, the ?rm has a monopolistic position in the
space and is therefore well-positioned vis-à-vis some coopetitors.
In any case, when a ?rm performs a value-adding activity, the activity con-
tributes to value creation and capture in one or more of the following ways. The
activity:
a Lowers the cost of, or adds to the differentiation of a product—it contrib-
utes to value creation, and customer bene?ts.
b Positions the ?rm better vis-à-vis its coopetitors.
c Transforms the value created into pro?ts.
d Exploits the position vis-à-vis coopetitors to pro?t from the value created
by the ?rm and that created by its coopetitors.
Characteristics of New Games
When ?rms perform new value chain activities, or existing ones differently, they
are playing new games. (Each ?rm’s strategy is then the set of activities, includ-
ing non-new game activities, that it pursues to create and appropriate value in
10 Introduction
the face of the new game.) Since the activities that underpin new games are new
or existing ones that are performed differently, new games create new value or
generate new ways of capturing value; and since performing activities requires
resources/capabilities, performing new game activities may require new
resources/capabilities that build on a ?rm’s existing resources/capabilities or
require very different ones. Because, in pursuing a new game, a ?rm may be
moving ?rst, such a ?rm has an opportunity to build and take advantage of ?rst-
mover advantages. Moreover, when a ?rm pursues a new game strategy, its
competitors are likely to react to the strategy. Therefore a ?rm is better off
anticipating and taking into consideration the likely reaction of competitors
when it pursues a new game strategy; and since ?rms usually pursue new game
strategies within the context of their industry, macro, or global environments, a
?rm is also better off identifying and responding to the opportunities and
threats of these environments. Effectively, new games exhibit several character-
istics of which ?rms can take advantage. New games:
1 Generate new ways of creating and appropriating new value.
2 Offer opportunity to build new resources/capabilities or translate existing
ones in new ways into value.
3 Create the potential to build and exploit ?rst-mover advantages and
disadvantages.
4 Attract reactions from new and existing competitors.
5 Have their roots in the opportunities and threats of the ?rm’s environments.
The ?rst three characteristics are about a ?rm’s internal environment—the
activities, resources, and capabilities that it can use to exploit the opportunities
and threats of its external environment. The fourth and ?fth characteristics are
about the external threats and opportunities. We explore each of these charac-
teristics of new games.
Generate New Ways of Creating and Appropriating Value
As we have seen above, a ?rm creates value when it offers customers bene?ts
that they perceive as being valuable to them and the ?rm’s cost of providing
the bene?ts does not exceed the bene?ts. Innovation (product or business
process) is a good example of value creation by new games, since it entails
doing things differently and results in differentiated and/or low-cost new
products.
New games give a ?rm an opportunity to create unique bene?ts for a valuable
set of customers, and/or uniquely position the ?rm vis-à-vis its coopetitors to
appropriate the value created. In choosing which new game strategy to pursue,
a ?rm can opt for those activities that enable it to offer unique bene?ts that meet
the needs of customers with a high willingness to pay. In so doing, the ?rm is
avoiding head-on competition, thereby keeping down the pro?t-sapping effects
of rivalry. For example, when Ryanair decided to expand its activities into
southern Europe, it did not try to ?ght established airlines head-on at larger
congested airports and try to outdo them at what they had been doing for
decades. Rather, it went for the less congested secondary airports where it did
not have to compete head-on with incumbent big airlines. Because the value is
Introduction and Overview 11
unique, a ?rm also has more power over its customers than it would have if the
bene?ts were not unique; and if customers have a high willingness to pay, a ?rm
can afford to set its prices closer to customers’ reservation prices without driv-
ing the customers away, since the customers need the unique bene?ts from the
?rm’s products. (A customer’s reservation price for a product is the highest
price that the customer is willing to pay for the product.) A ?rm can offer
unique bene?ts to such valuable customers by working with them to help them
discover their latent needs for a new product that it has invented or discovered,
leapfrogging existing needs through innovation, reaching out for a market seg-
ment that had never been served with the bene?ts in question, or following so-
called reverse positioning in which the ?rm strips some of the bene?ts that some
customers have come to expect but which other customers have no need for
while adding some new ones.
13
Offering a select group of customers unique bene?ts can dampen the power
of the customers and the effects of rivalry as well as the threat of substitutes and
potential new entries, but it may not do much about suppliers and some com-
plementors. Thus, beyond pursuing activities that offer unique customer bene-
?ts, a ?rm may also want to pursue the kinds of activity that dampen or reverse
the power of its suppliers. For example, by making sure that there are second
sources for all its key components, a ?rm can considerably dampen the power
of suppliers for the particular component. Cooperation with other coopetitors,
not just suppliers, can also dampen their power vis-à-vis a ?rm. Effectively, a
new game offers a ?rm an opportunity to build a system of activities that is
dif?cult to imitate and that enables the ?rm to create unique bene?ts for valu-
able customers and uniquely position it vis-à-vis its coopetitors to appropriate
the value.
14
The change element side of new game activities suggests that the new ways of
creating and capturing value can render existing ways obsolete or can build on
them. It also suggests that the value created or the new position attained can be
so superior to existing ones that the products that embody them render existing
products noncompetitive or can be moderate enough to allow existing products
to remain in the market. For example, the activities that are performed to create
and appropriate value in online auctions are so different from those for of?ine
auctions that the latter are largely obsolete as far as online auctions are con-
cerned. The value created is also so superior that for most items, of?ine auctions
have been completely displaced by online auctions.
The change element also suggests that new games may result in an industry
that is more or less attractive than before the games. An industry is more attract-
ive after change if the competitive forces that impinge on industry ?rms are
more friendly than before—that is, if rivalry, the bargaining power of suppliers,
the bargaining power of customers, the threat of potential new entry and of
substitutes are low. If the industry is more attractive, industry ?rms are, on
average, more pro?table. As we will see when we explore disruptive technolo-
gies, many new games increase the competitive forces on incumbents as barriers
to entry drop, and rivalry increases.
12 Introduction
Offer Opportunity to Build New Resources/Capabilities or
Translate Existing Ones in New Ways
New games also offer a ?rm an opportunity to build scarce distinctive
resources/capabilities for use in creating and appropriating value, or to use
existing resources/capabilities in new ways to create and appropriate value. To
perform the activities that enable a ?rm to create and/or appropriate value, a
?rm needs resources (assets). These can be tangible (physical assets such as
plants, equipment, patents, and cash), intangible (the nonphysical ones such as
brand-name reputation, technological know-how, and client relations), or
organizational (routines, processes, structure, systems, and culture).
15
A ?rm’s
capabilities or competences are its ability to integrate resources and/or translate
them into products.
16
New game strategies can be used to build resources/cap-
abilities and/or translate existing ones into value that customers want. The case
of eBay serves as a good example. By taking a series of measures to make its
online auction market feel safe, building a brand, and increasing the number of
members in its community of registered users, eBay was able to build a large
and safe community—a critical resource—that attracted even more members
every year. It was then able to use this large base of buyers and sellers to move
from an auctions format into a multiformat that included ?xed pricing and
auction formats, and from collectibles to many other categories.
Again, the change side of new games suggests that the resources/capabilities
that are needed to perform new game activities can build on existing resources/
capabilities or be so different that existing resources/capabilities are rendered
obsolete. For example, the resources/capabilities needed by eBay are so different
from those needed for an of?ine auction that of?ine resources such as of?ine
physical locations, bidding systems, etc., are obsolete as far as online auctions
are concerned. This has strategic implications that we will explore in later
chapters.
Create the Potential to Build and Exploit First-mover
Advantages and Disadvantages
A ?rst-mover advantage is an advantage that a ?rm gains by being the ?rst to
carry out a value creation and/or value appropriation activity or strategy.
17
Since, in pursuing a new game, a ?rm may be effectively moving ?rst, such a
?rm has an opportunity to earn ?rst-mover advantages. If a ?rm performs the
right activities to enable it to attain ?rst-mover advantages, it can take advan-
tage of them to build or consolidate its competitive advantage. For example,
when a ?rm introduces a new product, moves into a new market, or performs
any other new game activity that can allow it to create or appropriate value in
new ways, the ?rm has an opportunity to build and exploit ?rst-mover advan-
tages. For example, a ?rm that introduces a new product ?rst can build switch-
ing costs or establish a large installed customer base before its competitors
introduce competing products. In such a case, the switching costs or installed
base is said to be the ?rm’s ?rst-mover advantage. Perhaps one of the most
popular examples of a ?rm that built and exploited ?rst-mover advantages is
Wal-Mart. When it ?rst started building its stores in the Southwestern USA,
large powerful suppliers refused to give it goods on consignment. Wal-Mart
Introduction and Overview 13
turned things around in its favor when it grew big by pursuing the right activ-
ities: it saturated contiguous towns with stores and built associated distribution
centers, logistics, information technology infrastructure, and relevant “Wal-
Mart culture.” By scaling up its ef?cient activities, Wal-Mart became very large
and effectively reversed the direction of power between it and its supplier—with
Wal-Mart now having the power over suppliers. Effectively, a ?rm that uses
new games to offer unique value to customers and uniquely position itself to
appropriate the value, can use ?rst-mover advantages to solidify its advantage
in value creation and appropriation.
The more counterintuitive a new game strategy, the more opportunities that
the ?rst-mover has to build advantages before followers move in. As we will
argue in Chapter 6, ?rst-mover advantages are usually not automatically
endowed on whoever moves ?rst. They have to be earned. Of course, wherever
there are ?rst-mover advantages, there are usually also ?rst-mover disadvan-
tages that can give followers an advantage. Competitors that follow, rather than
move ?rst, can take advantage of ?rst-mover disadvantages (also called follow-
er’s advantages). For example, when a ?rm is the ?rst to pursue a new game, it is
likely to incur the cost of resolving technological and marketing uncertainties
such as proving that the product works and that there is a market for it. Follow-
ers can free-ride on ?rst movers’ investments to resolve these uncertainties and
be spared these extra expenses. If the technology and market are changing, the
?rst mover may make commitments in the early stages of the technology and
market that reduce its ?exibility in some later decisions. This again opens up
opportunities for followers. We will also explore ?rst-mover disadvantages in
more detail in Chapter 6.
Attract Reactions from New and Existing Competitors
If a ?rm pursues a new game ?rst, the chances are that competitors are not likely
to sit by and watch the ?rm make money alone. They are likely to react to the
?rm’s actions. Thus, it is important to try to anticipate competitors’ likely
reactions to one’s actions. In fact, business history suggests that many ?rms that
ultimately made the most money from innovations were not the ?rst to intro-
duce the innovations. So-called followers, not ?rst movers, won. One reason is
because followers often can exploit ?rst-mover’s disadvantages (also called fol-
lowers’ advantages). However, a ?rst mover can have three things going for it.
First, it can build and exploit ?rst-mover advantages. Second, it can take advan-
tage of the fact that new games are often counterintuitive, making it dif?cult for
followers to understand the rationale behind the utility of the new games. The
more that the idea behind a new game strategy is counter to the prevailing
dominant industry logic about how to perform activities to make money in the
industry, the more that a ?rst mover will not be followed immediately by poten-
tial competitors; and if a ?rm follows a ?rst mover, its dominant logic may
handicap it from effectively replicating the ?rst mover’s activities. While poten-
tial followers are still getting over their industry’s dominant logic to understand
the potential of the new game, a ?rst mover can preemptively accumulate valu-
able important resources/capabilities that are needed to pro?t from the
activities.
Third, a ?rm that pursues a new game strategy can take advantage of the fact
14 Introduction
that when a pioneer pursues a new game strategy, some of its competitors may
have prior commitments or other inseparabilities that handicap them when they
try to react to the pioneer’s actions. The role of prior commitments is best
illustrated by the case of Compaq when it tried to react to Dell’s direct sales and
build-to-order new game strategy. Compaq decided to incorporate the same
two activities into its business model. Citing previous contracts, Compaq’s dis-
tributors refused Compaq from selling directly to end-customers and the ?rm
had to abandon its proposed new business model. Some ?rms may decide not to
follow a ?rst mover for fear of cannibalizing their existing products. In some
cases, the inertia of large ?rms may prevent them from moving to compete with
?rst movers.
In any case, an important part of pro?ting from a new game is in anticipating
and proactively trying to respond to the likely reaction of competitors. This
entails asking questions such as: if I offer that new product, raise my prices,
invest more in R&D, adopt that new technology, advertise more, launch that
product promotion, form the strategic alliance, etc., what is likely to be the
reaction of my competitors? This also entails obtaining competitive intelligence
not only on competitors’ handicaps but also on their goals, resources/capabil-
ities and past behavior to help in making judgments about competitors’ likely
reactions. With such information, a ?rm can better anticipate competitors’
likely reactions and incorporate counter-measures in formulating and executing
new game strategies. Of course, the likely reaction of suppliers, complementors,
and customers should also be taken into consideration.
Have their Roots in the Opportunities and Threats of a
Firm’s Environments
Firms that pursue new games do not do so in a vacuum. They operate in their
industry, macro, and global environments. In fact, many of the new game activ-
ities that are performed to create value or improve a ?rm’s ability to appropri-
ate value are triggered by opportunities or threats from both their industry,
macro, and global environments. An industry environment consists of the act-
ors and activities such as supply and demand that take place among suppliers,
rivals, complementors, substitutes, and buyers. A ?rm may offer a new product
because it wants to occupy some white space that it has identi?ed in the markets
that it serves. Airbus’ offering of the A380 super jumbo plane falls in this
category. Sometimes, new games can be a result of a hostile competitive
environment. Dell’s decision to sell directly to customers rather than pass
through distributors was actually because the distributors would not carry its
products at the time. It was a ?edgling startup and many distributors were busy
selling products for the IBMs and the Compaqs. The macroenvironment is
made up of the political-legal, economic, socio-cultural, technological, and nat-
ural environments (PESTN) in which ?rms and industries operate. A ?rm may
enter a market because it fears that a disruptive technology will erode its com-
petitive advantage. Another may use the same disruptive technology to attack
incumbents that have been successful at using an existing technology. Yet
another ?rm may be responding to opportunities in its political-legal environ-
ment. For example, Ryanair’s expansion into secondary airports in the Euro-
pean Union followed the union’s deregulation of the airline industry. The drop
Introduction and Overview 15
in its pro?ts in 2008 was largely attributable to the sharp rise in the cost of oil to
more than three times what it had been paying for in earlier years.
The global environment consists of a world in which countries and their
industries and ?rms are increasingly interconnected, interdependent, and more
integrated, thereby moving towards having similar political-legal, economic,
socio-cultural, technological, and natural environments (PESTN). The
opportunities and threats of the global environment are exhibited through
globalization. Globalization is the interdependence and integration of people,
?rms, and governments to produce and exchange products and services.
18
Globalization creates opportunities for some ?rms and individuals but creates
threats for others. There are opportunities to market products to, outsource
work to export to, or import from foreign countries in new ways.
In any case, external environments differ from one industry to the other, and
from one country or region to another. In the carbonated soft drinks industry,
for example, regular and diet colas have been the major sellers for decades. In
fact, when coke tried to change the formula for its regular coke, customers did
not like it and the company had to revert to the old product. Other industries
are relatively less stable. Rapid technological change, globalization, changing
customer tastes, and more availability of skilled human resources in different
countries make some industries very turbulent. In such industries, ?rms often
have to cannibalize their own products before someone else does. Effectively,
how ?rms need to interact with or react to environments can differ considerably
from one industry to the other, or from one country to the other, and can
constitute opportunities and threats that ?rms can exploit through new games.
Concern for the natural environment also creates many opportunities to use
innovation to build better cars, build better power plants, better dispose of
waste, and reduce carbon emissions. Understanding these opportunities and
threats not only helps a ?rm to make better choices about which activities to
perform, but when to perform them and how to perform them.
Multigames and Dynamics
A new game usually does not take place in isolation. It usually takes place in the
context of other games and is usually preceded by, followed by, or played in
parallel with other games. When a ?rm introduces a new game, it often does so
in response to another game. For example, when Dell decided to sell its built-to-
order PCs directly to businesses and consumers, it did so in the context of a
larger new game—the introduction of PCs that were disrupting minicomputers.
When Google developed its search engine and pursued paid listings to monetize
the engine, it was doing so in the context of the Internet, a much larger new
game. When Wal-Mart initially located its stores in small towns in parts of the
Southwestern USA, it was doing so in the context of the larger game of discount
retailing that was challenging the standard department store. Each ?rm usually
plays multigames over a period. For example, Wal-Mart started out selling only
goods at discount prices in its discount stores but in 1988, it introduced its
version of superstores, selling both food and goods in its Wal-Mart Supercent-
ers. This multigame and dynamic nature of new games has implications that we
will encounter when we explore ?rst-mover advantages and disadvantages, and
competitors’ handicaps in Chapter 6.
16 Introduction
Competitive Advantage from New Games
Many ?rms pursue new game strategies in search of a competitive advantage,
or just to make money. A ?rm’s competitive advantage is its ability to earn a
higher rate of pro?ts than the average rate of pro?ts of the market in which it
competes. Since revenues come from customers, any ?rm that wants to make
money must offer customers bene?ts that they perceive as valuable compared
to what competitors offer. Thus, an important step in gaining a competitive
advantage is to create unique bene?ts for customers without exceeding the
cost of the bene?ts—creating unique value; but to create value, a ?rm has to
perform the relevant value-adding activities; and for a ?rm to perform value-
adding activities effectively, it needs to have the relevant resources and cap-
abilities. Since, as we saw earlier, not even unique value can guarantee that
one will pro?t from it, the activities that a ?rm performs should also position
it to appropriate the value created. If the activities are a new game, then there
is a change element in the creation and appropriation of value since new
games generate new ways of creating and appropriating value, offer opportun-
ities to build new resources or translate existing ones in new ways, create the
potential to build and exploit ?rst-mover advantages, attract reactions from
coopetitors, or identify and respond to the opportunities and threats of the
environment. Effectively, competitive advantage is about creating and
appropriating value better than competitors; but creating and appropriating
value requires the right activities and the underpinning of resources and
capabilities. Moreover, there is always the element of change from the new
game component of activities—either from a ?rm or from the actors in its
external environment.
Components of a New Game Strategy
In effect, when a ?rm pursues a new game strategy, the extent to which the
strategy can give the ?rm a competitive advantage is a function of the activities
that the ?rm performs, the value that it creates, how much value it captures, and
how much it is able to take advantage of change. It is a function of the four
components: Activities, Value, Appropriability, and Change (AVAC) (Figure
1.2). Thus, one can estimate the extent to which a new game strategy stands to
give a ?rm a competitive advantage by answering the following four questions:
1 Activities: is the ?rm performing the right activities? Does it have what it
takes to perform them?
2 Value: do customers perceive the value created by the strategy as unique?
3 Appropriability: does the ?rm make money from the value created?
4 Change: does the strategy take advantage of change (present or future) to
create unique value and/or position itself to appropriate the value?
Answering these four questions constitutes an AVAC analysis. The AVAC analy-
sis can be used to estimate the pro?tability potential of a strategy or the extent
to which a strategy is likely to give a ?rm a competitive advantage. The more
that the answers to these question are Yes rather than No, the more that the
strategy is likely to give the ?rm a competitive advantage. Although a detailed
Introduction and Overview 17
exploration of the AVAC analysis is postponed until Chapter 2, the analysis is
simple and fundamental enough for us to start using it below.
Competitive Consequences of Strategies
Each strategy—new game or otherwise—has competitive consequences.
Depending on the strategy that a ?rm pursues, the ?rm may have a sustainable
competitive advantage, temporary competitive advantage, competitive parity,
or competitive disadvantage (Table 1.1). An AVAC analysis enables a ?rm to
identify and rank strategies by their competitive consequences. Table 1.1 shows
six different strategies and the competitive consequence for each. In Strategy 1,
the set of activities that the ?rm performs creates value that customers perceive
as unique and the ?rm is able to appropriate the value so created. The ?rm also
has the resources and capabilities needed to perform the activities. Moreover,
the strategy takes advantage of change (present or future) to create and/or
appropriate value better. All the answers to the questions are Yes, and the ?rm is
thus said to have a sustainable competitive advantage.
In many industries, however, the more common cases are Strategy 2 and
Strategy 3, which give a ?rm a temporary competitive advantage. In Strategy 2,
the ?rm has a set of activities that enables it to create value that customers
perceive as unique, and put it in a position to appropriate the value. It also has
what it takes to perform the activities; but the strategy is such that the ?rm
cannot take advantage of change. During the period before the change, the ?rm
has a temporary competitive advantage. In Strategy 3, the set of activities that
the ?rm performs enables it to create value and take advantage of change, but
can appropriate the value created only for the short period that it takes com-
petitors to imitate it. It has the resources and capabilities to perform the value-
creating activities. Thus, the ?rm also has a temporary competitive advantage.
In pharmaceuticals, for example, strategies are often anchored on patents which
usually give their owners a competitive advantage for the duration of the
patent. When a patent expires, however, many imitators produce generic ver-
sions of the drug, eroding the advantage of the original patent owners. In Strat-
egy 4, the ?rm can neither appropriate the value created nor take advantage of
change, even though it creates value and has what it takes to perform the
Figure 1.2 Components of a New Game Strategy.
18 Introduction
activities. Such a strategy is also said to give the ?rm competitive parity. Most
producers of commodity products have comparative parity. In Strategy 5, the
?rm has what it takes to perform some activities but not others. It can appropri-
ate some of the value created, even though the value is not unique. It is vulner-
able to change. A ?rm that pursues such a strategy also has competitive parity
with competitors. In Strategy 6, the set of activities that a ?rm performs neither
creates unique value nor puts the ?rm in a position to appropriate value created
by others; nor does the ?rm have what it takes to perform the activities. The
?rm is said to have a competitive disadvantage.
Thus, the more that the answers to these question are Yes rather than No, the
more that the strategy is likely to give the ?rm a competitive advantage. What
should a ?rm do if an AVAC analysis shows that it has a temporary competitive
advantage, competitive parity, or a competitive disadvantage? Such a ?rm can
decide whether to perform the types of activity that will enable it to turn the
Noes to Yesses or at least dampen them, thereby giving it a more sustainable
competitive advantage or something closer to it. It may also decide to abandon
the strategy.
Table 1.1 Competitive Consequences of New Game Strategy
First-mover
advantage
Activities: Is the
firm performing
the right activities?
Does it have what
it takes (resources
and capabilities) to
perform the
activities?
Value: Is the value
created by the
strategy unique, as
perceived by
customers,
compared to that
from competitors?
Appropriability:
Does the firm
make money from
the value created?
Change: Does
the strategy take
advantage of
change (present or
future) to create
unique value and/
or position itself to
appropriate the
value?
Competitive
consequence
Strategy 1 Yes Yes Yes Yes Sustainable
competitive
advantage
Strategy 2 Yes Yes Yes No Temporary
competitive
advantage
Strategy 3 Yes Yes Yes/No Yes Temporary
competitive
advantage
Strategy 4 Yes Yes No No Competitive
parity
Strategy 5 No/Yes No Yes No Competitive
parity
Strategy 6 No No No No Competitive
disadvantage
Strategic
action
What can a firm do to reinforce the Yesses and reverse or dampen the
Noes, and what is the impact of doing so?
Introduction and Overview 19
Illustrative Example
We illustrate the signi?cance of a good new game strategy using the example of
Nintendo’s introduction of its Wii video game console.
Estimating the Value of a New Game Strategy: The Case of
Video Consoles
Nintendo introduced its Wii video console in the Americas on November 19,
2006, only about a week after Sony had introduced its PS3 console on Novem-
ber 11. Microsoft’s Xbox had been available for purchase about a year earlier
on November 22, 2005. Game developers, such as Electronic Arts, developed
the video games that customers bought to play on their consoles. For every
video game that a game developer sold to be played on a particular console, the
game developer paid the console-maker a royalty. This aspect of the game
console business model differed from the PC business model where software
developers did not pay any royalties to PC makers. Console-makers also
developed some games in-house. Each console-maker, on average, collected
0.415 of every game sold.
19
The average wholesale price of Xbox 360/PS3-
generation games was about $43.
20
The Xbox 360 and the PS3 used ever more powerful computing and graphics
chips to offer customers more lifelike images than those from their predeces-
sors. They also focused on advanced and experienced gamers, neglecting nov-
ices and casual games, many of whom were scared by the complexity of the
games, some of which took hours or days to play.
21
These faster chips and more
lifelike images enabled game developers to develop even more complex games
for avid gamers. The Nintendo Wii differed from the PS3 and the Xbox 360 in
several ways. It went after the less experienced, new, or lapsed potential gamers
that Sony and Microsoft had neglected. The Wii used less complex and cheaper
components than the PS3 and Xbox. The games were simpler to play and could
last a few minutes rather than the dozens of hours or days that it took to play
some Xbox 360/PS3 games. Rather than use the complicated joypad of the PS3
and Xbox that was full of buttons, the Nintendo Wii had simpler controls that
were easier to use and a wandlike controller that looked more like a simpli?ed
TV remote-control.
22
When connected to the Internet, the Wii could display
weather and news.
The estimated costs, wholesale prices, and suggested retail prices for the three
products are shown in Table 1.2, while the forecasted number of units are
shown in Table 1.3.
Question: What is the ?nancial impact of the difference between the Nintendo
Wii business model and the PS3 and Xbox 360 business models?
Answer: The calculations that are summarized in Table 1.4 demonstrate how
much a good new game strategy can contribute to the bottom line of a
company. The forecasted pro?ts from each product are also shown in Table
1.4. Over the three-year period from 2007 to 2009:
•
The Xbox 360 was projected to bring in pro?ts of $105 + 105 + 53 =
$263 million.
20 Introduction
•
The PS3 was projected (not) to bring in ? $478 ? 565 ? 565 = ? 1,608
million = $(1,608 million).
•
The Wii was projected to pull in pro?ts of $749 + 1,535 + 2,457 =
$4,741 million.
Effectively, Nintendo’s new game strategy for its Wii enabled it to expect pro?ts
of $4.741 million over the three-year period while Microsoft could only expect
pro?ts of $0.263 million from its Xbox 360 while Sony stood to lose large
amounts, to the tune of $1.608 million. Why? The primary reason was that
Nintendo’s reverse-positioning strategy enabled it not only to attract more cus-
tomers but also to keep its cost so low that it could sell each of its consoles at a
pro?t, while Microsoft and Sony sold their consoles at a loss, hoping to make
up the losses by selling more games.
Types of New Game
Not all new games exhibit the same degree of new gameness. For example, the
change from horse-driven carts to the internal combustion engine automobile
was a new game; but so was the decision of Japanese automobile makers
Honda, Nissan, and Toyota to offer the luxury brands Acura, In?niti, and
Lexus, respectively. So was Dell’s decision to sell directly to end-customers.
This raises an interesting question: how new game is a new game? What is the
new gameness of a new game? In this section, we explore this question.
Table 1.2 Costs, Retail, and Wholesale Prices
First year After first year
Product Year
introduced
Cost ($) Suggested
retail price ($)
Wholesale
price ($)
Cost Suggested
retail price ($)
Wholesale
price ($)
Xbox 360 2005 525 399 280 323 399 280
Sony PS3 2006 806 499 349 496 399 280
Nintendo Wii Late 2006 158.30 249 199 126 200 150
Sources: Company and analysts’ forecasts. Author’s estimates.
Table 1.3 Forecasted Console and Games Sales
2005 2006 2007 2008 2009 2010
Console
Xbox 360 1.5 8.5 10 10 5
Sony PS3 2 11 13 13 7
Nintendo Wii 5.8 14.5 17.4 18.3
Games
Xbox 360 4.5 25.5 30 30 15
Sony PS3 6 33 39 39 21
Nintendo Wii 28.8 66.5 114.3 128.8
Sources: Company and analysts’ reports. Author’s estimates.
Introduction and Overview 21
Table 1.4 Estimates of the Profitability of Three Different Strategies
Microsoft 2005 2006 2007 2008 2009 2010
Xbox 360 units
(million units)
A 1.5 8.5 10 10 5
Wholesale price B 399 280 280 280 280
Console production
costs
C 525 323 323 323 323
Profits from Console
($ million)
D A*(B ? C) (189) (366) (430) (430) (215)
Software units (using
attach rate of 3.0)
(million)
E 3*A 4.5 25.5 30 30 15
Profits from games ($
million)
F 0.415*43*E 80 455 535 535 268
Total profits ($ million) G D + F (109) 90 105 105 53
Sony 2005 2006 2007 2008 2009 2010
Console sales (million
units)
H 2 11 13 13 7
Wholesale price I 499 399 399 399 399
Console production
costs
J 806 496 496 496 496
Profits from Console
($ million)
K H*(I ? J) (614) (1,067) (1,261) (1,261) (679)
Software units (using
attach rate of 3.0)
(million)
L 3*H 6 33 39 39 21
Profits from games ($
million)
M 0.415*43*L 107 589 696 696 375
Total profits ($ million) N K + M (507) (478) (565) (565) (304)
Nintendo Wii 2005 2006 2007 2008 2009 2010
Console sales (million
units)
O 6 14.5 17.4 18.3
Wholesale price P 199 150 150 150
Console production
costs
Q 158 126 126 126
Profits from Console
($ million)
R O*(P ? Q) 246 348 418 439
Software units (games)
(million)
S 28.2 66.5 114.3 128.8
Profits from games ($
million)
T 0.415*43*S 503 1,187 2,040 2,298
Total profits ($ million) U R + T 749 1,535 2,457 2,738
22 Introduction
The Classification
How new game is a new game? We start answering this question by classifying
new games as a function of their new gameness. Since the ultimate goal of many
?rms is to gain a sustainable competitive advantage, one way to classify new
games is by how much they impact a ?rm’s (1) product space, and (2) resources/
capabilities. Why these two variables? Because they are key determinants of
competitive advantage. According to the product-market-position (PMP) view
of strategic management, the extent to which a ?rm can earn a higher rate of
returns than its rivals is a function of the bene?ts (low cost or differentiated
products, or both) that the ?rm offers its customers, and its position vis-à-vis
coopetitors (bargaining power over suppliers and customers, power of substi-
tutes, threat of potential new entry, rivalry) that help the ?rm capture the value
that customers see in the bene?ts.
23
The more that customers perceive the bene-
?ts from a ?rm as unique and superior to those from competitors, the better the
chances of the ?rm capturing the value from the bene?ts and having a higher
rate of return. The better a ?rm’s position vis-à-vis its coopetitors—that is, the
more that the ?rm has bargaining power over its suppliers and customers, and
the more that rivalry, the threat of substitutes, and of new entry are low—the
better the ?rm’s chances of having a higher rate of return. For want of a better
phrase, we will call the product (with associated bene?ts) that a ?rm offers
customers, and its position vis-à-vis coopetitors the ?rm’s product position.
According to the resource-based view (RBV), a ?rm that has valuable, scarce,
and dif?cult-to-imitate-or-substitute resources/capabilities is more likely to
create and offer unique bene?ts to customers and/or to position itself to capture
the value created than its competitors.
24
A ?rm’s resources/capabilities are
valuable if they can be translated into bene?ts that customers like. They are
scarce if the ?rm is the only one that owns them or if its level of the resources is
superior to that of competitors. They are dif?cult-to-imitate if there is some-
thing about the resources that makes it dif?cult for competitors to replicate or
leapfrog them.
From these two views of strategic management, a ?rm’s product position and
its resources are key determinants of its competitive advantage. Thus, in the
two-by-two matrix of Figure 1.3, we can classify new games along these two
variables. The vertical dimension captures a new game’s impact on a ?rm’s
product position. In particular, it captures the extent to which a game is so new
game as to render existing products and/or positions vis-à-vis coopetitors non-
competitive. The horizontal axis captures a new game’s impact on resources/
capabilities. It captures the extent to which the resources/capabilities needed to
play the new game are so different from existing ones that the latter are ren-
dered obsolete. These are the resources/capabilities that go into offering a prod-
uct to customers—resources/capabilities such as the equipment, locations,
skills, knowledge, intellectual property, relationships with coopetitors, and
know-how that underpin value chain activities such as R&D, design, manu-
facturing, operations, marketing, sales, distribution, human resources/capabil-
ities, purchasing, and logistics. The resulting four quadrants of the two-by-two
matrix represent different types of new games (Figure 1.3). New gameness
increases as one moves from the origin of the matrix of Figure 1.3 to the top
right corner, with the regular new game being the least new game while the
Introduction and Overview 23
revolutionary game is the most new game. We now explore each of the four
types of new games.
25
Regular
In a regular new game, a ?rm uses existing value chain resources/capabilities or
builds on them to (1) offer a new product that customers value but the new
product is such that existing products in the market are still very competitive,
and/or (2) improve its position vis-à-vis coopetitors but the new position does
not render existing ones noncompetitive.
New Product
If a regular new game offers a new product, the product may take some market
share from existing products, but the latter remain pro?table enough to be a
competitive force in the market. The new games pursued by Coke and Pepsi in
introducing products such as diet or caffeine-free colas were regular new games.
Both ?rms did some things differently but the resources/capabilities that they
used built on existing ones and the resulting products allowed their regular
colas to remain competitive. Gillette also played a regular new game when it
introduced most of its razors. For example, the Mach3 razor with three blades,
introduced in 1998, allowed the twin-blade Sensor and competing products to
remain in the market.
26
The ?ve-blade Fusion, introduced in 2006, allowed the
Figure 1.3 Types of New Game.
24 Introduction
three-blade razor to remain competitive. All razors used different extensions of
Gillette’s mechanical blade technology to offer each new product, and each
product, despite being well received by customers, allowed previous products to
remain a competitive force in the market. Marketing was also designed to make
improvements to the ?rm’s positioning vis-à-vis its coopetitors. Effectively, in a
regular new game, a ?rm builds on existing resources/capabilities to deliver new
products that are valued by customers but the new products are positioned so
that existing products remain competitive forces in the market.
Rather than introduce a brand new product, a regular new game can instead
make re?nements to an existing product and/or to the ?rm’s position vis-à-vis
its coopetitors through extensions of its resources/capabilities. The offering of
many so-called new car models that are introduced every year are a good
example. When this year’s model car is introduced, last year’s model is still a
competitive force to be aware of. Effectively, in a regular new game, what is
different about the activities being performed and therefore what quali?es them
as new game is the fact that some of them are performed differently to improve
products and the underpinning skills, knowledge, and know-how, or to position
a ?rm better vis-à-vis coopetitors. Offering a diet drink, for example, requires
keeping sugar out, adding an arti?cial sweetener, and convincing people that the
new drink tastes good and is good for them.
Position vis-à-vis Coopetitors
A regular new game can also better position a ?rm vis-à-vis coopetitors. For
example, if a ?rm successfully convinces its suppliers to create a second source
for the components that it buys from the suppliers, it is effectively improving its
position vis-à-vis suppliers using its existing resources/capabilities and without
rendering existing positions noncompetitive.
A ?rm with an attractive PMP or valuable distinctive dif?cult-to-imitate-or-
substitute resources/capabilities is the most likely to pro?t from a regular new
game. So-called strategic moves such as product preannouncement or how
much to spend on R&D may be able to give a ?rm a temporary advantage; but
long-term competitive advantage depends on the existing resources/capabilities
and product-market position.
Resource-building
In a resource-building new game, the resources/capabilities that are needed to
make the new product are so different from those that are used to make existing
products that these existing resources/capabilities are largely useless for per-
forming the new activities; that is, the degree to which existing resources are
rendered obsolete is high (Figure 1.3). However, the resulting (1) new product is
such that existing products remain largely competitive in the market, and/or (2)
new position vis-à-vis coopetitors is such that existing positions remain largely
competitive. Changes in the rules of the game are largely resource/capabilities-
related.
Introduction and Overview 25
New Product
The pursuit of ethanol as a fuel for cars is a good example of a resource-building
new game. Making ethanol—especially from cane sugar, sugar beat, corn, or
sweet potatoes—requires very different capabilities from those used to drill,
pump out, transport, and re?ne petrol to get gasoline for use in cars; but both
fuels coexist in the market. The strategies for pursuing the electric razor were
also resource-building but position-reinforcing. The electric razor uses a radic-
ally different technology (combination of battery, electric motor, and moving
parts) from the mechanical razor, which has only mechanical parts. Thus, the
engineering capabilities needed for one can be very different from those needed
for the other. However, the electric razor and the manual mechanical razor
coexist in the market for shavers. Another example is the use of synthetic rub-
ber (made from oil) and natural rubber from trees to make tires and other
rubber products. Making synthetic rubber from petroleum is very different
from tapping sap from trees and turning it into rubber, but the rubber from both
sources remains competitive.
Position vis-à-vis Coopetitors
From a positioning vis-à-vis the coopetitor’s point of view, a new game is
resource-building if the resulting new position allows existing positions to
remain competitive but the resources/capabilities needed are radically different
from existing resources/capabilities. A good example is Dell’s direct sales,
which improved its power vis-à-vis buyers by bypassing the more powerful
distributors to deal directly with the more fragmented end-customers. Distribu-
tors still remained a viable sales avenue for Dell’s competitors. Dell needed very
different manufacturing, business processes, and relationships to support the
new game.
Position-building
In a position-building new game, the resulting new PMP is so superior to
existing PMPs that (1) new products introduced render existing ones largely
noncompetitive, and/or (2) the new positions, vis-à-vis coopetitors, render
existing ones primarily noncompetitive; that is, the degree to which the new
game renders existing products and/or positions vis-à-vis coopetitors noncom-
petitive is high (Figure 1.3). However, the resources/capabilities needed to make
new products are the same as existing resources/capabilities or build on them.
Changes in the rules of the game are largely PMP-related.
New Product
The new games pursued by Intel over the years in introducing different gener-
ations of its microprocessors fall into this category. The P6 (Pentium Pro intro-
duced in 1995 and Pentium II introduced in 1997) replaced the P5 (Pentium),
which had been introduced in 1993. The Pentium replaced the 486 which
replaced the 386 which had replaced the 286. Each new product met the new
needs of customers. Throughout, Intel built on its core X86 processor and
26 Introduction
semiconductor technologies as well as on its distribution capabilities to intro-
duce each new product. This is not to say that the semiconductor technology
was not advancing. It did advance at tremendous rates, especially if measured
by the bene?ts perceived by customers; but each generation of the technology
built on the previous generation while introducing things that were new and
different. Existing core capabilities were not rendered obsolete.
Some of the new games used to exploit disruptive technologies fall into this
category. For example, the strategies pursued by the ?rms that used the PC to
displace minicomputers were position-building, since PC technology built on
minicomputer technology but minicomputers were rendered noncompetitive by
PCs. Other examples include the strategies for the mini-mills used to make steel
versus integrated steel mills.
Position vis-à-vis Coopetitors
There are also position-building strategies that have little to do with offering a
new product. For example, software ?rms can sell their software directly to
customers who can download the software directly from the ?rms’ sites. By
dealing directly with the more fragmented end-customer rather than the more
concentrated distributors, software ?rms are effectively better positioned vis-à-
vis their customers than before the days of the Internet. Another example of a
position-building new game would be to eliminate competitors, where legal, to
a point where one becomes a monopoly and the resources/capabilities needed
to exploit the monopoly position build on existing resources/capabilities. This
can be done through acquisition of competitors or predatory activities such as
pricing, where legal.
Revolutionary
In a revolutionary new game, the organizational resources/capabilities needed
to build new products are so different from those used to make existing prod-
ucts that these existing resources/capabilities are largely useless for performing
the new activities. At the same time, the new PMP is so different from existing
ones that (1) new products render existing ones largely noncompetitive, and/or
(2) any new positions vis-à-vis coopetitors created render existing ones non-
competitive. A revolutionary new game rede?nes what creating and capturing
value is all about while overturning the way value chain activities have been
performed before. The rules of the game are changed both resource/capabilities-
wise and PMP-wise. It is the most new game of all the new games. Examples,
from a new products point of view, include the new games pursued by makers
of refrigerators which replaced harvested ice as a cooling device, automobiles
which displaced horse-driven carts, online auctions which replaced of?ine auc-
tions, electronic point of sales registers that replaced mechanical cash registers,
and iPods which have displaced Walkmans. In each case, the technological
resources/capabilities needed to offer the new product were radically different
from those that underpinned the displaced product. Moreover, the new product
displaced existing products from the market. The new games played in the face
of most disruptive technologies also fall into this category.
Introduction and Overview 27
What is Strategy?
In de?ning a new game strategy as a set of activities that creates and/or
appropriates value in new ways, we are implying that a ?rm’s strategy is the set
of activities that the ?rm performs to create and appropriate value. The ques-
tion is, how does this de?nition of strategy compare to other de?nitions in the
strategic management literature? The problem with this question is that strategy
has too many de?nitions. One reason for the multitude of de?nitions is that
strategy is about winning, and since what it takes to win in business has evolved
over the years, the de?nition of strategy has also evolved. For example, in the
1960s, when most reconstruction, following World War II, had already taken
place and there was a lot of demand for goods in the growing economies of the
capitalist world, the biggest challenge for managers was to plan for this growth
and keep up with demand. Thus, the dominant theme in the ?eld of strategic
management at the time was corporate planning, and managers were largely
concerned with planning growth—how to allocate resources/capabilities to
meet demand. The following two de?nitions of strategy ?t the context at
the time:
the determination of the basic long-term goals and objectives of an enter-
prise, and the adoption of courses of action and the allocation of resources
necessary for carrying out these goals.
(Alfred Chandler in 1962)
27
the pattern of objectives, purposes, or goals and major policies and plans for
achieving these goals, stated in such a way as to de?ne what business the
company is in or is to be in and the kind of company it is or is to be.
(Kenneth Andrews in 1971)
28
In the late 1970s and early 1980s, emphasis moved to strategy as position, in a
large measure because of Professor Michael Porter’s in?uential work.
29
In the
late 1980s and early 1990s, emphasis changed to include resources, capabilities,
and core competences, following Professors C.K. Prahalad’s and Gary Hamel’s
in?uential work on the core competence of the ?rm and the increasing popular-
ity of the resource-based view of the ?rm.
30
These changes would lead to def-
initions such as:
Strategy is the creation of a unique and valuable position, involving a differ-
ent set of activities.
(Michael Porter in 1996)
31
A strategy is a commitment to undertake one set of actions rather than
another and this commitment necessarily describes allocation of resources.
(Sharon Oster in 1999)
32
Strategy is an overall plan for deploying resources to establish a favorable
position vis-à-vis competitors.
(Robert Grant in 2002)
33
28 Introduction
A strategy is an integrated and coordinated set of commitments and actions
designed to exploit core competences and gain a competitive advantage.
(Hitt, Ireland and Hoskisson, 2007)
34
Mintzberg’s classi?cation of strategies using his 5Ps captured this diversity of
de?nitions. He argued that strategy can be a:
Plan—“some sort of consciously intended course of action, a guideline (or
set of guidelines) to deal with a situation.”
35
Ploy—“speci?c ‘maneuver’ intended to outwit an opponent or
competitor.”
36
Pattern—“speci?cally, a pattern in a stream of actions . . . consistency in
behavior, whether or not intended.”
37
Position—“a means of locating an organization in its ‘environment’ . . .
usually identi?ed with competitors.”
38
Perspective—“the ingrained way of perceiving the world.”
39
More lately, Professors Hambrick and Frederickson have argued that a ?rm’s
mission drives its objectives, which drive its strategy.
40
This strategy has ?ve
elements:
Arenas: Where will the ?rm be active?
Vehicles: How will the ?rm get there?
Staging: What will be the ?rm’s speed and sequence of the moves to get
there?
Differentiators: How will the ?rm set itself apart so as to win?
Economic logic: How will the ?rm generate returns on its investment?
Whatever the de?nition of strategy, the bottom line is that ?rms have to make
money if they are going to stay in business for long—they have to create eco-
nomic value; and revenues come from customers who pay for what they per-
ceive as valuable to them. If these customers are to keep going to a ?rm rather
than to its competitors, the ?rm must offer these customers unique bene?ts that
competitors do not. The ?rm has to create unique value for these customers—
value that is dif?cult for competitors to replicate, leapfrog, or substitute. How-
ever, creating value—even unique value—does not always mean that one can
appropriate it. Thus, a ?rm should also be well positioned—vis-à-vis its coo-
petitors—to appropriate the value that it creates. Effectively, then, winning or
making money in business is about creating and appropriating value; and since
strategy is about winning, we can de?ne business strategy as the set of activities
that a ?rm performs to create and appropriate value.
Flow of the Book
This book is about value creation and appropriation, and the underpinning
activities and resources/capabilities in the face of new games. It is about stra-
tegic innovation. Thus all the chapters of the book are about some element of
activities, value, appropriation, and change. The book is divided into four
parts (Figure 1.4). Part I is made up of Chapters 1, 2, and 3. Chapter 1 is the
Introduction and Overview 29
introduction to new game strategies and an overview of the book. Chapter 2
explores the AVAC framework for analyzing the pro?tability potential of not
only strategies but also of brands, technologies, business units, etc. Only such a
detailed analysis can help managers understand why their ?rms are not per-
forming well and what they could do to improve that performance. Chapter 3 is
about the long-tail phenomenon—an example of the sources and opportunities
for new game strategies.
Part II is about a ?rm’s strengths and weaknesses in the face of a new game—
about a ?rm’s activities and underpinning resources/capabilities as well as the
value that it creates and appropriates. It follows from the ?rst three character-
istics of new games. It is about the concepts, frameworks, and analytics that
underpin the exploitation of the characteristics of new games to gain and/or
prolong a competitive advantage. Recall that, in the face of a new game, a ?rm
can take advantage of the characteristics of new games. It can:
•
Take advantage of the new ways of creating and capturing new value gener-
ated by a new game.
•
Take advantage of the opportunities to build new resources/capabilities
and/or translate existing ones in new ways into value generated by new
game.
•
Take advantage of the potential to build and exploit ?rst-mover advantages.
•
Anticipate and respond to the likely reactions of coopetitors.
Figure 1.4 Flow of the Book.
30 Introduction
•
Identify and exploit the opportunities and threats from the industry, macro,
or global environment.
Since strategy is about creating and appropriating value, taking advantage of
the new ways of creating and capturing value generated by a new game is
critical to pro?ting from a new game. Thus, Chapter 4 is about value creation
and appropriation in the face of new games; and since resources/capabilities are
a cornerstone of value creation and appropriation, taking advantage of the
opportunity to build new resources/capabilities and/or translate existing ones in
new ways into value can play a signi?cant role during new games. Thus, in
Chapter 5, we explore the role of resources and capabilities in the face of new
game strategies. Since a ?rm can build and exploit ?rst-mover advantages to
attain or solidify its competitive advantage, we explore ?rst-mover advantages
and disadvantages as well as competitors’ handicaps in Chapter 6. Since a
strategy is often only as good as its implementation, we dedicate Chapter 7 to
the implementation of new game strategies; we explore more about resources/
capabilities, this time focusing on implementation resources/capabilities—those
resources and capabilities that are used to execute a strategy.
Part III is about the opportunities and threats that a ?rm faces when it pur-
sues a new game strategy, and follows from the last two characteristics of new
games—the fact that (1) new games attract reactions from new and existing
competitors, and (2) have their roots in the opportunities and threats of a ?rm’s
environments. Disruptive technologies are a very good example of opportun-
ities or threats from new games. Thus, we start Part III with an exposition of
disruptive technologies in Chapter 8. In particular, we explore how one can use
the concept of disruptive technologies to detect opportunities and threats from
new games. This is followed by an exploration of globalization through new
games and value appropriation by global players in Chapter 9. In Chapter 10,
we brie?y explore the environments in which new games take place. In particu-
lar, we explore which environments are conducive to new game activities and
the role that governments can play in shaping such environments. We conclude
Part III by exploring how and why a ?rm should take the likely reaction of
coopetitors into consideration when it takes a decision. Although game theory
is not the theory of strategy, it can be very useful in exploring how a ?rm can
take the likely reaction of its coopetitors into consideration when making its
decisions. In Chapter 11, we summarize the relevant cooperative and non-
cooperative game theory, and start applying it to coopetition and competition
in the face of new games.
In Part IV, we explore the application of the concepts and tools of Parts II and
III to strategy and business model questions. Chapter 12 is about entering a new
business using new games. For entrepreneurs or any new entrant, the chapter
suggests that a ?rm is much better off entering a new business using new games
rather than trying to beat incumbents at their game. Although strategy litera-
ture usually does not encourage entering unrelated businesses, using new games
to enter new businesses can reduce some of the pitfalls of entering unrelated
businesses. Chapter 13 presents a summary of key strategy frameworks. This is
a good and popular reference for students, professors, and managers alike.
Part V consists of twelve cases of ?rms and products in game-changing situ-
ations. These include New World wine makers, Sephora, Net?ix, Threadless,
Introduction and Overview 31
Pixar, Lipitor, New Belgium Brewery, Botox, IKEA, Esperion, Xbox 360,
and the Nintendo Wii. These cases are meant to illustrate the concepts of
the book.
More chapters, cases, and potential additions to the book can be found at
acateh.com:
Key Takeaways
•
Strategy is about winning. It is about creating value and putting a ?rm in a
position to appropriate the value. It is about not only creating bene?ts for
customers but also putting a ?rm in a position, vis-à-vis coopetitors, to
pro?t from the value created.
•
A new game strategy is a set of activities that creates and/or captures value
in new ways. New game strategies often overturn the way value has been
created and/or appropriated—they often rede?ne the rules of the game.
New game strategies are an excellent way to create and appropriate value.
They can be very pro?table if well pursued.
•
A ?rm creates value when it offers customers something that they perceive
as valuable (bene?cial) to them and the bene?ts that these customers per-
ceive exceed the cost of providing them. The value appropriated (captured)
is the pro?t that a ?rm receives from the value it created.
•
New games go beyond product innovation; they are often about delivering
existing products to customers in new ways, or better positioning a ?rm to
capture existing value.
•
First movers, in de?ning new rules of the game, often make money; but so
do followers. The important thing is to pursue the right new game
strategy.
•
Firms often must cooperate to create value and compete to appropriate it.
•
The cornerstones of new game strategies are new game activities. A new
game activity is a new value chain activity or an existing activity that is
performed differently from the way existing industry value chain activities
have been performed to create and/or appropriate value. Because a set can
have only one member, a new game activity can be a new game strategy.
•
New game activities are of interest not only because they are the corner-
stones of new game strategies, but also because many strategy decisions are
taken one action at a time.
•
When a ?rm performs activities, it can (1) produce a product with bene?ts
that customers value, (2) better position itself vis-à-vis its coopetitors, or (3)
do both.
•
To pro?t fully from the product, the ?rm must price it well, seek relevant
sources of revenue, seek out customers for the product, and position it in
product spaces with little competition.
•
To pro?t from the better position vis-à-vis coopetitors, a ?rm must exploit
the position to capture the value that it has created, or capture the value that
its coopetitors have created.
•
When ?rms perform new value chain activities or perform existing activities
differently, they are effectively playing new games. New games posses the
following characteristics. They:
32 Introduction

Generate new ways of creating and capturing new value.

Offer opportunities to build new resources/capabilities and/or translate
existing ones in new ways into value.

Create the potential to build and exploit ?rst-mover advantages and
disadvantages.

Potentially attract reactions from new and existing competitors.

Often have their roots in the opportunities and threats of a ?rm’s
environments.
•
A ?rm that uses new games to offer unique value to customers and uniquely
position itself to appropriate the value, can use ?rst-mover advantages to
solidify its advantage in value creation and appropriation. The ?rm can
further solidify the advantage by anticipating and responding appropriately
to coopetitors’ likely reactions, and identifying and taking advantage of the
opportunities and threats of its environment.
•
A new game usually does not take place in isolation. It is usually preceded,
followed or played in parallel with other games.
•
Strategic management has been evolving. And so has the de?nition of strat-
egy from one that had more to do with long-term plans, objectives, and
allocation of resources to one that is now more about creating and
appropriating value.
•
New games can be grouped by their new gameness. In particular, they can
be grouped by the extent to which they impact two determinants of com-
petitive advantage: (1) product-market position (PMP) and (2) distinctive
difficult-to-imitate resources/capabilities. Such a grouping results in four
types of new games—regular, resource-building, position-building, and
revolutionary—with the regular new game being the least new game, and
revolutionary being the most new game.
•
Regular new games are about making improvements and re?nements to
both existing resources/capabilities and product-market positions. They are
the least new game of the four types. Capabilities needed are the same as
existing ones or build on them. The resulting product or position allows
existing products to still be competitive in the market.
•
In resource-building games existing products or positions remain competi-
tive but the resources/capabilities needed are radically different from exist-
ing ones. Changes in the rules of the game are largely resource/capabilities-
related.
•
In position-building games, the resources/capabilities needed are existing
ones or build on them but the new product-market positions are radically
different. Changes in the rules of the game are largely PMP-related.
•
In revolutionary games, the resources/capabilities needed and the product-
market-positions pursued are radically different from existing ones. They
are the most new game of the four new game strategies. Changes in the rules
of the game are both PMP and resource/capabilities-related.
Key Terms
Activities
Appropriability
Introduction and Overview 33
Change
Competitive advantage
Coopetitors
Handicaps
New game activities
New game strategies
Position vis-à-vis coopetitors
Position-building new game
Regular new game
Resource-building new game
Revolutionary new game
Strategic innovation
Strategy
Value
Value appropriation
Value creation
34 Introduction
Assessing the Profitability
Potential of a Strategy
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Go beneath a ?rm’s ?nancial performance to understand the pro?tability
potential of the ?rm’s strategy.
•
Use the Activities, Value, Appropriability, and Change (AVAC) framework
to explore the pro?tability potential of products, resources, brands, busi-
ness units, etc.
•
Question the use of P/E ?nancial ratios to determine whether or not a stock
is overvalued.
Introduction
How can a ?rm or an investor tell if one strategy is better than others? Since
business strategies are usually about performance, a trivial answer to this ques-
tion is to compare the pro?tability of each business and the one with the highest
pro?tability is judged to have the best strategy. But suppose one of the busi-
nesses is a startup that is not yet pro?table but has the potential to be pro?table
in the future. Better still, suppose one wants to ?nd out what can be done to
improve the pro?tability of a strategy. Only a detailed analysis of the underpin-
nings of pro?tability can unearth any hidden potential or faults that a strategy
might have. Even better still, if an investor wants to invest in a startup that does
not have a long history of steady earnings, pro?tability numbers are not likely
to tell a good enough story. Existing frameworks such as the Balanced Score-
card, Porter’s Five Forces, Growth/Share matrix, SWOT analysis, the 7Cs, and
other frameworks are useful in exploring different aspects of ?rm pro?tability.
However, they are not integrative enough and therefore leave out important
determinants of pro?tability potential.
In this chapter we explore a framework for assessing not only why a ?rm is
performing well or not so well, but also for assessing the pro?tability potential
of a strategy or business model, and strategic actions. Called the AVAC frame-
work, it is predicated on the argument that strategy is about value creation and
appropriation.
1
A related framework, called the 7Cs, also adequately explores
why a ?rm is performing well or not so well but the AVAC is better for explor-
ing new game strategies. The AVAC framework is about understanding how a
?rm creates value and positions itself to appropriate the value, and about what
else it could do to perform even better. It can therefore be used not only to
Chapter 2
analyze the pro?tability potential of a ?rm’s strategy but also to analyze the
pro?tability potential of business models, business units, products, technolo-
gies, brands, market segments, acquisitions, investment opportunities, partner-
ships such as alliances, different departments such as an R&D group, and cor-
porate strategies, and make recommendations as to what needs to be done to
improve the pro?tability potential of the target. We start the chapter by brie?y
exploring two ?nancial measures that are sometimes used to estimate the prof-
itability potential of strategies. We will then lay out the key elements of the
AVAC framework, and follow that with an example to illustrate the use of
the model.
Financial Measures
Financial measures are sometimes used to measure the extent to which one
strategy is better than another. We consider two of them: historical earnings and
market value.
Historical Earnings
A ?rm’s historical earnings are sometimes used to measure the pro?tability
potential of the ?rm’s strategy. Actual earnings-before-interest-depreciation-
and-tax (EBIDT), net income, income per sales, etc. over a period are used to
predict future earnings and therefore the effectiveness of a strategy. These esti-
mates provide some idea of how pro?table a ?rm’s strategy has been and might
be in the future. This approach has many shortcomings. First, it assumes
that historical earnings are a predictor of future earnings. Such an assump-
tion undermines the fact that a ?rm’s strategy might change, competitors
might change their own strategies, or the environment in which the ?rm oper-
ates might change. Earnings are not always a good predictor of future
earnings, let alone a good indicator of the pro?tability potential of a strategy.
Second, earnings say nothing about the scale, dif?culty, and shortcomings of
activities that were performed to earn the pro?ts and that might have to be
performed to earn future income. They say nothing about what is being done in
the trenches to create and appropriate value; that is, there is little about the
cornerstones of pro?ts—the resources and activities that go into creating and
appropriating value.
Market Value
Another measure of a ?rm’s strategy’s pro?tability potential is the ?rm’s market
value. Recall that the value of a stock or business is determined by the cash
in?ows and out?ows—discounted at the appropriate interest rate—that can be
expected to accrue from the stock or business. Thus, since strategy drives pro?ts
and cash ?ows, a ?rm’s market value can be used to estimate the pro?tability
potential of the underpinning strategy. The value of a business or ?rm is the
present value of its future free cash ?ows discounted at its cost of capital, and is
given by:
2
36 Introduction
V = C
0
+
C
1
(1 + r
k
)
+
C
2
(1 + r
k
)
2
+
C
3
(1 + r
k
)
3
+ . . .
C
n
(1 + r
k
)
n
=
?
t = n
t = 0
C
t
(1 + r
k
)
t
(1)
where C
t
is the free cash ?ow at time t. This is the cash from operations that is
available for distribution to claimholders—equity investors and debtors—who
provide capital. It is the difference between cash earnings and cash investments;
r
k
is the ?rm’s discount rate.
An important assumption in using a ?rm’s market value as a measure of its
strategy’s pro?tability potential is that the future cash ?ows from the strategy
can be forecasted. The problem with this assumption is that forecasting future
cash ?ows accurately is extremely dif?cult. To determine the market value at
time t, for example, we need to estimate the cash ?ows for all the years beyond t
(see equation (1)). This can be dif?cult when t > 5. However, equation (1) can be
further simpli?ed by assuming that the free cash ?ows generated by the ?rm
being valued will reach a constant amount (an annuity) of C
f
, after n years.
Doing so, equation (1) reduces to:
V =
C
f
r
k
(1 + r
k
)
n
(2)
If we further assume that the constant free cash ?ows start in the present year,
then n = 0, and equation (2) reduces to:
V =
C
f
r
k
(3)
Another way to simplify equation (1) is to assume that today’s free cash ?ows,
C
0
, which we know, will grow at a constant rate g forever. If we do so, equation
(1) reduces to:
V =
C
0
r
k
? g
(4)
Equations (2), (3), and (4) have an advantage over equation (1) in that only one
cash ?ow value has to be estimated rather than many dif?cult-to-forecast
values. However, there may be more room to make mistakes when one depends
on only one value.
Example
On March 15, 2000, Cisco’s market valuation was $453.88 billion. Its pro?ts
in 1999 were $2.10 billion.
3
Was Cisco overvalued? We can explore this ques-
tion using equations (2), (3), or (4). From equation (3):
Assessing the Profitability Potential of a Strategy 37
453.88 =
C
f
r
k
From whence, C
f
= $453.88 × r
k
billion; that is, the free cash ?ows that Cisco
would have to generate every year, forever, to justify its $453.88 billion valu-
ation are C
f
= $453.88 × r
k
billion. If we assume a discount rate of 15%, then
Cisco would have to generate $68.8 (that is, $453.88 × 15) billion in free cash
?ows every year to in?nity. Since free cash ?ows are usually less than pro?ts
after tax, Cisco would have to make annual profits of more than $68 billion to
justify this valuation. Its pro?ts in 1999 were $2 billion. How can any company
generate after-tax pro?ts of more than $68 billion a year, forever? In particular,
what is it about Cisco’s business model, its industry and competitors that would
make one believe that the company could quickly ramp its pro?ts from $2
billion to more than $68 billion and maintain that advantage forever? Only a
detailed analysis of the company’s underpinning strategy can help us under-
stand what it is about a company such as Cisco that would make it possible for
the ?rm to earn this much cash.
Beneath the Numbers
The AVAC analysis goes beyond pro?tability or market value numbers and digs
deeper into what drives the numbers; so do some previous strategy frameworks;
but, as we will see later, AVAC does more. A. Porter’s Five Forces framework,
for example, was designed to analyze the average pro?tability of industries but
has been used to evaluate the extent to which a ?rm’s strategy dampens or
reinforces the competitive forces that impinge on a ?rm and its pro?tability.
However, the Five Forces framework leaves out important aspects of value
creation and appropriation that can be critical to the pro?tability of a strategy.
It neglects the role of (1) change (the new game factor), (2) resources/capabil-
ities/competences (including complementary assets), (3) industry value drivers,
(4) pricing, (5) the number and quality of customers, and (6) market segments
and sources of revenue. In the Balanced Scorecard, a ?rm is viewed from four
perspectives in developing metrics, collecting and analyzing data: learning and
growth, internal business processes, customer, and ?nancial.
4
The Scorecard
incorporates some aspects of value creation such as learning but falls short of
incorporating appropriation activities. It also has little or nothing about the
macro and competitive forces that impact a ?rm as it creates value and positions
itself to appropriate value. The 7Cs framework goes beneath pro?tability
numbers and explores why some strategies are more pro?table than others.
5
However, it does not adequately get into what can be done to improve the
pro?tability of a new game strategy. The player-type framework that we will
see in Chapter 6 is good when a top-level manager wants to cut through lots of
detailed information and get a feel for where his or her ?rm stands as far as
being a superstar, adventurer, exploiter, or me-too; but it does not dig deep into
the activities that a ?rm performs to create and appropriate value. Popular
strategy frameworks such as the Growth/Share matrix and SWOT analysis do
not explicitly evaluate the pro?tability of a strategy. The AVAC framework
overcomes these shortcomings.
38 Introduction
The AVAC Framework
The AVAC framework gets its name from the ?rst letter of each of its four
components (Activities, Value, Appropriability, and Change). These com-
ponents are displayed in Figure 2.1.
6
Brief Logic of the Framework
Before describing the components of the framework in detail, let us brie?y
explore the rationale behind them. The framework has its roots in the de?nition
of strategy. Since we have de?ned a ?rm’s strategy as the set of activities that it
performs to create and appropriate value, we can assess a strategy by examining
how and the extent to which these activities contribute to value creation and
appropriation. Since not all activities contribute equally to value creation, the
types of activity which a ?rm chooses to perform, when it chooses to perform
them, where it performs them, and how it performs them are important—that
is, a ?rm has to choose the right set of activities to perform to increase its
chances of creating the most value possible and capturing as much value from
its value system as possible. Thus, the Activities component of the AVAC
framework is about determining whether the right set of activities has been
chosen. For a ?rm to keep making money from the value that it has created,
there must be something about the value that makes customers prefer to buy
from the ?rm rather than from its competitors—the value should be unique.
Figure 2.1 Components of an AVAC Analysis.
Assessing the Profitability Potential of a Strategy 39
Hence the Value component, which is about whether the activities, collect-
ively, contribute enough to value creation for customers to prefer the perceived
bene?ts in the value as better than those from competitors. Since not even
unique value can always guarantee pro?ts, it is also important that the ?rm
translates the value into money—that the ?rm ?nds a way to appropriate the
value. The ?rm should be positioned well enough vis-à-vis its coopetitors to
make sure that the coopetitors do not capture the value that it has created. In
fact, if it positions itself well, it can capture not only the value that it has
created but also the value created by its coopetitors. Hence the Appropriability
component, which is about whether the activities performed are such that the
?rm makes money. Finally, a ?rm will continue to create and capture value
using the same activities and underpinning resources only if there is no major
change, or when there is change, the change reinforces what the ?rm is doing,
or the ?rm can react well to it. Hence the Change component that is behind the
question: does or will the ?rm take advantage of change in value creation and
appropriation?
Effectively, the activities component of the analysis tells us which activities
make up the strategy, what and how each activity contributes to value creation
and appropriation, and where or when the contribution is made. The value
component explores the extent to which the contributions made by the activ-
ities are unique enough for customers to prefer the ?rm’s products to com-
petitors’ products. The appropriability component explores whether the
contributions made by the activities are large enough to put the ?rm in a
superior position vis-à-vis its coopetitors and for the ?rm to pro?t from the
position and the value created. The change component is about whether the
?rm is doing what it can to exploit existing change or future change. We now
explore each of these components in detail (Figure 2.2).
Activities (Is the Firm Performing the Right Activities?)
The activities which a ?rm performs, when it performs them, where it per-
forms them, and how it performs them determine the extent to which the
?rm creates and appropriates value and the level of competitive advantage
that it can have. Therefore the central question for this component is
whether the ?rm is performing the activities which it should be performing,
when it should be performing, where it should be performing, and how it
should be performing them to give it a competitive advantage? We answer
this question indirectly by exploring whether or not each activity contributes
to value creation and appropriation. In Chapter 1, we saw that when a ?rm
performs an activity, the activity can contribute to lowering the cost of its
products, differentiating the product, moving its price towards the reserva-
tion price of customers, increasing the number of customers, or ?nding prof-
itable sources of revenue. We also saw that an activity can also contribute to
improving the ?rm’s position vis-à-vis its coopetitors by, for example, damp-
ening or reversing repressive competitive forces while reinforcing favorable
ones, or improving relationships from adversarial to friendly. Thus, two
questions that can give us a good idea of whether a ?rm is performing the
right activity are, if the activity contributes, (1) to low cost, differentiation,
better pricing, reaching more customers, and better sources of revenues, and
40 Introduction
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(2) to improving the ?rm’s position vis-à-vis coopetitors—for example,
dampening repressive competitive and macroenvironmental forces while
reinforcing friendly ones.
However, in each industry, there are usually some industry-speci?c factors
that stand to have a substantial impact on cost, differentiation, or other drivers
of pro?tability such as the number of customers. Thus, activities that take
advantage of these industry value drivers make a larger contribution to value
creation and appropriation than those that do not. For example, in of?ine
retailing, location is an industry value driver since it determines the type and
number of customers who can shop there, the cost of operations, the cost of
retail space, and the number and types of competitor, and so on. A ?rm that
chooses the right location is taking advantage of industry value drivers. Thus, a
third important question that helps us determine if an activity is the right one is
if the activity takes advantage of industry value drivers.
Moreover, resources and capabilities play two crucial roles in creating and
appropriating value. First, they are at the root of all activities and can be a
source of competitive advantage. For example, Toyota’s ability to develop and
manufacture dependable cars, using its lean manufacturing processes, is a
scarce resource/capability that enables it to create value that is dif?cult to repli-
cate. Second, resources act as differentiators. For example, a ?rm’s brand or
reputation can be the reason why customers buy the ?rm’s products rather than
competitors’ products. Thus, a ?rm’s activities can contribute to value creation
and appropriation when they contribute either to building valuable resources
and capabilities, or to translating existing ones into unique customer bene?ts, to
better position a ?rm vis-à-vis its coopetitors, or to translate customer bene?ts
and position into pro?ts. Therefore, a fourth question the answer to which can
tell us if an activity is the right one is—does the activity contribute to building
new distinctive resources/capabilities, or to translating existing ones into
unique positions and pro?ts?
Finally, in choosing how many activities to perform, a ?rm is guided by two
rather opposing forces. On the one hand, a ?rm does not want to leave out some
activity that could have made a signi?cant contribution to value creation and
appropriation. It wants its set of activities to be as comprehensive as possible—
to include as many relevant activities as possible. On the other hand, having too
many activities, especially low value-adding activities, can be costly. A ?rm
wants to be parsimonious—perform as few activities as possible without leav-
ing out key activities. Thus, a ?rm not only has to perform the right types of
activities, it also has to perform the right number of activities. Therefore, the
?nal question that a ?rm ought to ask in assessing its strategy is—is it perform-
ing super?uous activities, or are there some activities that it should be
performing?
Effectively, analyzing the Activities component of an AVAC consists of
determining the extent to which each activity:
7
1 Contributes to low cost, differentiation, better pricing, reaching more
customers, and better sources of revenues.
2 Contributes to improving its position vis-à-vis coopetitors.
3 Takes advantage of industry value drivers.
4 Contributes to building new distinctive resources/capabilities or translating
42 Introduction
existing ones into unique positions and pro?ts (including complementary
assets).
5 Fits the comprehensiveness and parsimony criteria.
We now explore all ?ve questions.
Contribute to Low Cost, Differentiation, or other Drivers of
Profitability?
The idea is to determine whether each activity which a ?rm performs, when it
performs it, how it performs it, and where it performs it contributes towards
lowering its cost, differentiating its products, increasing the number of its cus-
tomers, improving its pricing, or better identifying and serving pro?table
sources of revenues. If the activity does, the answer to the question is Yes. If it
does not, the answer is No. For example, when a luxury goods maker advertises
to the af?uent, the activity may be contributing to differentiating its products,
and therefore contributing to value creation. Thus the answer to this question
would be Yes. If a ?rm obtains a second source for a critical input, it may be
able to extract lower prices from its suppliers, thereby lowering its cost, and
contributing to the value that it creates and appropriates. Activities that con-
tribute to increasing the number of customers that buy a product, getting the
price right, and pursuing the right sources of revenue also make a contribution
to the revenue earned.
Contribute to Improving a Firm’s Position vis-à-vis Coopetitors?
An activity contributes to improving a ?rm’s position vis-à-vis its coopetitors if
it improves the extent to which coopetitors need the ?rm more than it needs
them. For example, if a ?rm convinces its suppliers of a key component to have
second sources for the component, the ?rm now needs the supplier less and this
increases the ?rm’s position vis-à-vis the supplier. A classic example of a ?rm
improving its position vis-à-vis coopetitors is that of Wal-Mart. When the com-
pany started out, it had very little in?uence over major suppliers such as Procter
& Gamble, who dictated the terms of exchange. As Wal-Mart scaled up its
activities by saturating contiguous small towns with discount stores and build-
ing appropriate distribution centers, using information technology extensively,
and establishing the Wal-Mart culture, it chipped away at the balance of who
needed whom more. The ?rm would grow to become the world’s largest retailer
at some point. Many of Wal-Mart’s activities were new game activities in the
retail industry at the time and helped the company to reverse the balance of who
needed whom more in Wal-Mart’s favor.
When we talk of improving a ?rm’s position, it does not necessarily mean
that the ?rm is starting from a bad situation. A ?rm can already be in a good
position and perform an activity that improves the situation, putting it in an
even better position vis-à-vis its coopetitors. For example, if industry ?rms are
in a superior position vis-à-vis buyers and one of the ?rms buys some of its
competitors, it improves its position vis-à-vis buyers since there are now fewer
?rms. This is likely to increase the amount of value that the ?rm appropriates.
Assessing the Profitability Potential of a Strategy 43
Take Advantage of Industry Value Drivers?
The next question is, whether, in performing an activity, a ?rm has taken advan-
tage of industry value drivers. A ?rm takes advantage of industry value drivers
if the activity exploits an industry-speci?c factor to reduce cost, further differen-
tiate its products, or improve other pro?t drivers such as the number of its
customers. Answering this question entails listing the industry value drivers in
the industry and identifying which activities take advantage of them. The
answer to the question is Yes, if the ?rm’s activities take advantage of the
industry value drivers identi?ed.
Contribute to Building New Distinctive Resources/Capabilities or
Translating Existing Ones into Unique Value?
Each activity that a ?rm performs exploits some of its resources and capabil-
ities, or contributes to building new resources/capabilities. Thus, one of the
questions that a ?rm should ask about each activity that it performs is whether
the activity contributes to exploiting its existing resources/capabilities better, or
to building distinctive resources/capabilities (new or old). By identifying the
resources/capabilities that are valuable to a ?rm, one can determine which of
them are being exploited by existing activities or are being built by these
activities.
Are Comprehensive and Parsimonious?
Whereas the other questions are about each individual activity, the com-
prehensiveness and parsimony question is about the whole set of activities that
constitutes the ?rm’s strategy. After laying out the set of activities, a ?rm should
carefully explore what other activities it should be performing, that it is not
presently performing. It should also think about dropping some of the activities
that make the least contribution towards value creation and appropriation. If
there are no activities that it should be performing, or that it should drop, the
answer is Yes, since the strategy is comprehensive and parsimonious.
Effectively, the Activities component of the AVAC analysis starts out by iden-
tifying all the key activities that make up the strategy. Then, for each question,
see if any of the identi?ed activities make the contribution called for in the
question. If the answer to a question is a No, the ?rm may need to take another
look at the particular factor and ?nd ways to reverse things. When the answer is
a Yes, there is still always room for improvement. For example, if the answer is
Yes, the ?rm still has to think of ways to reinforce the Yes. Note that where
there are multiple answers to a question, it only takes one positive for the
question to get a Yes. Take Question 1, for example. If an activity contributes to
low costs but does not contribute to differentiation, etc., Question 1 still gets a
Yes. However, the analyst now knows that something could be done to improve
differentiation, increase number of customers, etc. One of the most useful
applications of an AVAC analysis is in identifying possible areas for improve-
ment; and these areas of improvement come out clearly when a question
scores a No.
44 Introduction
Value (Is the Value Created by the Strategy Preferred by
Many Customers? Yes/No)
The Activities component tells us whether or not each activity contributes to
value creation, but it does not tell us whether the contributions are enough to
make a difference with customers. It does not tell us if the contributions of all
the activities, when added together, are unique enough to make customers pre-
fer the ?rm’s products to competitors’ products. The Values component allows
one to explore whether the set of activities that is a ?rm’s strategy creates value
that is unique enough for customers to prefer it to competing value. If customers
are going to keep buying from a ?rm, its strategy needs to create bene?ts that
they perceive as being unique compared to competitors’ offerings. Thus, the
?rst question in the Value component is whether the value created is unique
enough, as perceived by customers, for them to prefer it to competing value.
Since the number of customers that perceive value as unique is also important,
the next question is, do many customers perceive the value as unique? The more
customers that perceive the bene?ts created, the higher the revenue potential is
likely to be and the better the chances of having economies of scale and of
reducing the per unit costs; also, the more valuable a customer, the better the
pro?tability potential of the ?rm is likely to be in selling to the customer. A
customer is valuable if it has a high willingness to pay, represents a decent share
of revenues, and does not cost much (relative to the revenues from the cus-
tomer) to acquire and maintain. Finally, nearby white spaces into which a ?rm
can easily move, can also increase the pro?tability potential of a ?rm. A white
space is a market segment that is not being served—it has potential customers.
Effectively, an analysis of the Value component is about determining the
extent to which a ?rm’s strategy results in differentiated or low-cost products
that are targeted at many valuable customers. Such an analysis is done by
answering the following simple questions with a Yes or No (Figure 2.2):
1 Do customers perceive the value created by the strategy as unique?
2 Do many customers perceive this value?
3 Are these customers valuable?
4 Are there any nearby white spaces?
If the answer to the ?rst three questions is Yes, the strategy is OK as far as the
Value component is concerned. The ?rm can then work on reinforcing the
Yesses. If any of the answers are No, the ?rm may need to take another look at
its strategy by asking the following questions: how can the value be improved?
How can the ?rm gain new valuable customers or enter new market segments?
If the answer to the fourth question is Yes, the ?rm may want to explore the
possibilities of getting into the white space. Finally, any opportunities and
threats to value, such as shifts in customer tastes or demographics, or a techno-
logical change that can in?uence expected customer bene?ts, are also examined.
Appropriability
The Activities component tells us whether the activities which a ?rm performs
contribute to better positioning it vis-à-vis its coopetitors, but it does not tell us
Assessing the Profitability Potential of a Strategy 45
if the contributions are enough to put the ?rm in a superior position relative to
its coopetitors. Neither does it tell us if a ?rm that has a superior position vis-à-
vis coopetitors exploits that position by, for example, setting its prices as close
as possible to the reservation prices of customers, or obtaining other conces-
sions from customers. The Apropriability component tells us whether a ?rm has
a superior position vis-à-vis coopetitors, and whether the ?rm translates the
customer bene?ts created and its position vis-à-vis coopetitors into money. The
analysis consists of asking whether:
1 The ?rm has a superior position vis-à-vis its coopetitors.
2 The ?rm exploits its position vis-à-vis its coopetitors and customer bene?ts.
3 It is dif?cult to imitate the ?rm.
4 There are few viable substitutes but many complements.
Does the Firm Have a Superior Position vis-à-vis Coopetitors?
A ?rm has a superior position vis-à-vis its coopetitors if it needs the coopetitors
less than they need it. Two factors determine whether a ?rm needs a coopetitor
more, or vice versa: industry factors, and ?rm-speci?c factors. Take a ?rm and
its suppliers, for example. Suppliers need a ?rm more than the ?rm needs them,
if there are more suppliers than there are ?rms; that is because there are more
suppliers competing for the ?rm’s business. Effectively, the concentration of
both the coopetitor’s and ?rm’s industries matter. Firm-speci?c factors are those
things about ?rms that differ from one ?rm to the other, even within the same
industry, and that often distinguish one ?rm from others. A ?rm’s valuable,
scarce, dif?cult-to-imitate resources, such as its brand, are ?rm-speci?c factors.
Such distinctive factors increase the likelihood of a ?rm being better positioned
vis-à-vis coopetitors. For example, Coke’s brand pulls customers into stores and
that pull makes even large ?rms such as Wal-Mart carry Coke drinks even
though there are many competing drinks. Coke’s brand makes Wal-Mart need
Coke more than they would have without the brand.
Effectively, one can determine if a ?rm has a superior position vis-à-vis its
coopetitors by determining if the ?rm needs the coopetitor more, or the other
way around. The ?rm has a superior position vis-à-vis its coopetitors if the ?rm
needs them less.
Does the Firm Exploit its Position vis-à-vis Coopetitors, and Profit from
Customer Benefits?
The next question is whether a ?rm exploits its position vis-à-vis coopetitors
and whether it pro?ts from the bene?ts that customers perceive in the ?rm’s
products. The value that a ?rm captures is a function of how well it exploits its
position. For example, if a ?rm has a superior position vis-à-vis its suppliers, it
can extract lower input prices from them, thereby lowering its costs and increas-
ing the value that it captures. (Recall that value captured equals price paid by
customers less the cost of providing the customer with the product.) If a ?rm has
a superior position vis-à-vis its complementors, it can more easily convince
them to sell complements at lower prices, which will increase its own sales. It
effectively captures some of the value created by complementors. For example,
46 Introduction
Microsoft is very powerful in the PC world and therefore, compared to PC
makers, appropriates a lot of the value created. A ?rm’s appropriation of value
created also depends on its position vis-à-vis coopetitors’ customers. If cus-
tomers have a superior position, they are likely to extract low prices from the
?rm, diminishing its share of the pie (share of the value created that it
appropriates).
The value that a ?rm captures is also a very strong function of the ?rm’s
pricing strategy. Developing low-cost or differentiated products is great; but the
products must be priced carefully so as not to drive customers away or leave
money on the table. The closer that a ?rm can set its prices to each customer’s
reservation price without driving customers away, the more money that a ?rm
is likely to make. Recall that a customer’s reservation price for a product is the
maximum price that the customer is willing to pay for the product. If the price is
higher than the reservation price, the customer may be lost. If the price is below
the customer’s reservation price, the customer pockets the difference as con-
sumer surplus. Back to the question, does the ?rm exploit its position vis-à-vis
coopetitors, and pro?t from customer bene?ts? The answer is Yes, if either the
?rm sets its prices as close as possible to the reservation prices of customers, or
if it exercises its superior position in some other way.
Is it Difficult to Imitate the Firm?
If the value that a ?rm creates can be easily imitated, it will be dif?cult for the
?rm to make money. Thus, an important question for a ?rm that creates value is
whether it is easy for existing rivals and potential competitors to imitate or
leapfrog the ?rm’s set of activities. Two factors determine the extent to which a
?rm’s activities can be imitated. First, it depends on the ?rm and its set of
activities. A ?rm can reduce imitability of its activities or resources/capabilities,
for example, by acquiring and defending any intellectual property that under-
pins such activities or resources. It can also establish a history of retaliating
against any ?rms that attempt to imitate its activities by seeking legal action,
lowering its prices, introducing competitive products, or making early product
announcements. The complexity of the system of activities that a ?rm performs
can also prevent competitors from imitating its set of activities. Imitating one
activity may be easy; but imitating a system of activities is a lot more dif?cult
since one has to imitate not only the many activities that form the system but
also the interactions among the components. Resources and capabilities can
also be dif?cult to imitate when they are protected by law, are rooted in a
history that cannot be re-enacted, are scarce and cannot be recreated, or require
a critical mass to be effective.
Second, whether a ?rm’s set of activities can be imitated is also a function of
the potential imitators. Sometimes, potential imitators are unable to imitate a
?rm not so much because of the ?rm and its system of activities and resources
but because of the potential competitors’ prior commitments and lack of what it
takes to imitate. Prior commitments include union contracts, and agreements
with suppliers, distributors, governments, shareholders, employers, or other
stakeholders. When Ryanair started moving into secondary airports in Europe,
it was dif?cult for established airlines such as Air France to abandon the major
airports such as General de Gaulle in Paris for secondary airports if they wanted
Assessing the Profitability Potential of a Strategy 47
to replicate Ryanair’s strategy. Performing activities requires resources and
when such resources are scarce, a potential imitator might not be able to ?nd
the resources that it needs to compete. For example, a ?rm may want to start
producing new cars but may not have what it takes to do so. Thus, in exploring
appropriability, it is important to ask the following two questions: is there
something about the ?rm and its set of activities and resources that makes
it dif?cult for competitors to imitate its strategy? Is there something about
competitors that impedes them from imitating the ?rm?
Are There Few Substitutes but Many Complements?
If a ?rm offers rare value that is dif?cult to imitate, it may still not be able to
pro?t enough from the value if there are products that can act as substitutes for
the value that customers derive from the ?rm’s products. Thus, a ?rm may be
better off understanding the extent to which substitutes can take away the
?rm’s customers. Complements have the opposite effect (compared to substi-
tutes) on a ?rm’s products. Availability of complements tends to boost a prod-
uct’s sales. Thus, customers would perceive a ?rm’s products as being more
valuable if such a product required complements and there were many such
complements available at good prices. For example, availability of software at
low prices boosted the sale of PCs. Two important questions for a ?rm, then,
are: is the value that it creates nonsubstitutable? Do complements (if relevant)
play a good enough role to boost the bene?ts that customers perceive from
the ?rm?
Change: The New Game Factor
Change can have a profound effect on a ?rm’s ability to create and appropriate
value. Change can originate from a ?rm’s environment, or from its new game
strategies. It can come from a ?rm’s industry or macroenvironment. For
example, government laws can raise or lower barriers to entry or exit, introduce
price limits, put limitations on the type of cooperation that ?rms can have, or
impose import quotas or tariffs, forcing them to change. Consumer tastes can
change, and changes in demographics can alter the willingness to pay of a
market segment. Technological change can result in new markets or industries,
the disruption of existing ways of doing things, and the erosion of existing
industries and competitive advantages. Witness the case of the Internet. In
responding to these changes from their environments, ?rms often introduce
change in the way they create and appropriate value.
Change is often initiated by entrepreneurs or ?rms, through new game activ-
ities. Firms invent new products that create new markets or new industries, and/
or overturn the way value is created and appropriated in existing industries.
Witness Intel’s invention of the microprocessor and its revolution of computing,
or Wal-Mart’s reinnovation of discount retailing. Firms can also introduce
change when they move into a new market or business, reposition themselves
vis-à-vis coopetitors, develop a new product, or restructure their internal
activities.
In any case, a ?rm has to deal with existing change and potential future
changes. It has to create and appropriate value in the face of existing change but
48 Introduction
must also anticipate and prepare for future changes. Without constantly antici-
pating and preparing for future change, a ?rm’s existing competitive advantage
can easily be undermined by events such as disruptive technologies.
The role of change and the extent to which a ?rm can take advantage of it are
analyzed in two parts: determination of strengths and handicaps, and the
exploration of some key change questions.
Determination of Strengths and Handicaps
As we will detail in Chapter 5, when a ?rm faces a new game, some of its pre-
new game strengths remain strengths while others become handicaps. These
strengths and handicaps play a key role in determining the extent to which the
?rm can perform value chain activities to create and appropriate value, in the
face of the change. Strengths and handicaps can be resources (distribution
channels, shelf space, plants, equipment, manufacturing know-how, marketing
know-how, R&D skills, patents, cash, brand-name reputations, technological
know-how, client or supplier relationships, dominant managerial logic, rou-
tines, processes, culture, and so on), or product positions (low-cost, differen-
tiation, or positioning vis-à-vis coopetitors). A classic example of a strength that
became a handicap is that of Compaq, which wanted to participate in the new
game created by Dell when the latter introduced the direct-sales and build-to-
order business model. Prior to this new game, Compaq’s relationships with
distributors were a strength; but when the company decided to sell directly to
end-customers, bypassing distributors, the distributors would not let Compaq
dump them that easily. Compaq had to abandon its new business model. Effect-
ively, Compaq’s pre-new game strength had become a handicap in the face of
the new game. Of course, many pregame strengths, such as brands, usually
remain strengths in the face of a new game. Thus, the ?rst step in a Change
analysis is to determine which of a ?rm’s prechange strengths remain strengths
and which ones become handicaps in the face of the change. (In Chapter 5, we
will see how a ?rm can determine its strengths and handicaps in the face of a
new game.)
The Questions
Having determined a ?rm’s strengths and handicaps, the next step is to deter-
mine how the ?rm can take or is taking advantage of the change by asking the
following questions: Given its strengths and handicaps in creating and
appropriating value in the face of the change, does or will the ?rm take advan-
tage of:
1 The new ways of creating and capturing new value generated by the
change?
2 The opportunities generated by change to build new resources or translate
existing ones in new ways?
3 First mover’s advantages and disadvantages, and competitors’ handicaps
that result from change?
4 Coopetitors’ potential reactions to its actions?
5 Opportunities and threats of environment? Are there no better alternatives?
Assessing the Profitability Potential of a Strategy 49
These factors are a direct outcome of the characteristics of new games that we
explored in Chapter 1. Effectively, the change component is about the new
game factors of activities.
Does the Firm Take Advantage of the New Ways of Creating and
Capturing Value Generated by Change?
A ?rm takes advantage of new ways of creating and appropriating value gener-
ated by a change if, given the change and the ?rm’s associated strengths and
handicaps, it can still offer customers the bene?ts that they prefer, position itself
well vis-à-vis coopetitors, and pro?t from the bene?ts and position. Identifying
the new ways of creating and capturing value generated by change consists of
picking those activities that are being performed differently—or should be per-
formed differently—in the face of the change, and verifying that these new game
activities have made (or will make) a signi?cant contribution towards value
creation and appropriation. The activities make a signi?cant contribution if
customers prefer the value from them, or the ?rm pro?ts from them. Thus, the
question here is, do the new game activities (1) create value that customers
prefer over value from competitors, and (2) enable the ?rm to make money? If
the answer to any of these questions is Yes, the answer to the question, does the
?rm take advantage of the new ways of creating and capturing value generated
by change? is Yes.
Does the Firm Take Advantage of Opportunities Generated by Change
to Build New Resources, or Translate Existing Ones in New Ways?
In the face of change, ?rms usually require both new and old resources to
perform the new game activities. The ?rst step towards seeing whether a ?rm
has taken advantage of these resources, is to identify them. To identify them,
construct the value chain, and pinpoint the activities that are being performed
differently or should be performed differently as a result of the change. The
relevant resources are those that are needed to perform the new activities. The
next step is to answer the question, do the identi?ed resources make a signi?-
cant contribution towards (1) creating value that customers prefer over value
from competitors, (2) enabling the ?rm to make money? If the answer to either
question is Yes, then the ?rm takes advantage of the opportunities generated by
change to build new resources, or translate existing ones in new ways.
Does the Firm Take Advantage of First-mover’s Advantages and
Disadvantages, and Competitors’ Handicaps?
If a ?rm initiates change, or is the ?rst to take advantage of change, it has an
opportunity to build and take advantage of ?rst-mover advantages. A ?rst-
mover advantage is a resource, capability, or product position that (1) a ?rm
acquires by being the ?rst to carry out an activity, and (2) gives the ?rm an
advantage in creating and appropriating value. These include preemption of
scarce resources such as gates and landing slots at an airport such as Heath-
row’s London Airport. The ?rst step towards seeing whether a ?rm has taken
advantage of ?rst-mover advantages is to identify them. Chapter 6 contains a
50 Introduction
complete list of ?rst-mover advantages. The next step is to establish whether
the advantages make a signi?cant contribution to the bene?ts that customers
perceive, or to the pro?ts that the ?rm makes.
First-mover disadvantages are those shortcomings that a ?rm has by being
the ?rst to pursue a particular activity. For example, a ?rm that moves ?rst into
a virgin market spends a great deal to establish the market. Followers that move
into the established market are effectively free-riding on the investments that
the ?rst mover made to establish the market. A ?rst mover would rather the
follower did not get so much free. Interestingly, the cure to ?rst-mover dis-
advantages can be better ?rst-mover advantages. For example, by seeking intel-
lectual property protection, a ?rst mover can reduce the extent to which follow-
ers free-ride on its investments. Of course, if a ?rm is a following, it can take
advantage of ?rst-mover disadvantages. A ?rm can also take advantage of com-
petitor’s handicaps. Thus, the answer to this question is Yes, if a ?rm takes
advantage of ?rst-mover advantages and disadvantages, OR of competitors’
handicaps in performing its activities.
Does the Firm Anticipate and Respond to Coopetitors’ Reactions to its
Actions?
A ?rm is better able to perform the activities that allow it to create and
appropriate value in the face of change if the ?rm anticipates and responds to its
coopetitor’s actions and reactions to the change. To determine if a ?rm’s strat-
egy anticipates and responds to coopetitors’ reactions, we list the activities that
the ?rm performs as a result of the change and ask whether, for each of the key
activities, the ?rm took the actions and reactions of the relevant coopetitor into
consideration.
Identify and Take Advantage of Opportunities and Threats from the
Macroenvironment? Are there no Better Alternatives?
In taking advantage of change, it is critical for a ?rm to identify and take
advantage of opportunities and threats, beyond the change, from its environ-
ment. For example, most new pharmaceutical products in the USA need
approval from the Food and Drug Administration (FDA) and therefore ?rms
that pursue new game activities in pharmaceuticals are better off exploring how
they can take advantage of the FDA’s approval processes. For example, in
developing Lipitor, Warner Lambert took advantage of an FDA law that gives
fast-track reviews to drugs that treat special conditions. Doing so shortened the
FDA approval of Lipitor by six months, saving the ?rm billions of dollars in
revenues. Sometimes, the opportunities are complementary technologies that
enhance the effectiveness of the new game. For example, Dell’s direct sales and
build-to-order model were more effective because Dell used the available tech-
nologies to reach customers directly. It started out using telephone banks to
reach customers and when the Internet emerged, Dell used it.
The bene?ts of changes are often ended by other changes. For example, many
innovations are usually displaced by so-called disruptive technologies. Thus,
paying attention to one’s environment can enable a ?rm to be better prepared
for disruption. Sometimes, by looking into its environment, a ?rm may ?nd
Assessing the Profitability Potential of a Strategy 51
better alternatives to its new game. After developing its search engine, Google
found an alternative monetization model in paid listings that was much better
than pop-up ads.
Applications of the AVAC Framework
What Can be Analyzed Using the AVAC?
Since the AVAC can be used to analyze the pro?tability potential of a ?rm’s
strategy, it can also be used to analyze the pro?tability potential of most things
whose pro?tability rests on performing a set of activities. (Recall that we
de?ned a strategy as a set of activities for creating and appropriating value.)
Thus, the AVAC can be used to analyze business models, business units, prod-
ucts, technologies, brands, market segments, acquisitions, investment
opportunities, partnerships such as alliances, an R&D group, corporate strat-
egies, and so on. The different main questions that a ?rm may want to ask in an
analysis are shown in Table 2.1 below. The subquestions remain primarily the
Table 2.1 Applications of AVAC Analysis
Activities Value Appropriability Change
(new game
factor)
Acquisition In making and exploiting
the acquisition, is the firm
performing the right set
of activities?
Do customers prefer the
value from the
acquisition, compared to
that from competitors?
Does the firm
profit from
the activities?
Does the
set of
activities
take
advantage
of change
(present or
future) to
create and
appropri-
ate value?
Brand Does the firm perform
the right activities, in
building and exploiting
the brand?
Do customers prefer the
value from the brand,
compared to that from
competitors?
Ditto Ditto
Business model Does the firm perform
the right business model
activities?
Do customers prefer the
value from the business
model activities,
compared to that from
competitors?
Ditto Ditto
Business unit Does the firm perform
the right business unit
activities?
Do customers prefer the
value from the business
unit, compared to that
from competitors?
Ditto Ditto
Corporate
strategy
Does the firm perform
the right corporate level
activities?
Do customers prefer the
value from the
corporate-level activities,
compared to that from
competitors?
Ditto Ditto
52 Introduction
same as those explored above. Take brand, for example. The ?rst question is,
does the ?rm perform the right activities for building and exploiting the brand?
Is the value created using the brand preferred by customers compared to the
value from competitors. Does the ?rm make money from the brand? And
?nally, in building and exploiting the brand, does the ?rm take advantage of
change or expect to take advantage of it?
When Should Such an Analysis be Undertaken?
The question is, when would one want to analyze the pro?tability potential of a
business unit, brand, product, etc. and therefore need to use the AVAC?
Compare Outcomes
AVAC can be used to compare the pro?tability potential of different business
strategies, business units, brands, products, corporate strategies, technologies,
R&G strategies, partnerships, acquisitions, market segments, etc. The AVAC
analysis is particularly suitable for such comparisons because it pinpoints the
likely weaknesses and strengths of each activity and shows (via the associated
questions) what questions need to be asked to remedy the weaknesses and
reinforce the strengths.
Organizing Platform for Data
Like most frameworks, from the Growth/Share matrix to a Porter’s Five Forces,
AVAC can be an excellent organizing stage for displaying data in some mean-
ingful way for discussions before a decision is taken. For example, before taking
a major strategic decision, managers may want to discuss the pro?tability of the
?rm before the decision and compare it to the projected pro?tability after the
Market segment Does the firm perform
the right market segment
activities?
Do customers prefer the
value from the market
segment, compared to
that from competitors?
Ditto Ditto
Partnership Does the firm perform
the right activities to
support and exploit the
partnership?
Do customers prefer the
value from the
partnership, compared to
that from competitors?
Ditto Ditto
Product Does the firm perform
the right activities to
offer the product?
Do customers prefer the
value from the product,
compared to that from
competitors?
Ditto Ditto
R&D group Does the group perform
the right R&D activities?
Do customers prefer the
value from the R&D,
compared to that from
competitors?
Ditto Ditto
Technology Does the firm perform
the right activities, as far
as the technology is
concerned?
Do customers prefer the
value from the
technology, compared to
that from competitors?
Ditto Ditto
Assessing the Profitability Potential of a Strategy 53
decision. An AVAC enables managers to see the before and potential after. It
provides a common platform and language to start off discussions.
Strategic Planning
Strategic planning builds on strategic analysis; that is, before performing
strategic planning, a ?rm needs ?rst to understand its existing strategy and
pro?tability potential. Strategic planning then follows. This process consists of
pinpointing a ?rm’s strengths and weaknesses as well as the opportunities and
threats that the ?rm faces as far as each component of AVAC is concerned.
Example 2.1: AVAC Analysis of a Strategy
To illustrate the AVAC analysis, we now analyze Ryanair’s strategy.
Ryanair 2008
To customers, a visit to Ryanair’s website (www.ryanair.com) in 2008 showed
some remarkable things: one could ?y from a number of airports in the United
Kingdom (UK) to towns in southern Europe for as little as £10, make hotel
reservations, ?nd apartments, rent a car, or ?nd out about important events
going on in many cities in Europe.
8
There were even buttons for “Ryanair
Casino,” “Airport transfers,” “Money” and “Ski.” To investors, Ryanair’s
?nancial performance was remarkable: from 2000 to 2007, the company’s
after-tax pro?t margins were some of the highest of any company in Europe,
ranging from 20–26%, slowing down to 18% because of higher per barrel oil
prices. In 2007, Ryanair’s Chief Executive Of?cer (CEO), Mr Michael O’Leary,
was estimated to be worth over US$ 800 million.
9
Ryanair was founded in Ireland in 1985 by Tom Ryan, made its ?rst pro?ts in
1991, and by 2000 had become one of the most pro?table airlines in the world
(Tables 2.2 to 2.4).
10
After almost going bankrupt in 1990, O’Leary had visited
Southwest Airlines in the USA to see why the latter had been pro?table since
incorporation, compared to other US airlines.
11
Deregulation of the airline
industry by the European Union (EU) in 1997 allowed any airline from any EU
Table 2.2 Selected Financials
Year ended 2000 2001 2002 2003 2004 2005 2006 2007
Passengers flown
(million)
6.1 8.1 11.1 15.7 23.1 27.6 34.8 42.5
Load factor (%) 85 81 84 83 82
Revenues (in million) 370.1 487.4 624.1 842.5 1,074 1,337 1,693 2,237
Profit after Tax (in
million)
72.5 104.5 150.4 239.4 227 269 302 401
Net margin (%) 20 21 24 28 21 20 18 18
EBITFAR (%) 36 37 36 41 36 34 31 30
Cash earnings (%) 31 34 34 38 30 27 25 26
Sources: Ryanair’s investor relationships. Retrieved August 27, 2007, from http://www.ryanair.com/site/about/invest/
docs/present/quarter4_2007.pdf
54 Introduction
country to operate scheduled ?ights to any other EU country. This was a great
opportunity that Ryanair seized. It also went public that same year.
In January of 2000, the company launched Europe’s largest booking website
(www.ryanair.com) and within three months, the site was taking over 50,000
bookings a week. By 2004, 96% of its tickets were sold online.
12
Thus, it was
able to avoid the $2 per reservation fee that booking a seat via the Sabre or
Apollo reservation systems cost. A customer could also book hotels, rent cars,
or apartments using the site. Agreements with hotels, transportation com-
panies, casinos, ?nancial institutions, and car rental agencies allowed Ryanair
to “handover” customers to each.
In the ?nancial year ending March 2007, the company carried 42.5 million
passengers. At the check-in desk, customers received a boarding pass but with
no seat assignment. Unlike other carriers, however, passengers were not
allowed to check baggage through to connecting ?ights on other airlines. It
charged for baggage in excess of 10 kg (22 lbs) so that some passengers could
end up paying as much as $200 for extra baggage. At most airports, Ryanair
negotiated with private companies or airport authorities to handle check-in,
baggage handling, and aircraft servicing. Its targeted turnaround time at these
secondary airports was 25 minutes, half the turnaround time of competitors at
major airports.
13
Table 2.3 Customer Service for Year Ending March 2005
% on time Lost bags per 1,000 passengers
Ryanair 89.4 0.6
Alitalia 82.5 12.9
Air France 80.5 14.9
Iberia 80.3 11.5
SAS 79.6 11.3
Austrian 79.4 18.8
Lufthansa 79.3 18.6
easyJet 78.3 RTP
British Airways 74.2 18.3
Sources: Ryanair’s investor relationships. Retrieved August 27, 2007, from http://www.ryanair.com/site/about/invest/
docs/present/quarter4_2007.pdf
Table 2.4 Industry Leading Margins for Year Ending March 2005
Revenues per passenger () Cost per passenger () Net profit margin (%)
Ryanair 48 39 20.10
Southwest Airlines 72 69 4.80
British Airways 268 257 4.10
Iberia 178 171 3.90
easyJet 66 63 3.80
JetBlue 84 81 3.70
Air France 298 292 1.80
Lufthansa 333 328 1.60
Alitalia 184 204 ?11.30
Sources: Ryanair’s investor relationships. Retrieved August 27, 2007, from http://www.ryanair.com/site/about/invest/
docs/present/quarter4_2007.pdf
Assessing the Profitability Potential of a Strategy 55
In 1994, the company had decided to ?y only Boeing 737 aircraft, taking
delivery of its ?rst eight Boeing 737s that year to replace its ?eet of BAC 1–11
jets. By 2007, the ?eet had grown to over 120 737–800s, giving Ryanair the
youngest ?eet of any airline. The list price of a 737 in 2007 ranged from $50–85
million depending on the options, with each plane estimated to have a lifespan
of over 20 years. In 2004, a typical Ryanair ?ight lasted over an hour (1.2 h)
and covered about 491 miles. By 2005, partly because of the frequent ?ights
and short distances ?own, more passengers ?ew on Ryanair per year than on
any other European airline. In-?ight, three or four ?ight attendants sold drinks,
snacks, and other merchandise that together accounted for 5–7% of Ryanair’s
revenues.
Whenever possible, it served only secondary airports such as Beauvais in the
Paris region and Charleroi near Brussels. When it sought airports in cities that
had been declining, it usually received concessions and cash in exchange for
promotion and injection of “life” into the area. Passenger traf?c on a route
usually skyrocketed after Ryanair initiated service on the route, leading to what
has come to be called the “Ryanair effect” in Europe. At these secondary air-
ports, gate fees per passenger could be as low as $3 below rates at the more
prestigious but more congested airports.
The spaces behind seat-back trays and on headrests were sold to advertisers.
For a fee of 150,000–200,000 per year, an advertiser could splash the exterior
of a Ryanair plane with its logo. In-?ight magazines were made up entirely of
advertising so that while other in-?ight magazines struggled to break even,
Ryanair’s were pro?table. The company also collected fees from car rental and
hotel referrals. All ancillary services accounted for 13.9% of operating revenues
in 2004.
Employees were paid according to their productivity. For example, ?ight
attendants received a ?xed salary, a payment based on how many sectors or
?ights they ?ew, and a commission on in-?ight sales. On average, Ryanair ?ight
attendants earned more money than their counterparts at other airlines. Their
pilots earned a ?xed salary and a payment per sector ?own. These pilots earned
10% more than the typical pilot in the industry and ?ew 50% more sectors.
Unlike other European airlines, Ryanair did not pay employees based on the
length of their tenure with the airline. Only engineers and maintenance personal
were paid on the basis of their quali?cations. For the year ended March 31,
2004, Ryanair’s average pay of 50,582 looked good compared to 42,077 for
Iberia, 41,384 for easyJet, 41,377 for Lufthansa, 38,329 for Aer Lingus,
and 37,602 for British Airways.
14
Ryanair also had its share of criticism ranging from false advertising to anti-
unionism to not treating customers well.
An AVAC Analysis of Ryanair’s Strategy in 2007
We explore each of the components of the AVAC analysis separately.
Activities
The question here is, is Ryanair performing the right activities? There are two
parts to this component. In the ?rst part, we answer the questions: what is the
set of activities that constitutes the ?rm’s strategy? Does Ryanair have the
56 Introduction
resources and capabilities to perform the activities? Here is Ryanair’s set of
activities. The ?rm:
1 Operated largely out of secondary airports, preemptively acquiring as many
gates and landing slots as possible at each airport.
2 Operated only Boeing 737s.
3 Instituted onboard sales and advertising.
4 Built and tried to maintain a low-cost culture.
5 Established relationships and links with local airport authorities, hotels,
transportation, and events.
Do the Activities Contribute to Low Cost, Differentiation, etc?
By operating largely out of secondary airports, Ryanair reduced takeoff and
landing delays, thereby reducing its turnaround time (and increasing aircraft
utilization). It was also keeping its landing and gate fees low, accessing a low-
cost labor force for its operations, and had an opportunity preemptively to
acquire gates, landing slots, and other access rights when it moved into these
airports and had little or no competition. It also had an opportunity to expand
its activities to increase the number of passengers that it carried. Because some
of these airports were in economically depressed zones, local of?cials were
eager to work with Ryanair to bring in business in an effort to jumpstart their
local economies. Effectively, moving into secondary airports was consistent
with keeping its costs low so that it could pass on costs savings to customers in
the form of low prices. It was also consistent with offering frequent ?ights, and
attracting and keeping many valuable customers—differentiation.
By advertising to its passengers, its cost of advertising was lower than those
of media such as TV and newspapers, which had to pay for programming or
news to attract eyeballs. Ryanair did not have to pay for its eyeballs—that is,
the number of people that were likely to see an advertisement; the eyeballs paid
Ryanair. Thus, Ryanair could pass on some of its costs savings to advertisers in
the form of lower advertising prices. It could also pass on some of the costs
savings from advertising to passengers in the form of lower ticket prices. Like
Southwest Airlines, whose business model Ryanair had copied, Ryanair did not
offer free meals on its ?ights; but Ryanair went even further: it sold the snacks
that Southwest Airlines gave away. It also sold duty-free goods. By selling its
own tickets using its own website, the airline avoided the fees charged by travel
agents and reservation systems. Direct contact with customers also helped the
company build relationships with customers that could not be built through
travel agents. Moreover, Ryanair was effectively doing what travel agents
would do by providing links to hotels, car rental, and local events. By ?ying
only Boeing 737s, the company potentially kept its maintenance costs low and
reduced downtime since any mechanic could repair any plane and Ryanair did
not have to track many different types of spare part for different planes. This
also meant that any of the company’s 737-certi?ed pilots could ?y any of its
planes, and any plane could pull up to any gate. Effectively, ?ying only 737s not
only reduced costs but also reduced turnaround time, thereby increasing the
utilization of planes. These activities were consistent with attracting and keep-
ing many valuable customers. By offering no baggage transfers, the ?rm kept its
Assessing the Profitability Potential of a Strategy 57
turnaround time low since its planes could take off without waiting for luggage
from other planes.
Table 2.5 shows some estimates of the contribution of some activities to cost
reductions, and revenues. For example, the company’s activities saved at least
$193.5 + 85 + 212.5 + 127.5 + 87.75+ 209 million = $915.25 million, plus
$34,000 per pilot. It also had extra revenues of $352 million from non-airline
operations.
Table 2.5 Back-of-the-envelope Estimates of the Contribution of Some Activities to Low
Cost and Revenues
Activity Cost savings or extra revenues in
2007
Source of data used in estimate,
and assumptions made
Used its own booking-website for
its reservations
Cost savings of 96% × $2.24B ×
9% = $193.5M
Did 96% of own booking, agents
charged 9% of ticket sales. In
2007 revenues were $2.24B
Did not use Sabre and Apollo
reservation systems
Cost savings of 42.5M × $2 =
$85M
Saved on $2 per passenger
reservation fee. In 2007, there
were 42.5 million passengers
Offered no free meals Cost savings of 42.5M × $5 =
$212.5M
There were 42.5 million
passengers in 2007. Assume that
each meal cost airline $5
Operated out of secondary
airports
Cost savings of 42.5M × $3 =
$127.5M
Gate fees were $3 per
passenger lower at secondary
airports than at primary
airports
Kept turnaround time low (from
operating out of secondary
airports, using only one type of
airplane, having Ryanair culture,
etc., etc.)
Ryanair’s planes were utilized
122/97 = 1.26 as much as the
average competitor’s planes.
Thus, Ryanair needed 26 fewer
planes than the average
competitor.
Cost savings = $67.5M × 26/20
= $87.75M
Turnaround time was 25
minutes, half the average turn
time of competitors. Average
Ryanair flight lasted 1.2 hours.
Therefore flight time for
average competitor was 72 + 50
= 122 while for Ryanair, the
number was 72 + 25 = 97.
Planes cost $50–$85M and
lasted 20 years
Had pilots working 50% more but
earning only 10% more
Costs savings of 50/
(100*1.1)*$0.075 =$0.034M per
pilot
Assume that an average pilot’s
salary was $75,000 in 2007
Splashed advertiser’s logo on
plane
Extra revenues of $175,000 ×
120 = $21M
150,000–200,000 per year to
advertise on the outside of a
plane. 120 planes in 2007
Offered ancillary goods and
services
Extra revenues of $2.24B ×
0.139 = $311.4M
All ancillary services accounted
for 13.9% of operating revenues
in 2004. Assume that same
percentage held for 2007
No baggage transfers to or from
other airlines, more dedicated
employees, etc. resulting in the
least number of bags lost
Cost savings from not losing
bags
200*(25.19–0.6)*42.5M/1,000
= $209M
Assume that, in 2007, each piece
of baggage lost cost an airline
$200.
Average number of bags lost by
other airlines =15.19 bags per
1,000 passengers. But Ryanair
lost only 0.6
58 Introduction
Do Activities Contribute to Improving Its Position vis-à-vis its
Coopetitors?
By ?ying only 737s and ramping up its activities to a point where it bought very
many of these planes, Ryanair was increasing its bargaining power over Boeing.
It was also making itself more dependent on just one aircraft maker, setting
itself up for opportunistic behavior from the maker. It often cooperated with
local authorities in order to start up operations in a secondary airport. Local
authorities in southern Europe wanted tourists and jobs for their towns while
Ryanair wanted the airports to bring in the tourists. Both parties worked to
start operations at these local airports. Contrast this with starting operations at
the larger and busier airports where local authorities were not as hungry for
more traf?c. Ryanair also worked with local hotels and transporters to provide
them with tourists.
Do Activities Take Advantage of Industry Value Drivers?
Recall that industry value drivers are those characteristics of an industry that
stand to have the most impact on cost, differentiation, and other drivers of
pro?ts such as the number of customers. Thus, a ?rm that takes advantage of
these factors in formulating and executing its strategy stands to have the most
impact on customer value and the pro?ts that the ?rm can make. In the airline
industry, utilization of airplanes is an industry value driver. Utilization here
includes two things: (1) higher load factor (?lling up planes with passengers) so
that planes do not ?y around empty, and (2) reducing the turnaround time of
the plane so that planes are busy ?ying people to their destinations instead of
sitting around at terminals or under repair. The idea here is that airplanes make
money when ?ying full, not while sitting on the ground or ?ying empty. Many
of the activities that Ryanair performed increased utilization. For example, as
we pointed out earlier, operating out of secondary airports reduced the turn-
around time since planes did not have to queue for takeoff or landing.
The ?rm’s other source of revenues was advertising; and in advertising a
critical industry value driver was the number of eyeballs. Firms with advertising
business models spent lots of money generating eyeballs. For example, TV sta-
tions spent money on programming while online advertisers such as Google
spent on expensive R&D to develop search engines and other software to
attract viewers. An airline had a captive audience in passengers and it cost the
airline relatively little or nothing to advertise to them. By advertising to its
passengers, Ryanair was taking advantage of the eyeballs that it already had.
Because it did not have to spend on acquiring these eyeballs, Ryanair could
charge less for some of its tickets than competing airlines that did not advertise.
Of course, there was the chance that the airline lost some passengers who did
not like advertising.
Finally, the cost of labor in an airline constituted a high percentage of its
overall cost. By building a workforce that worked 150% more hours for only
110% more in pay, Ryanair was taking advantage of this driver of costs to keep
its overall costs low.
Assessing the Profitability Potential of a Strategy 59
Do Activities Build or Translate Distinctive Resources/Capabilities into
Unique Positions?
A key distinctive resource for Ryanair was its network of secondary airports
and the associated gates, landing slots, and contracts with local authorities,
hotels, and transportation providers. By moving into these airports (sometimes
being the ?rst), securing the gates and agreements, and ramping up its activities
there, Ryanair was able to build its network system. Each time that it occupied
one airport, it used it as a starting point to move to adjoining locations, offering
low-cost frequent ?ights; and each time it took up gates and landing slots, or
built relationships with local authorities, it was preempting some potential new
entrants to these airports. Its low-cost culture, airplanes, relationships with
local authorities, and its brand also contributed to keeping its costs low or
differentiated it. These are important resources/capabilities.
Are the Activities Comprehensive and Parsimonious?
One signal that Ryanair’s activities were parsimonious was the fact that its
employees worked 150% more for only 110% the pay of the average European
airline.
Value
Ryanair had many types of customers. These included ?ying passengers, advert-
isers, hotels, car rental companies, and local authorities of the secondary
airports in which the company operated. To passengers, the company offered
low-cost, frequent ?ights, access to hotels, cars, apartments, and other com-
ponents of a vacation package. To what extent was the value that Ryanair
offered its customers unique compared to that offered by its competitors? It
offered very low prices compared to other European airlines. It also offered
advertising, onboard sales, links to hotels, apartments and ground transporta-
tion that most of its competitors did not. Passengers were valuable in that, in
addition to paying for the ?ight, they also constituted “eyeballs” that the ?rm
could use as “value” to advertisers. (We cannot tell from the case whether or
not they had a high willingness to pay.) The eyeballs came cheap compared to
what TV and other media had to spend for eyeballs. In fact, most of Ryanair’s
eyeballs paid to be on the plane. In the year 2008, Ryanair ?ew over 42 million
passengers, all of them potential eyeballs for advertising revenues. In addition
to paying for seats and providing eyeballs, passengers also provided another
source of revenues: they purchased snacks and duty-free goods. To advertisers,
the company offered eyeballs not only to its own passengers but potentially
those of its competitors, who could see the advertisements on the outside of
Ryanair’s airplanes. To hotels, car rental companies, and local authorities of the
secondary airports, Ryanair provided traf?c. As far as white spaces were con-
cerned, there were many other cities in Europe and the rest of the world with
secondary airports into which Ryanair could ?y. There could also be white
spaces in what it could advertise or sell to passengers.
60 Introduction
Appropriability
Did Ryanair make money from the value that it created? Yes. From 2000–8, the
company recorded after-tax pro?t margins of 18–28%, making Ryanair one of
the most pro?table companies in Europe.
Does Ryanair Have a Superior Position vis-à-vis Coopetitors?
European airlines did not have a superior position vis-à-vis suppliers and cus-
tomers but, as we saw above, Ryanair managed to position itself well relative to
its suppliers and customers than its rivals. Moreover, switching costs were low
for customers. Ryanair may have extracted low prices for the airplanes that it
bought from Boeing, given the relatively large number of 737s that it pur-
chased, but we are not told whether this is the case. Because Ryanair’s costs
were very low compared to those of its rivals, and it also offered advertising and
sales, the effects of rivalry and substitutes on it was not as large as it was on
competitors.
Did Ryanair Exploit its Position vis-à-vis Coopetitors?
Like many airlines, Ryanair practiced price discrimination, charging different
prices for different types of customer. This got the company closer to the aver-
age reservation price of each group of customers. Additionally, Ryanair also
charged for extra baggage. Some of the company’s very low prices were meant
to attract passengers who would otherwise not travel but who then contributed
to the number of eyeballs, buying products in the plane, staying in hotels,
renting cars, or attending local events, thereby contributing to its revenues.
Did Ryanair Have the Right Resources/Capabilities, Including
Complementary Assets?
Ryanair had the resources, including its brand, low-cost culture, and the net-
work of secondary airports that it built (see below). It also had the comple-
mentary assets to pro?t from its advertising and on-board sales activities, both
of them new game activities since they had not been offered in the European
airline industry before. It had the eyeballs and passengers to whom sales could
be made.
Imitability
Although it was easy for some airlines to imitate some of what Ryanair did, it
was dif?cult to imitate the whole system of activities that it performed. Its
system of activities—operating out of a network of secondary airports, advertis-
ing, onboard sales, offering no meals, a culture that made people work 50%
more than their competitors while paid only 10% more, operating only Boeing
737s, offering no baggage transfers, with their own website for ticketing and
hotel and car rental booking—was dif?cult to replicate. Existing rivals or
potential new entrants might have been able to replicate some of these activities
but replicating the whole system was dif?cult. Moreover, Ryanair was up the
Assessing the Profitability Potential of a Strategy 61
learning curve for most of these activities and was already carrying many pas-
sengers. Moreover, resources such as the network of secondary airports with
associated landing slots and gates were scarce valuable resources and once
taken by an airline such as Ryanair, were gone.
Existing rivals such as Air France or Lufthansa may also have been handi-
capped by prior commitments. For example, switching to operate only out of
secondary airports would have meant having to give up their existing space,
landing slots, and gates at existing primary airports. Doing so may have meant
reneging on existing contracts with the local municipalities that owned or oper-
ated the airports, unions, and some employees. Switching to ?ying only one
type of plane such as the Boeing 737 or the Airbus 320 may have meant having
to get rid of all the Boeing 777s, 757s, 767s, 747s, A330s, A300s, A340s, and
other airplanes that the airline had been ?ying for decades. Contracts with
suppliers, pilots, and unions may have made such a switch dif?cult. Getting
employees to work 50% more than they had in the past and for only 10% more
would be very dif?cult in some European countries. Of course, imitability was
dif?cult but not impossible. One thing that a ?rm such as Ryanair, which did
more than one thing, had to watch out for was so-called category killers. For
example, some airlines may have decided to take the advertising on airplanes
even further, stealing customers from Ryanair.
Substitutability and Complementarity
Cars and trains were good substitutes for those travelers who had time as far as
air transportation was concerned. The lower that Ryanair’s prices were, the less
of a problem that these substitutes may have been. Advertisers could also adver-
tise elsewhere other than on airplanes; but the more eyeballs and the more
effective the advertising was with Ryanair, the more that advertisers were likely
to stay with Ryanair rather than seek substitutes. Passengers could buy snacks
and goods elsewhere. Important complements in air travel included security and
air traf?c control over which Ryanair had little control. Business was affected
by government security-related decisions. For example, security concerns often
cut into turnaround time.
By having a low-cost structure that allowed it to keep its prices low, offering
frequent ?ights, and providing connections to hotels, cars, and local events,
Ryanair was effectively reducing the power of substitutes, since travelers were
more likely to ?nd it more convenient and inexpensive ?ying Ryanair than
driving or taking a train.
Change: The New Game Factors
We ?rst explore the change with which the ?rm was dealing. Change came
from two major sources: from its environment and from its new game activ-
ities. The EU deregulated the airline industry in Europe, and Ryanair took
advantage of the changes to pursue new game activities that allowed it to create
and appropriate value. When the EU deregulated air travel Ryanair already had
the beginnings of a low-cost culture in place as well as an operating base in
Dublin. These were strengths that would continue to be strengths in the new
game. It was not bound by major contracts that could have become handicaps.
62 Introduction
In 2008, the biggest threat that Ryanair faced was the rapidly increasing price
of oil.
Take Advantage of the New Ways of Creating and Capturing New
Value Generated by Change?
Yes. In deregulating the airline industry in Europe, the EU created an opportun-
ity for Ryanair to keep offering low-cost service to customers in more of
Europe. The company took advantage of the deregulation to extend its activ-
ities to a lot more of the EU. The ?rm was able to build on its low-cost culture
and extend its network of secondary airports beyond the UK and Ireland. Its
low-cost system of activities resulted in a low-cost structure that allowed the
?rm to pass on some of its costs savings to customers in the form of low prices.
Many of the ?rm’s new activities to exploit these changes built on its prechange
system of activities and product-market position. Deregulation of the industry
increased the competitive forces in it; but Ryanair’s system of activities allowed
it to dampen the repressive forces and reinforce the favorable ones. Effectively,
Ryanair took advantage of the new ways of creating and appropriating value
created by deregulation and Ryanair’s new game activities. Its new game activ-
ities enabled Ryanair better to create value and position itself rather than its
rivals to appropriate it.
The other change with which Ryanair had to deal was the Internet. It too
reinforced Ryanair’s position vis-à-vis customers. Ryanair had performed most
of its own bookings rather than go through travel agents. The advent of the
Internet enabled the ?rm to create a website that allowed customers to book
their own ?ights, ?nalizing the bypassing of travel agents.
Take Advantage of Opportunities Generated by Change to Build New
Resources or Translate Existing Ones in New Ways?
Yes. Ryanair took advantage of opportunities generated by change to build new
resources and translate new ones into unique value. It was fast to take up space
at airports in southern Europe. Its resulting network of secondary airports and
low-cost cultures built on its prechange culture and hubs in Ireland and Eng-
land. It also built valuable relationships with authorities at airports. More
importantly, the Internet allowed the ?rm to build its brand with customers via
its website.
Does the Firm Take Advantage of First-mover’s Advantages and
Disadvantages, and Competitors’ Handicaps?
Ryanair took advantage of ?rst-mover advantages by quickly ramping up its
activities at secondary airports and taking up gates and landing slots at the
airports. It quickly built up a network of secondary airports in each of which it
had a large number of gates, landing slots, and relationships with local of?cials.
By preemptively taking up these resources, Ryanair was also raising barriers to
entry for potential new entrants into its secondary airports. By establishing
good relationships with authorities at secondary airports, it was preemptively
acquiring a valuable scarce resource. By quickly setting up a website to reach its
Assessing the Profitability Potential of a Strategy 63
customers, it was preemptively taking up customer perceptual space. In the
process, it built a reputation and brand as a low-cost carrier. By being the ?rst to
accumulate scarce resources such as gates and landing slots at the secondary
airports that it used, to build relationships with local of?cials, and to establish a
brand name reputation as the low-cost airline for its routes, Ryanair was effect-
ively taking advantage of ?rst-mover advantages.
Does the Firm Anticipate and Respond to Coopetitors’ Reactions to its
Actions?
One can argue that, in preemptively taking up gates and landing slots at air-
ports, Ryanair was anticipating its competitors’ likely reaction. Competitors
would like to get into the same airports from which it was operating but
Ryanair responded to this anticipated entry by preemptively capturing many of
the valuable scarce resources that were critical to operating pro?tably out of the
secondary airports.
Identify and Take Advantage of Opportunities and Threats of
Environment? Are There no Better Alternatives?
The ?rm took advantage of opportunities from its environment when it
expanded its activities following EU deregulation of the airline industry. It was
also one of the ?rst to take advantage of the Internet to build a website to
enhance its decision to undertake its own reservations. Opportunities also
existed for low-cost transatlantic ?ights and short-hall ?ights in the former
eastern European economies.
The ?rm had alternative airline market segments, but these were not very
attractive ones for Ryanair. It could have tried to compete head-on with the
major European airlines such as Air France—a mistake. It could have also
invested its money in other ?rms, diversi?ed into other businesses; but the fact
that it had one of the highest pro?t rates of any major European company
suggested that it was not likely to have done much better investing in these other
companies that were not as pro?table as Ryanair.
In 2008, the price of oil hit many airlines hard. Traditionally, the cost of fuel
was second only to employee wages in the hierarchy of airline costs; but in
2008, the price of oil had become the biggest cost item for many airlines. The
price of oil was one of those macroeconomic threats over which airlines had
little control. Although many airlines stood to lose money as a result of the high
oil prices, those with good strategies stood to lose less money than those with-
out good strategies. The case says very little about other future changes. It was
not clear what the EU was likely to do about air traf?c in the future; nor is it
clear about what Ryanair’s next steps or its competitors’ moves might be.
Key Takeaways
•
Although pro?tability numbers can tell us something about the success of
an underpinning strategy, they say very little about what drives the num-
bers. They say little about the value creation and appropriation that under-
pin the numbers. Without an understanding of the underpinning strategy
64 Introduction
and its pro?tability potential, it is dif?cult for managers to know how to
improve or maintain present performance. Strategy frameworks can be used
to analyze ?rm strategies and understand their pro?tability potential.
•
The AVAC framework can be used not only to explore the pro?tability
potential of a ?rm’s strategy and make recommendations on what the ?rm
could do to improve the strategy and its performance, but also to explore
the pro?tability potential of business models, business units, products,
technologies, brands, market segments, acquisitions, investment opportun-
ities, partnerships such as alliances, an R&D group, corporate strategies,
and more (Table 2.1).
•
Each of the four components explores critical questions that are meant to
bring out the extent to which the pro?tability potential of a strategy has
been reached and what can be done to improve or sustain pro?tability.
•
Activities. The main question here is whether a ?rm is performing the right
activities—activities that contribute to value creation and appropriation.
This larger question is explored via the following subquestions. Do the
activities:

Contribute to low cost, differentiation, number and type of customers,
better pricing, better sources of revenues?

Contribute to improving a ?rm’s position vis-à-vis coopetitors?

Take advantage of industry value drivers?

Contribute to building new distinctive resources/capabilities or trans-
late existing ones into unique value and positions?

Conform to parsimony and comprehensiveness criteria?
•
Value. The primary question here is whether the value created is preferred
by customers over competitor’s offerings: how unique is the value created,
as perceived by customers, compared to that from competitors? This ques-
tion is explored via the following subquestions:

Do customers perceive the value created by the strategy as unique?

Do many customers perceive this value?

Are these customers precious (valuable)? What are the market segments
and sources of revenues?

Are there any white spaces nearby?
•
Appropriability. The primary question here is whether the ?rm makes
money from the value created? (How much money and why?) This question
is answered using the following more detailed questions:

Does the ?rm have a superior position vis-à-vis its coopetitors (buyers,
suppliers, rivals, partners, etc.)?

Does the ?rm pro?t from customer bene?ts and its position vis-à-vis
coopetitors?

Is there something about the ?rm and its set of activities and resources
that makes it dif?cult for competitors to imitate its strategy? Is there
something about competitors that impedes them from imitating the
?rm?

Is the value nonsubstitutable? If there are complements, are they being
strategically used?
Assessing the Profitability Potential of a Strategy 65
•
Change. The overarching question here is whether the strategy takes advan-
tage of change (present or future). This larger question is explored via the
following questions: does or will the ?rm take advantage of:

The new ways of creating and appropriating value generated by change?

New ways of building new distinctive resources or translating existing
ones into unique value?

First-mover’s advantages and disadvantages, and competitors’
handicaps?

Coopetitors’ reactions to its actions?

Opportunities and threats of environment? Are there no better
alternatives?
•
The AVAC framework is more comprehensive than existing models. Com-
pared to Porter’s Five Forces, for example, it includes the role of (1) change
(the new game factor), (2) resources/capabilities/competences (including
complementary assets), (3) industry value drivers, (4) pricing, (5) the num-
ber and quality of customers, and (6) market segments and sources of
revenue.
•
AVAC Applications. It:

Serves as an organizing platform for displaying information and data in
a common business language that managers can use as a starting point
for exploring strategic management questions.

Can be used to compare different strategy outcomes.

Constitutes a parsimonious and comprehensive checklist.

Can be used as a platform for business model or strategy planning.
•
More than anything else, the AVAC is an organizing framework for display-
ing information in a common business language that managers can use as a
starting point for exploring strategic management questions to help them
take decisions.
66 Introduction
The Long Tail and New Games
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Understand the long tail concept.
•
Understand that the long tail is not limited to the Internet and products.
•
Explore how a ?rm can make money from a long tail.
•
Begin to understand how all members of the value system—aggregators,
producers; and suppliers—can bene?t from the long tail.
•
Begin to understand the strategic impact of the long tail.
Introduction
Every year, hundreds of movies are released, but only a few of them become box
of?ce hits or blockbusters. Each of the hits accounts for hundreds of millions of
dollars in revenues while many of the nonhits each account for a lot less. Every
year, hundreds of thousands of books are published, but only a select few make
the best-seller list. In the music industry, only a few songs go on to become hits.
In all three cases, a few “blockbuster” products or best-sellers are each respon-
sible for millions of dollars in sales while the great majority of the products each
account for only thousands or fewer dollars. This behavior can be captured by
the graph of Figure 3.1 in which the vertical axis represents the sales while the
horizontal axis captures the products (movies, books, songs) that bring in the
revenues. As one progresses along the horizontal axis away from the origin to
the right, sales start out high but tail off as one moves further away from the
origin. Effectively, the graph has a long tail to the right and a short head to the
left. This phenomenon in which a few get most of the action while many get
very little is not limited to product sales. In the Internet, a few blogs each get
thousands of visitors while thousands of other blogs get a few hits each. In a
book such as this one, a few words like “the” are used frequently while many
others such as “consequently” are used less frequently. In some countries, 80%
of the wealth is owned by less than 10% of the population.
Although the long tail phenomenon has been described by statisticians using
the graph of Figure 3.1 and given names such as Pareto Law, Pareto Principle,
80/20 rule, heavy tail, power-law tail, Pareto tails, and so on, it was Chris
Anderson, Editor-in-Chief of Wired magazine and former correspondent for
The Economist, who used the term long tail speci?cally to refer to this often-
neglected group of products and developed the argument for why, in the face of
Chapter 3
the Internet, ?rms can make money by selling products that had languished
in the long tail.
1
He argued that if a store or distribution channel is large
enough, the many products in the long tail can jointly make up a market share
that is as high as, if not higher than, that of the relatively fewer hits and block-
busters in the short head.
2
Thus, by focusing on the long tail of the distribution
where there are many products, each of which sells a few units, one can bring in
as much in revenues (if not more) as a ?rm that focuses on a few blockbuster
products, by taking advantage of the Internet’s properties such as its near in?n-
ite shelf space. eBay’s business model was originally based largely on products
that are in the long tail—that is, many one-of-a-kind products such as antiques
and collectibles, few units of which are sold; but by selling very many such
articles, the ?rm was able to bring in lots of revenues. Although Amazon sells
many best-seller books, it also carries very many titles each of which sells a few
units. Since there are many such books (from the long tail), the total revenues
from selling the many books can be large enough to parallel the revenues from
the best-sellers. Many of Google’s advertisers are very small ?rms that ordinar-
ily would not advertise in an of?ine world. By aggregating the revenues from
these small but many customers, the company can make as much money as, if
not more than, it would make from a few big customers. To understand why
and when the long tail may offer an opportunity for pro?table new game busi-
ness models, let us explore the rationale behind blockbuster products, the so-
called hits that form the short head, and the laggards that form the tail of the
long-tail distribution.
Figure 3.1 A Long Tail Distribution.
68 Introduction
The Phenomenon
Rationale for the Long Tail of Products
The question is, why do some products become hits, bestsellers, or blockbusters
while others end up languishing in the long tail? How do we explain the shape
of the long tail distribution for products of Figure 3.1? There are three reasons
why a few products usually do very well, forming the short head of a distribu-
tion, while many products can languish in the long tail:
1 The high cost and scarcity of distribution channels and shelf space.
2 Customers’ cognitive limitations and dif?culties in making choices.
3 Customer heterogeneity, and the high cost of and dif?culties in meeting the
individual unique needs of all customers.
High Cost and Scarcity of Distribution Channels and Shelf Space
First, shelf space and distribution channels for many products are limited, espe-
cially in the of?ine world; that is, the cost of providing the space to display
products in an of?ine world is very high, and so are the inventory carrying costs
for distributors who decide to carry too many products. Thus, even if a pro-
ducer were to try to offer products that satisfy the unique needs of everyone,
there would not be enough space on shelves to display all such products at low
cost. There just isn’t enough room in stores or in distribution channels to hold
everything for everyone at affordable costs. Moreover, without access to every-
one, most producers would not be able to reach every customer to ?nd out what
their needs are so as to incorporate them in each customer’s product. Effect-
ively, shelf space and distribution channels are a scarce resource and a barrier to
entry for many products. The few products that have access to these scarce
resources have a good chance of becoming best-sellers or hits. Those products
that do not have access to the scarce sources are more likely to end up in the
long tail.
Customers’ Cognitive Limitations and Difficulties in Making Choices
Even if there were enough shelf space to carry all the products that satisfy all
individual needs, most customers would have a dif?cult time choosing from the
huge variety. Given human cognitive limitations, it can be a frustrating experi-
ence choosing between ?ve similar products, let alone hundreds or thousands.
Think about how dif?cult it can be choosing between the cars that you can
afford. Because of this cognitive limitation of many customers, some of them
end up buying the mass-produced and mass-marketed products that may not be
what they really need.
Customer Heterogeneity, and the Difficulties and High Cost of Meeting
Individual Unique Needs
No two people have identical tastes (with the exception of some identical
twins). Thus, it would be nice if each product were custom-made to meet the
The Long Tail and New Games 69
unique needs of each individual; but doing so would be exorbitantly expensive
for some products. Imagine how much it would cost if a pharmaceutical com-
pany had to develop and produce a drug for each patient since each patient’s
physiology differs from that of other patients. Thus, most ?rms would rather
mass-produce one product and mass-market it to as many customers as pos-
sible. Doing so enables them to enjoy the bene?ts of economies of scale that
usually come from specialization in designing, producing, marketing, promot-
ing, and selling one product for many customers. If the one product that is
mass-produced and marketed wins, it can become a hit.
For these three reasons, a limited number of products are produced and mass
marketed, and some go on to occupy the limited shelf space and distribution
channels. Some of these products gain wide acceptance and end up in the short
head of the distribution while others are relegated to the long tail.
Then Comes the Internet
Information technology (IT) innovations have changed some of the reasons why
products in the short head do so much better than those in the long tail. This
change potentially alters the long tail distribution. How? Because of the tre-
mendous amount of improvements in the cost-performance of computer hard-
ware, software, and the Internet, websites can represent shelf space for many
products. Thus, a bookstore or any other retailer can have millions of items on
display on its website rather than the thousands that are possible in an of?ine
world. Digital products such as music and movies can also be distributed elec-
tronically. Additionally, search engines, online reviews, online community
chats, software that makes suggestions using buyers’ past purchases, and blogs
can help consumers choose from the many available choices. Moreover, because
IT gives more producers and customers more low-cost access to each other,
producers have an opportunity to ?nd out more about customers and work
with them to offer products that more closely match individual needs. Because
of the low cost of interactions, ?rms can afford to sell to very small customers to
whom they would ordinarily not pay attention. That is why, for example,
Google could afford to sell advertising to many small advertisers. It developed
software that many of these advertisers could use to “interact” with the com-
pany. Firms and their customers also have more tools that they can use for
lower-cost customization of products.
Effectively, the Internet’s and other IT innovation’s properties—low-cost
shelf space and distribution channel, tools for making better purchase choices,
and a lower-cost tool for producers better to meet customer needs—have miti-
gated some of the reasons why some products were relegated to the long tail.
Products that may never have found themselves on of?ine shelves can now ?nd
their way onto electronic shelves. For example, rare books that were not in
demand enough to be put on shelf space can now be listed on an online shop.
Available software also helps consumers choose products that better meet their
individual tastes from the many available products. Thus, products that would
ordinarily have languished in the long tail may ?nd their way to people with
diverse tastes who want them. The Internet not only extends the tail, it thickens
it (Figure 3.2).
3
70 Introduction
Who Profits from the Long Tail?
The phenomenon of the long tail tells us that money can be made from the long
tail. However, it does not say who is more likely to make that money and why.
After all, not all the ?rms that can aggregate old books or movies and sell can
make money or have a competitive advantage in doing so. A ?rm’s ability to
pro?t from the long tail depends on (1) the industry in which it competes
(industry factors), and (2) the ?rm’s ability to create and appropriate value in
the markets in which it competes in the industry (?rm-speci?c factors).
Industry Factors
A ?rm’s ability to pro?t from the long tail is a function of its industry—of the
competitive forces that impinge on industry ?rms and determine average pro?t-
ability for industry ?rms. These forces depend on, among other factors, the
location of the industry along the value system for the products or services in
the long tail (Figure 3.2). There are at least three categories of ?rms in this value
system that can take advantage of the long tail: distributors or so-called
aggregators, the producers of the products, and the suppliers to producers
(Figure 3.3).
Figure 3.2 Impact of the Internet on a Long Tail Distribution.
Figure 3.3 Value System of Long Tail Potential Coopetitors.
The Long Tail and New Games 71
Distributors and Aggregators
Firms such as Amazon.com and Wal-Mart that buy books, movies, DVDs, etc.
and sell them over the Internet stand to bene?t from the long tail since they can
reach out to the long tail of nonbest-seller books, nonhit music DVDs, and
nonblockbuster movies, and sell them to their customers by taking advantage of
the low-cost almost-limitless shelf space of the Internet, better interaction with
customers, and lower-cost information technologies for consumers to make
better choices. For example, when Blockbuster Inc. ?rst started renting movies
in its brick-and-mortar stores, 90% of the movies rented from them were new
releases;
4
but when Net?ix ?rst started using the Internet to rent out movies,
70% were new releases while 30% were back catalog. According to Chris
Anderson, 25% of Amazon’s book sales are from outside its website’s top
100,000 best-sellers, about 3.6 million of them.
5
However, as we will see below, the same technologies that create these
opportunities for aggregators also create a threat of forward vertical integration
from producers (book publishers, record labels, movie ?rms, etc.). Moreover,
depending on the power of producers, they can also capture most of the value
created by aggregators.
Producers (Manufacturers)
Although the literature on the long tail so far has focused largely on how
aggregators can make money reselling what they bought from producers, pro-
ducers also stand to make money from the long tail if they are well-positioned
visa-vis their coopetitors and have the right strategies to boot. Every old book
that Amazon sells means some money for its publisher and author. Every classic
movie that Net?ix can rent means a royalty for its producers. Moreover,
makers of products or content can also use the Internet to sell their products
directly to end-customers or ?nd out what their customers want in the prod-
ucts. Dell used the Internet to sell more varieties (as perceived by customers) of
its build-to-order PCs directly to end-customers than it would have been able to
sell through distributors. If a product is digital, producers can deliver it directly
to consumers using the Internet. For example, consumers can download movies
directly from the movie maker’s site, bypassing aggregators such as Block-
buster and Net?ix. Customers can buy books directly from the publisher’s
site. Effectively, makers of content and other products can also pro?t from the
long tail.
However, the competitive advantage of some producers may be eroded. If
sales of products from the long tail are at the expense of blockbusters from the
short head, the makers of these blockbusters may lose sales. If content providers
and other producers bypass publishers and aggregators, the latter may lose
some of their competitive advantage.
Suppliers
If suppliers are well-positioned vis-à-vis producers, they can capture more of the
value that producers create in exploiting the long tail than they did prior to the
technological change. Suppliers, such as authors and musicians, who usually
72 Introduction
depend on publishers and record labels, respectively, can produce and sell their
products directly to customers, bypassing producers and aggregators.
Firm-specific Factors: Ability to Create and Appropriate
Value
How well a ?rm performs in its industry, relative to its competitors, is a func-
tion of ?rm-speci?c factors. It is a function of how well the ?rm is able to create
value and appropriate value. And as we saw in Chapter 2, it is a function of:
1 Whether the ?rm is performing the right set of activities—activities that
contribute to creating value, better positioning the ?rm vis-à-vis coopeti-
tors, and to the ?rm’s exploitation of the value and position.
2 The extent to which the value created is preferred by customers over value
from competitors.
3 The extent to which the ?rm makes money from the value created and its
position vis-à-vis coopetitors.
4 The extent to which the ?rm can take advantage of the innovation that is
changing the status quo of the long tail, and any future change.
Effectively, a ?rm’s ability to create and appropriate value in a long tail can be
explored using the AVAC analysis. We will return to this shortly with an
example.
Beyond the Internet: Some Long Tail Cases
Although we have limited our discussion of the long tail phenomenon to the
context of the Internet, the phenomenon exists in many other contexts. As the
following cases illustrate, there is an opportunity to take advantage of the long
tail in the face of many innovations—technological and nontechnological.
Botox and Cosmetic Surgery
Cosmetic surgery is the use of surgical or medical procedures to enhance the
appearance of a person. Until the introduction of Botox, cosmetic procedures
were performed by surgeons. In the USA, the best surgeons performed the most
surgeries and made the most money while the not-so-good surgeons and gener-
alist doctors made very little money from surgery. Thus, great surgeons were in
the short head while not-so-good surgeons and general practitioners were in the
long tail of the cosmetic surgery Pareto distribution. The FDA approval of
Botox in April 2002 for use in cosmetic procedures promised to change all of
that.
6
A Botox procedure involved injecting the substance into the wrinkle,
frowning line, or targeted area using a ?ne gauge needle. The procedure lasted a
few minutes, there was no surgery or anesthesia needed, and the patient could
return to work the same day. More importantly, any doctor could apply it—
that is, the procedure was not limited to surgeons. Thus, the not-so-good sur-
geons and general practitioners who were in the long tail of the cosmetic sur-
gery distribution could now earn more money from the cosmetic procedures
using Botox than they did before Botox.
The Long Tail and New Games 73
Cell Phones in Developing Countries
Before wireless cell phones, most villages and small towns in developing coun-
tries had little or no phone services. Only ?xed-line telephones were available
and because it was very costly to lay the wires (cabling) and exchanges to low
population centers, it was very uneconomical to offer phone services to rural
areas. (Government-mandated monopoly phone companies were also very
inef?cient.) Thus, many communities had no phone service. If a person in one of
these underserved areas wanted to make a phone call, he or she would go to a
small town and make the phone call there. Thus, the number of phone calls
made by people in cities was very large relative to that made by people from
villages or small towns. Effectively phone service for villagers was in the long
tail of each country’s phone system. Cell phone service changed all of that.
Because wireless phone services did not require wires, the cost of cabling was no
longer a large constraint. Moreover, government monopolies were eliminated
and competition was introduced in many countries. Suddenly, not only did
phone service in rural areas increase considerably, but that in cities also
increased. Thus, both the short head and long tail phone service increased.
Discount Retailing in Rural Areas
Before Wal-Mart moved into rural areas of the Southwestern USA, sales of most
products in rural areas were at the long tail of discount retailing. Most discount
retailing sales were at large discount stores built in large cities. Occasionally,
people from the rural areas would drive the long distance to cities to buy some
of what they needed or use catalogs from the likes of Sears to order products.
Wal-Mart’s strategy was to saturate contiguous small towns with small stores.
Thus, by aggregating the sales in many small stores, Wal-Mart was able to
generate the volumes that its competitors generated by building large stores in
big cities, and more. It also adopted the latest in information technology at the
time, built a ?rst-class logistics system, established the Wal-Mart low-cost cul-
ture, grew in size, and so on. Wal-Mart performed the right set of activities to
create value in rural areas and appropriate much of the value created.
Internet and Political Contributions in the USA
Prior to the Internet, most political contributions, especially those to presiden-
tial candidates, were made by a few in?uential donors who made large contri-
butions at fundraising dinners, dances, or other gatherings. Organizations such
as unions could also raise money for candidates using their mailing lists or
meetings. Many small donors who could have contributed were largely in the
long tail of donations since each of them donated little or nothing. The advent
of the Internet not only increased the amplitude of the tail but extended it, since
many more small donors made more contributions. By appealing to these small
donors, candidates such as would-be President Barack Obama, were able to
raise huge amounts of donations from ordinary Americans.
74 Introduction
Internet and User Innovation
For years now, Professor Eric von Hippel of the Massachusetts Institute of
Technology (MIT) has argued that users and suppliers can be as good a source
of product innovations as manufacturers of products. Each user, for example,
can make improvements to a product that other users and the manufacturer
have not or cannot. Technologies such as the Internet enable manufacturers to
aggregate these innovations and come up with a greatly improved product.
Microfinancing
In many developing countries, a few rich people or businesses get most of the
loans from banks, credit unions, and other major lenders. The large majority
has no access to ?nancing and when it does, interest rates are extremely high.
This large majority can be said to be in the long tail of loans. Very small poten-
tial lenders can also be said to be in the long tail of lenders too, since they do not
have enough money to lend to large borrowers. Micro?nancing is an innovation
that tackles these two long tails. It makes small loans available to poor people in
developing countries at reasonable interest rates in an attempt to enable them to
dig themselves out of poverty. When aggregated, these microloans can be large
enough for big lenders to enter the business. Also, small lenders can also get into
the business of lending since they are people who want small loans. Effectively,
we get more borrowers and more lenders borrowing and lending more money.
Organic Foods at the Long Tail of Foods
For a long time in developed countries, conventional foods (crops and animals)
have been at the short head of foods while organic foods have been at the long
tail. Organic crops are grown without using arti?cial fertilizers, conventional
pesticides, human waste, or sewage sludge, while organic animals are grown
without the use of growth hormones and routine use of antibiotics. Neither
food is processed with ionizing radiation or food additives, and in some coun-
tries, they cannot be genetically altered. Producers of organic foods emphasize
the conservation of soil and water as well as the use of renewable resources.
Because conventional foods did not have these constraints, and the bene?ts of
organic foods were not widely understood, most of the foods grown were con-
ventional. Availability of organic foods tended to be limited to what local farm-
ers could grow and sell in their local farmers’ market or cooperative. They did
not enjoy the economies of scale of conventional foods.
In 1978, Whole Foods Markets was founded to sell organic foods. It took
advantage of the growing awareness of the health and environmental bene?ts of
organic foods, and built many organic and natural foods stores in the USA.
Whole Foods and its competitors increased the share of organic foods in the
communities in which they built stores. Effectively, they increased the sales of
organic foods—the products that had languished in the long tail of groceries.
The Long Tail and New Games 75
Printing and the Written Word
Before printing, all works were handwritten and duplicating such works was
manual and therefore very expensive and time-consuming. Thus, only a select
few rich people or religious ?gures such as kings, monks, and priests had access
to written information. Ordinary people were in the long tail of the written
word since they had little or no access to it. The library helped people to the
written word; but it was the invention of the printing press that changed all
that. It made a lot of the written word available to the masses. Thus the amount
of learning from books by ordinary people, when added, may have rivaled or
surpassed that by kings, priests, and other well-placed people.
Radio and TV Broadcasting
Before radio and TV, news reception was available largely to people in cities
who were close enough to each other to spread it by word of mouth, or get it
from city theatres. Some of the news also spread via newspapers. Many villages
and small cities were in the long tail of news. TV and radio changed all that,
since people in these small villages and towns with TV could now have access to
news before it had become history.
Video Tape Recorders and Blockbuster
Although Net?ix’s use of the Internet to erode Blockbuster Inc.’s competitive
advantage is a classic example of a ?rm exploiting the long tail to displace an
incumbent, Blockbuster actually attained its own competitive advantage by
taking advantage of a new technology to exploit the long tail. The new technol-
ogy at the time was the home videotape recorder. Before home videotape
recorders, people had to go to theatres to see movies or hope that the movie
would appear on TV some day. (A select few people had their own projectors at
home.) Moreover, when a movie was released, it had a few days to prove itself.
After a few weeks in theatres, movies would be relegated to storage, unless a TV
station came calling.
Sony introduced the home videotape recorder (Betamax format) in 1975 and
in 1977 George Atkinson launched the ?rst video rental store called Video
Station, in Los Angeles.
7
Blockbuster Video was founded in 1985 to also rent
out videocassettes for people to play in the comfort of their own homes. Sud-
denly each person with a videotape recorder who lived near a video rental store
could turn his or her house into a theatre. The choices for each customer
increased considerably from the ten or so movies that were available in one’s
local theatre, to the thousands of movies that were available in a rental store.
The result was that sales of both the hits in the short head and the nonhits in the
long tail increased. How? First, people who wanted to watch hits after they
were out of theatres could now watch them again, at home, thereby increasing
the sales of hits. Second, nonhits that did not do well in theatres or never even
entered theatres could also be watched at home. This increased sales of the long
tail. Third, some movies, such as adult entertainment movies, that would never
have been allowed in some theatres, could now be played at home. This also
increased sales of stuff from the long tail. There were also some changes in the
76 Introduction
vertical chain. First, some moviemakers bypassed the theatres and went straight
to the video store or to end-customers. Many makers of adult movies could now
sell their movies directly to consumers with video recorders. At a later time,
DVDs, the Internet, and movies on demand also offered opportunities to
exploit long tail effects.
Effectively, for a ?rm to exploit the long tail effect, an innovation with one or
more of the following properties should impact the relevant value system. The
innovation should:
1 Reduce the high cost and scarcity of distribution channels and shelf space.
2 Help cognitively limited customers better make product choices.
3 Help ?rms better to meet the individual needs of heterogeneous cus-
tomers—lower cost of product being one of them.
Take the case of movies. Videotape recorders, DVDs, and computers became
individual screening theatres for movies, giving moviemakers the option to
bypass theatres. Consumers did not have to go to theaters to see a movie.
Effectively, the cost of distribution per movie seen by consumers dropped.
Movie-rental stores could help customers with some of their movie choices.
Moreover, customers could now watch movies that were not allowed in local
theatres. Thus, all three conditions were met. In the case of organic foods,
Whole Foods brought different organic foods to populations, thereby decreas-
ing the cost that each grower would have to bear if he or she had to take his or
her own produce to each individual market and sell it. By aggregating the
different products and providing information on them, Whole Foods also
helped consumers better to make their choices of organic products to buy.
Whole Foods was also meeting the individual needs of people who believed in
organic foods but could not ?nd enough of them in their local grocery stores.
The case of Wal-Mart in rural areas is similar to that of Whole Foods in organic
foods. In the case of cell phones in developing countries, the cost of distributing
phone services to villages using cell phones was a lot lower than that of distrib-
uting ?xed-line phone services. Elimination of monopolies gave consumers
choices that they never had before; but not too many choices. Cell phones also
satis?ed the needs of people who were on the move, people who did not want to
wait at a particular place to receive a phone call, or go there to make one.
Because Botox could be administered by any doctor, compared to cosmetic
surgery that could be performed only by surgeons, Botox-based cosmetic pro-
cedures were available to more people in more places. This effectively reduced
distribution costs of cosmetic procedures. Moreover, cosmetic procedures were
now available to people who hated going under the knife, being put under
anesthetic, or missing work for days. The product also created an opportunity
for general practitioners who wanted to be in the cosmetic medicine business
but could not become good surgeons.
Implications for Managers
So what does all of this mean to a manager? Before answering this question, let
us recap the short version of the long tail story so far. In many games, there
are likely to be a few hits, blockbusters, high frequency, or high amplitude
The Long Tail and New Games 77
occurrences that occupy the short head of a distribution—the so-called 20%
that get 80% of the action of the Pareto 20/80 rule. The nonhits, nonblock-
buster, low-amplitude, or low frequency occurrences occupy the long tail—the
so-called 80% that see only 20% of the action. Innovations usually shake up
the distribution, enabling more of the 20% to see more action. Thus, a ?rm that
exploits such an innovation, in creating and appropriating value, increases its
chances of pro?ting from the long tail. The question is, how can you, as a
manager, help your ?rm exploit the long tail effect? You can improve your
?rm’s chances by going through the following four steps:
1 Identify the long tail distributions in your markets or any markets that you
might like to attack, and their drivers.
2 Identify those new game ideas or innovations that can eliminate or take
advantage of those conditions that make some products languish in each
long tail.
3 Perform an AVAC analysis to determine which activities stand to give your
?rm a competitive advantage as it uses new games to create and appropriate
value in the long tail.
4 Decide on which activities to focus, and how to execute the strategy.
Identify the Long Tail Distributions in your Markets and their
Drivers
As a manager, the ?rst thing to do is identify the long tails (niches) in the
industries in which your ?rm competes or would like to compete. For each of
these niches, determine which of the three factors that drive long tail distribu-
tions are responsible for the long tails that you would like to exploit; that is,
determine the extent to which the high cost and scarcity of distribution
channels, dif?culties in customers making product choices, and dif?culties in
producers meeting the unique needs of heterogeneous customers are responsible
for products/services languishing in the long tail rather than thriving in the
short head.
Identify New Game Ideas or Innovations that Eliminate or
Take Advantage of Long Tail Factors
Next, scan within your ?rm and its environment for those new game ideas or
innovations that the ?rm can use to exploit the identi?ed long tail. That is,
search for those new game ideas or innovations that can overcome those factors
that have been identi?ed as being responsible for relegating products/services to
the long tail. The environment can be internal to the ?rm or external. Scanning
the internal environment involves combing through a ?rm’s resources/capabil-
ities to see if any of them can be used to pursue the sort of new game that can
overcome or take advantage of those factors that relegate products to the long
tail. Scanning the external environment entails searching for those new game
ideas, knowledge, and capabilities from coopetitors, other industries, and other
countries that can be used to exploit the long tail. Note that the new game ideas
and innovations can be technological or nontechnological.
78 Introduction
Perform an AVAC Analysis to Determine How Best to
Exploit Tail
Having determined what new game ideas or innovations can be used to exploit
the long tail, the next step is to perform a detailed AVAC analysis to understand
those activities that must be performed to create and appropriate value in
exploiting the long tail in such a way that your ?rm has a competitive advan-
tage. There are two kinds of analysis that can be performed here. If the ?rm
already offers some of the products in the long tail, the analysis is very similar to
the one that we perform next for iTunes Music Store, except that the change
component will be about the new game or innovation that was identi?ed in Step
2 above as the key to overcoming or taking advantage of the factors that rele-
gated products to the long tail. If a ?rm does not offer any products in the long
tail, the analysis starts with the type of value that the ?rm would like to offer
and how much of the value the ?rm would like to appropriate, given the new
game. From there, the ?rm can work backwards to the types of activities that it
needs to perform to create and appropriate the value needed to have a competi-
tive advantage in exploiting the long tail. Note that when a ?rm chooses which
activities to perform, it is also choosing the industry in the value system in
which it wants to locate.
Decide Which Activities to Focus on and How to Execute the
Strategy
From the AVAC analysis, the ?rm can zoom in on those activities that must be
reinforced or reversed to enable it to have a competitive advantage. It must then
hire the right people and build the right organizational structure and systems to
execute the strategy, given its environment.
Effectively, the long tail concept offers managers one way to identify white
space. You would recall that when a ?rm introduces a new product or service, it
usually chooses between entering a battle?eld with many existing competitors,
or pursuing white space where there is little or no existing competition. The
long tail concept offers one method for locating such white space. The short
head has the established providers of the hits who are likely to be strong com-
petitors. The long tail is where there is more room to enter, using the innov-
ation. Thus, by identifying the reasons why a long tail exists, one can innovate
around these reasons and improve one’s chances of having a competitive advan-
tage. Many disruptive technologies actually start by addressing long tail needs
before moving on to attack the hits of the short head.
Example 3.1
When a ?rm takes advantage of the Internet’s properties—low-cost shelf space
and distribution channel, a tool for making better purchase choices, and a
lower-cost tool for producers to meet customer needs better—to pursue a strat-
egy to pro?t from a long tail, the ?rm is playing a new game. It must cooperate
with its coopetitors to create value and compete with them to appropriate the
value in the face of the changes brought about by the Internet. As we detailed in
Chapter 2, an AVAC analysis can be used to not only explore the pro?tability
The Long Tail and New Games 79
potential of a strategy but also to develop a business plan or strategic plan. We
use the case of the iTunes Music Store (iTMS) to illustrate how the AVAC can be
used to explore what a ?rm is doing or should be doing to exploit a long tail.
The Case of iTunes Music Store in 2007
iTunes Music Store was launched on the Mac on April 28, 2003, and in seven
days, customers bought one million songs. In October 2003, a Windows ver-
sion of the software was launched and in just three and a half days, over one
million copies of it were downloaded and over one million songs purchased
through the store.
8
Later that year, Time Magazine declared iTunes Music Store
“the coolest invention of 2003.”
9
Music from the store could be played without
dif?culty only in iTunes or on Apple’s iPods. However the songs could be burnt
onto a CD and then played on another digital audio player. Apple also
developed its FairPlay digital rights management (DRM) system that protected
songs from piracy. When protected songs were purchased from the iTunes
Store, they were encoded with Fairplay which digitally prevented users from
playing the ?les on unauthorized computers. By December 2005, more than one
billion songs had been sold through iTunes Music Store. In 2007, iTunes had
two primary functions: It was used for organizing and playing music and video
?les, for interfacing with the iTunes Music Store (iTMS) to purchase digital
music and movie ?les, and for interfacing with the iPod to record and play
music and video.
10
Effectively, iTunes, in conjuction with iPod and iTunes
Music Stores enabled users to access millions of songs, make a choice of what to
purchase, backup songs onto DVDs and CDs, copy ?les to a digital audio
player, download and play podcasts, organize music into playlists, and so on.
Customers paid $0.99 for each song purchased in the iTunes store, of which
$0.65 went to the record label while distribution collected $0.25.
11
Apple was
therefore left with about 10 cents. Question: to what extent was Apple exploit-
ing the long tail effect?
An Analysis of Apple’s Exploitation of the Long Tail Effect Using iTunes: The
AVAC Analysis
The products in the case were songs, some of which were hits at one time or the
other but most of which were nonhits or old hits (oldies) that languished in the
long tail. The combination of the Internet, MP3 technology, and other informa-
tion technologies constituted the innovation that made exploitation of the long
tail possible. The combination (1) made more shelf space and distribution
channels available for music at much lower costs, (2) enabled more low-cost
and effective access between producers and customers since of?ine record stores
could be bypassed, and (3) offered customers better ways of choosing between
the many songs available. For Apple to have a competitive advantage in exploit-
ing the long tail, it had to create and appropriate value better than its competi-
tors. We use an AVAC analysis to examine the extent to which Apple was
able to take advantage of the changes introduced by the Internet and other
technologies to exploit the long tail.
80 Introduction
Activities
Recall that the Activities component of an AVAC framework is about exploring
the extent to which the ?rm is performing the right set of activities—activities
that contribute to creating value, better positioning the ?rm vis-à-vis coopeti-
tors, and to the ?rm’s exploitation of the value and position. The AVAC questions
that are explored to understand the role of activities are shown in Table 3.1:
Apple performed the following iTunes-associated activities. It:
•
Introduced iTunes on both the Mac and Windows platforms.
•
Offered a complementary product, iPod, to match.
•
Developed the FairPlay digital rights management (DRM) system.
•
Entered into agreements with content providers to provide music.
•
Priced the music at 99 cents a song.
In performing these activities, the ?rm contributed to differentiating Apple’s
offerings in several ways. By offering iTunes on both the Mac and Windows
computers, Apple made it accessible not only to its Mac users but also to the
much larger installed base of Windows users and machines. This was the ?rst
Table 3.1 The Activities Component of an iTunes AVAC Analysis
Questions Answers
A. Was Apple performing the right activities?
What was the set of activities (and
associated resources) that constituted
Apple’s strategy for iTunes?
Did the activities and/or resources/capabilities:
1. contribute to low cost, differentiation,
and other drivers of profitability?
2. contribute to better position Apple vis-
à-vis coopetitors?
3. take advantage of industry value drivers?
4. build new distinctive resources/
capabilities or translate existing ones
into unique positions?
5. maintain parsimony and
comprehensiveness?
A: What
•
Introduced iTunes on both the Mac and Windows
platforms
•
Offered a complementary product, iPod, to match
•
Developed the FairPlay digital rights management
(DRM) system
•
Entered into agreements with content providers to
provide music
•
Priced the music at 99 cents a song
B: How
1. YES. NO. Availability of iTunes on both the Mac and
PC, together with the Apple brand, DRM and iPod
contributed to differentiation. Two sources of
revenue: songs and iPod. Not clear if customers
stayed.
2. YES. NO. DRM better positioned Apple vis-à-vis
content suppliers.
3. YES. Took advantage of two key industry value
drivers: intellectual property protection of songs,
and network externalities effects of Windows and
Mac installed base.
4. YES. Built iPod brand, installed base in Windows,
relationships with coopetitors, and DRM system.
Exploited the Apple brand.
5. NO. No mention of superfluous activities being
performed by Apple; but it appears there are other
activities that it could perform to create and
appropriate value better.
The Long Tail and New Games 81
product that Apple had offered on both its Mac and the competing Windows
platforms. By making sure that music from the store could be played without
dif?culty only in iTunes or on iPods, Apple may have been slowing access to its
music store but limiting the competition faced by its iPod—a much higher
margin product for Apple than songs. By developing the FairPlay digital rights
management (DRM) system that protected songs from piracy, Apple reduced
the fear of piracy by record labels and musicians. Thus, Apple could enter
agreements with these record companies, giving it the right to sell their songs
online. By demonstrating to the recording companies that it could protect their
intellectual property from online piracy and cooperating with them, Apple was
also effectively dampening their bargaining power. The agreements also
reduced the amount of rivalry that Apple ordinarily faced. By developing Fair-
Play, Apple was also taking advantage of a key industry value driver in the
music industry: intellectual property protection. By porting its iTunes software
to the Windows camp, continuing to build the iPod brand, and offering attract-
ive iPod models, Apple was able to build a loyal audience within the Windows
camp. This Windows-installed base was a valuable resource. The Apple brand
and Steve Jobs were also valuable resources. None of the activities that Apple is
performing appear to be super?uous. There is limited information in the case,
but it would appear that there is more that Apple can perform to improve value
creation and appropriation.
Value
The Activities component above tells us how the activities contributed to the
value created and appropriated. The Value component is about the uniqueness
of the value created and who perceived it—whether the contributions made to
value creation were enough. The questions for exploring the Value component
are shown in Table 3.2.
Music customers perceived the value from iTunes Music Store as being
Table 3.2 The Value Component of an iTunes AVAC Analysis
Questions Answers
How unique was the value created by Apple’s
strategy for iTunes, as perceived by customers,
compared to that from competitors?
1. Did customers perceive value created by
Apple as unique relative to what competitors
offered?
2. Did many customers perceive this value?
3. Were these customers precious (valuable)?
What are the market segments and sources
of revenue?
4. Were there any white spaces nearby?
When iTunes, the music store, and associated
DRM were introduced, they were the only
ones on both the Mac and Windows.
1. YES. Features of iTunes, the Apple brand, and
iTunes availability on Macs and PCs were
perceived as unique.
2. YES. Millions of customers downloaded the
software and a billion songs were bought in a
very short time.
3. YES. NO. There were some valuable
customers in the large base of Mac and
Windows users but it was difficult to tell
which ones were valuable.
4. There were white spaces in phones, and
other handhelds. Apple offered an iPhone.
82 Introduction
unique. Through the store and associated information technologies, customers
had access to millions of songs. They also had the means to choose from the
millions of songs. Customers did not have to buy an album because of one good
song on it. They could also see the rating of the popularity of a song to help
them make their choices. They could shop 24 hours a day, seven days a week,
from anywhere in the world, and could test-play portions of any song on
iTunes. Because Apple made iTunes available on Windows, it had a lot more
valuable customers than it may have had, had it limited iTunes to the Mac
platform. As of 2007, customers with the Apple or Microsoft operating systems
on their computers and access to the Internet could shop at the music store.
However, computers with the Linux operating system could not. Many cus-
tomers with PCs and access to the Internet were probably more willing to pay
the $0.99 per song that they liked than the average music of?ine customer. As
far as white spaces were concerned, there were lots of handheld devices, outside
of MP3 devices, that did not have access to iTunes when Apple introduced
iTunes on Windows. One of these white spaces was the phone, which Apple
would later occupy by introducing the iPhone.
Appropriability
The Activities component tells us how a ?rm’s activities contribute to value
appropriation but does not tell us the extent to which the activities actually
result in value appropriation. The Appropriability component tells us the extent
to which value was appropriated by the activities performed by Apple. The
questions for exploring the appropriability component are shown in Table 3.3.
Table 3.3 The Appropriability Component of an iTunes AVAC Analysis
Questions Answers
Did Apple’s strategy for iTunes (set of activities)
enable the firm to make money from the value
created? (How much money?)
1. Did Apple have a superior position vis-à-vis
its coopetitors?
2. Did Apple exploit its position vis-à-vis
coopetitors and take advantage of the value
perceived by customers?
3. Was Apple’s iTunes strategy difficult to
imitate? (a) Was there something about
Apple and its set of activities and resources
that made it difficult for competitors to
imitate its strategy? (b) Was there something
about competitors that impeded them from
imitating Apple?
4. (a) Was the value non-substitutable? (b)
Were complements being strategically well
used?
Apple did not make much money directly from
songs. It made money indirectly from iPods and
iPhones.
1. NO. Although its activities improved its
position vis-à-vis coopetitors, Apple still did
not have a superior position vis-à-vis its
suppliers and customers.
2. YES. NO. Was able to get content providers
to agree on something. Possible that by fixing
its price at $0.99 per song, Apple’s price for
songs was not close enough to customers’
reservation prices.
3. YES. NO. Apple’s brand, DRM, and system of
activities were not easy to imitate; but there
was nothing about competitors that
prevented them from offering similar
products or performing similar activities.
4. NO. YES. In 2007, offline music stores were
still viable substitutes. Apple used the iPod
and iPhones strategically. These were priced
to give Apple better margins than songs.
The Long Tail and New Games 83
Although Apple did not make much money directly from sales of songs in the
iTunes digital music store, it may have been making money from sales of its
iPods and iPhones. Content providers still had lots of bargaining power over
Apple since other channels for selling their content to end-customers existed.
Thus, Apple made only 10 cents out of every 99 cents collected for each song
sold, while the record labels made 65 cents and distribution the remaining 24%.
This constituted a very low pro?t margin for Apple, but the margins on iPods
were a lot larger; and without the iTunes music store, the iPod would not have
had access to many songs, reducing its value to customers. Having access to
both Windows and Mac users gave access to many valuable customers; but with
a ?xed price of $0.99 per song, there was little attempt to get closer to cus-
tomers’ reservation prices. Apple’s brand and the iPod constituted important
complementary assets. There was little about Apple and its competitors to show
that iTunes would not be imitated. In fact, because iTunes worked only with
iPods, many competitors who wanted a piece of the action were more likely to
try to build their own online music stores. Substitutes for iTunes were the other
channels that artists and record labels could use to sell their music. Comple-
ments were all compatible MP3 players.
Change: New Game
The primary change in this case was the Internet—the innovation that created
the opportunity to exploit the long tail of music. When a ?rm took advantage of
the Internet’s properties—low-cost shelf space and distribution channel, a tool
for making better purchase choices, and a lower-cost tool for producers to meet
customer needs better—the ?rm was playing a new game. Apple was taking
advantage of the change brought about by the Internet to exploit the long tail of
music, and we can explore the extent to which Apple succeeded in doing so
using the questions of Table 3.4.
Apple’s primary strength in the pre-iTunes era was its brand name reputation
as well as its installed base of Mac users. These strengths continued to be
strengths in the iTunes era. Its biggest weakness in the pre-iTunes era had been
its rather small installed base of Macs (4%) compared to the much larger (94%)
installed base of Windows. In making software available on both the Mac and
Windows, Apple has eliminated this weakness. In offering iTunes, Apple took
advantage of the Internet in several ways. It utilized the Internet’s huge low-cost
virtual shelf space to offer millions of song titles to customers who could access
the store from anywhere in the world with a Mac or a PC. Complemented by
the FairPlay DRM system that protected songs from piracy, iTunes was unique
on the web when it was introduced. Effectively, Apple was offering unique
value. By offering the iPod and later, the iPhone, Apple was making sure that
customers not only had access to songs, but that they also had access to more
platforms to play them. Apple used iTunes and iPod not only to reinforce its
brand name reputation but also to establish new Internet-based brands in iPod
and iTunes. We now have podcast as a verb, thanks to Apple and its iPod/
iTunes.
Apple took advantage of some opportunities for ?rst-mover advantages. By
being the ?rst with a system that could protect songs from piracy—its FairPlay
DRM system—Apple demonstrated to record labels and musicians that their
84 Introduction
songs would not be pirated away. The timing was right given the amount of
music piracy that was taking place on the Internet. This enabled the ?rm to
establish relationships with content providers. It was not the ?rst to offer an
MP3 player, and therefore took advantage of MP3 ?rst-mover disadvantages—
the fact that the technology and market for MP3s had already been established
by ?rst movers—when Apple offered its own MP3—the iPod.
One can argue that, in porting iTunes to Windows, Apple was anticipating
the likely reaction of Windows-based competitors who could have offered an
iTunes equivalent for Windows. By offering iTunes on Windows ?rst, Apple
was effectively preempting potential competitors. By the time other ?rms
offered competing online music stores on Windows, Apple had built switching
costs and other ?rst-mover advantages at many customers.
The Internet offered both opportunities and threats. The same properties of
the Internet that Apple took advantage of could also be threats to it later since
competitors could take advantage of them to attack Apple.
Table 3.4 The Change Component of an iTunes AVAC Analysis
Change
Did the strategy take advantage of change (present
or future) to create unique value and/or position
Apple to appropriate the value? In creating and
appropriating value in the face of the change,
given its strengths and handicaps, did the firm:
1. Take advantage of the new ways of creating
and capturing new value generated by
change?
2. Take advantage of opportunities generated
by change to build new resources or
translate existing ones in new ways?
3. Take advantage of first-mover’s advantages
and disadvantages, and competitors’
handicaps that result from change?
4. Anticipate and respond to coopetitors’
reactions to its actions?
5. Identify and take advantage of the
opportunities and threats of the
environment? Were there no better
alternatives?
The strategy took advantage of change. Apple’s
brand was a strength.
1. YES. Apple took advantage of the new ways
of creating and capturing value created by
the Internet. It offered unique value in iTunes,
iPod and its brand.
2. YES. It built new resources: Windows
installed base, iPod/iTunes brand, and
relationships with record labels.
3. YES. Apple built and took advantage of some
first-mover advantages. Its DRM system
allowed it to convince record labels that
their music would not be pirated. It also
moved on to build an Internet music brand.
It took advantage of an established market
and technology for MP3 players.
4. YES. In porting iTunes to Windows, Apple
was anticipating the likely reaction of
Windows-based competitors such as mighty
Microsoft. It was expected that many
competitors would still enter.
5. YES. NO. In creating and appropriating value
the way it did, Apple was taking advantage of
opportunities and threats of environment.
Musicians, record labels, and competitors
could also build their own online music
stores, thanks to change (the Internet).
The Long Tail and New Games 85
Strategic Consequence of the iTunes AVAC Analysis
Apple’s strategy for iTunes in 2007 is compared to alternate strategies in Table
3.5. The strategy compares well vis-à-vis alternatives. The competitive parity
designation re?ects the fact that Apple did not make much money directly from
iTunes. The record labels make most of the money. However Apple makes
money indirectly from its iPods and iPhones. It also re?ects the fact that
although Apple took advantage of the Internet, it was not clear that it would be
able to take advantage of future change.
As we saw in Chapter 2, the most important thing about an AVAC analysis
may not be so much that we can classify a strategy as having a sustainable
competitive advantage, temporary competitive advantage, competitive parity,
or competitive disadvantage. The important thing is what the ?rm can do to
reverse the Noes or reinforce the Yesses and in the process, get ever so closer to
having a sustainable competitive advantage. The question for Apple was, what
could it do to have a competitive advantage rather than competitive parity?
Apple was taking some steps in the right direction. Introduction of the iPhone,
patenting its DRM, etc. were all good steps.
Table 3.5 Strategic Consequences of an AVAC analysis of Apple’s iTunes Activities
Activities: Is Apple
performing the
right activities?
Value: Is the
value created by
Apple’s iTunes
strategy unique,
as perceived by
customers,
compared to
that from
competitors?
Appropriability:
Does Apple
make money
from the value
created?
Change: Does the
strategy take
advantage of
change (present
or future) to
create unique
value and/or
position itself to
appropriate the
value?
Strategic
consequence
Strategy 1 Yes Yes Yes Yes Sustainable
competitive
advantage
Strategy 2 Yes Yes Yes No Temporary
competitive
advantage
Apple’s
iTunes
strategy in
2007
Yes Yes No/Yes Yes/No Competitive
parity
Strategy 4 Yes Yes No No Competitive
parity
Strategy 5 No No No No Competitive
disadvantage
Strategic
action
What can Apple do to reinforce the YESes and
reverse or dampen the NOes
86 Introduction
AVAC for Record Labels and Musicians
Note that the analysis that we have just completed is for an aggregator, Apple,
which exploited the long tail by aggregating songs from different record labels
and musicians and selling them; but as we saw earlier, aggregators were not the
only ones that could exploit the long tail. Record labels (producers), and
musicians (suppliers) could also exploit the long tail effect. Thus, an AVAC
analysis could be conducted for each of them to explore the extent to which
each takes advantage of the characteristics of the Internet to make money from
the long tail.
Key Takeaways
•
In many markets, there are likely to be a few hit or blockbuster products/
services, and many nonhits. The hits occupy the so-called short head while
the nonhits occupy the long tail of a distribution that has been called names
such as Pareto Law, Pareto Principle, 80/20 rule, heavy tail, power-law tail,
Pareto tails, and long tail.
•
Chris Anderson was the ?rst to use the name long tail to describe the non-
hits that end up in the long tail (niches) of each distribution. He argued that
in the face of the internet, the combined sales of the many products in the
long tail can be equal to, if not more than, sales of the relatively fewer hits in
the short head. Thus, by aggregating these nonhits, a ?rm may be able to
make as much money from them as it could from hits.
•
In general, distributions in which there are a few product hits and many
nonhits are a result of:
1 The high cost and scarcity of distribution channels and shelf space.
2 Customers’ cognitive limitations and dif?culties in making product/ser-
vice choices.
3 Customer heterogeneity and the high cost of and dif?culties in meeting
individual unique needs of all customers.
•
Any new games or innovations that alleviate the above three factors can
alter the shape of the long tail distribution.
•
The Internet, for example, drastically reduces the cost of distribution and
shelf space for some products, facilitates consumer choices, and makes it
possible to better meet more varied kinds of consumer taste. Thus, ?rms can
use the Internet to improve sales of products that once languished in the
long tail. The question is, which ?rm is likely to have a competitive advan-
tage in exploiting the long tail?
•
The Internet is not the only innovation that drives or drove the long tail
phenomenon. Many others did and continue to do so:

Botox and cosmetic surgery

Cell phones

Discount retailing in rural areas

Internet and political contributions

Internet and user innovations

Micro?nancing

Organic food stores
The Long Tail and New Games 87

Printing press

Radio and TV broadcasting

Video tape recorders.
•
To have a competitive advantage in exploiting the long tail, a ?rm has to
create and appropriate value in the face of the innovation that makes
exploitation of the long tail possible.
•
An AVAC analysis is a good tool for exploring which activities are best for
creating and appropriating value in a long tail.
•
To take advantage of what we know about the long tail, you, as a manager,
should:
1 Identify the long tail distributions in your markets, or the markets that
you want to attack, and their drivers.
2 Identify those new game ideas or innovations that can eliminate or take
advantage of those conditions that make some products languish in
each long tail.
3 Perform an AVAC analysis to determine which activities stand to give a
?rm a competitive advantage as it uses new games to create and
appropriate value in the long tail.
4 Decide which activities to focus on, and how to execute the strategy.
Key Terms
Long tail
Short head
88 Introduction
Strengths and
Weaknesses
Chapter 4: Creating and Appropriating Value Using
New Game Strategies
Chapter 5: Resources and Capabilities in the Face of
New Games
Chapter 6: First-mover Advantages/Disadvantages
and Competitors’ Handicaps
Chapter 7: Implementing New Game Strategies
Part II
Creating and Appropriating Value
Using New Game Strategies
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Increase your understanding of the determinants of value creation and
appropriation.
•
Analyze how much value each member of a value system captures and why.
•
Understand the contribution of new game and value chain factors to a
?rm’s competitive advantage.
•
Strengthen your ability to think strategically.
Introduction
Do you own a PC, iPhone, car, airplane, shoes, or a watch? How much of what
you value in each of these products do you think was created by the “maker” of
the product? How much of the value does the “maker” appropriate? What is its
strategy for creating and appropriating value? How many countries contribute
to the bene?ts that you value in the product? Consider one of these products,
the iPhone: Each owner of an iPhone perceives value in the device when he or
she navigates through the device by touching the screen, makes or receives
phone calls, surfs the Web, sends or receives e-mail, takes or views pictures, and
so on. Apple conceived of and designed the iPhone but did not manufacture the
product when it introduced it in 2007. The hundreds of components that went
into the product came from numerous suppliers from the USA, Europe, and
Asia, and were shipped to an Asian manufacturer who assembled and shipped
them to the USA for distribution. Many of the critical components, especially
the microchips, were themselves systems that were designed and either manu-
factured by the suppliers, or manufactured by their subcontractors before being
shipped to Apple’s own subcontractors for assembly. (Microchips, with their
rapidly increasing functionality but dropping prices, are what have made
innovations such as the iPhone possible.) Infenion AG, a German company,
supplied the digital baseband, radio-frequency transceiver, and power-
management devices.
1
Samsung, a Korean company, made the video processor
chip, while Sharp and Sanyo, Japanese ?rms, supplied the LCD display. The
touch-sensitive modules that were overlaid unto the phone’s LCD screen to
make the multitouch control possible were designed by Balda AG, a German
company and produced in its factories in China. Marvel Semiconductor of
the US provided the WiFi chips. The Camera Lens was supplied by Largan
Chapter 4
Precision of Taiwan while the camera module was supplied by three Taiwanese
companies: Altus-Tech, Primax, and Lite On. Delta Electronics supplied the
battery charger. Various other ?rms supplied other components. Apple also
supplied the operating system and other software that manages the device.
The question is, how much value does Apple create and appropriate in offer-
ing the iPhone? How much value is created and/or appropriated by each sup-
plier? How much value is created by which country? We will return to these
questions later in this chapter. We start the chapter with a very important dis-
cussion of what creating and appropriating value is all about. We then explore
the impact of new game activities on the creation and appropriation of value. In
particular, we argue that the contribution of a set of new game activities to value
creation and appropriation has two components: a component that is due to
the fact that the activities are value chain activities and another that is due to the
fact that they are new game. We conclude with the reminder that value creation
can be as important as value appropriation and focusing only on one and not
the other can make for bad strategy. One need only recall the example of
musicians, who create lots of value but often do not appropriate all of it, to be
reminded of the signi?cance of value appropriation.
Creating and Appropriating Value
The concepts of creating and appropriating value are central to strategy and one
way to understand them is through the illustration of Figure 4.1. Recall that
business strategy is about making money and that revenues come from cus-
tomers who buy products or services from ?rms. A customer buys a product
from a ?rm because it perceives the product as providing it (the customer) with
bene?ts, B; but to provide the bene?ts, B, a ?rm has to perform value-adding
activities such as R&D, purchasing of equipment, components and materials,
transformation of these components and materials into products or services,
marketing these products and services to customers, and distributing the
products to customers. These activities cost C. The economic value created, V,
Figure 4.1 Value Creation and Appropriation.
92 Strengths and Weaknesses
by the ?rm is the difference between the bene?ts, B, that a customer perceives to
be in the product and how much it costs the ?rm to provide the bene?ts;
2
that is,
V = B ? C. The customer pays a price P for the bene?ts that it receives. This
gives the ?rm a pro?t of P ? C, and the customer gets to keep B ? P; that is, the
value captured (value appropriated) by the ?rm is the pro?t, P ? C, from the
value created. In economics, this pro?t is sometimes called the producer’s sur-
plus while what the customer gets to keep, B ? P, is called the consumer’s sur-
plus. As an example, consider the value created when a ?rm builds and sells a
car. Suppose a carmaker develops and markets a new car that customers love so
much that they would be willing to pay $30,000 for the bene?ts that they
perceive in owning the car. Also suppose that it costs the ?rm $15,000 to pro-
duce the car (including R&D, marketing and manufacturing costs) whose price
the ?rm sets at $20,000. From Figure 4.1, the value created is $15,000
(30,000 ? 15,000), the carmaker’s pro?t is $5,000 (20,000 ? 15,000). The cus-
tomer’s consumer surplus is $10,000 (30,000 ? 20,000).
Note that although the value created by the ?rm is B ? C, the ?rm only
captures a fraction of it in the form of pro?ts (P ? C). In other words, it only
appropriates part of the value that is created, P ? C. The other part of the value
created is captured by the customer in the form of consumer surplus. In other
words, making money involves both creating value and appropriating the value
created. We now discuss both value creation and appropriation in detail.
Value Creation
Recall that the value created is the difference between the bene?ts that cus-
tomers perceive and the cost of providing the bene?ts. Effectively, value cre-
ation is about performing value chain activities so as to offer customers
something that they perceive as bene?cial to them, and insuring that the cost of
offering the bene?ts does not exceed the bene?ts—it is about bene?ts and costs.
The bene?ts that customers derive from a product can be from the product’s
features (performance, quality, aesthetics, durability, ease of use), the product’s
or ?rm’s brand, location of the product, network effects associated with the
product, or the service that comes with the product. Thus, designing a product,
manufacturing and testing it all add value since they all contribute to the prod-
uct’s features. Advertising a product also adds value when it improves cus-
tomers’ perception of the product. Distributing a product adds value when it
brings the product closer to customers who would otherwise not have access to
it. For products which exhibit network effects, performing activities that add
more customers constitutes value creation because the more people that use the
product, the more valuable that it becomes to each user.
There are numerous things that a ?rm can do to keep its costs down while
creating bene?ts for customers. It can innovate by using new knowledge or a
combination of existing knowledge to drastically improve existing ways of per-
forming activities, thereby drastically lowering its costs. It can take advantage
of economies of scale, if its products are such that the higher its output, the
lower the per unit costs of its products. It can take advantage of economies of
scope, if the different products that it sells are such that the per unit costs of
producing these products together is less than the per unit cost of producing
each product alone. It can lower its costs by taking advantage of what it has
Creating and Appropriating Value Using New Game Strategies 93
learnt from its experiences in moving up different learning curves. It can also
take advantage of any unique location that it may have such as being close to a
cheap source of labor. A ?rm can also take advantage of industry or macro-
related factors. For example, if a ?rm has bargaining power over its suppliers, it
can negotiate to pay lower prices for its inputs, thereby keeping its costs lower.
It can also use that power to work more closely with suppliers to keep compon-
ent costs lower so that the supplier can pass on some of the costs savings to the
?rm in the form of lower input costs. Finally, a ?rm can keep its costs low by
putting in place the right incentives and monitoring systems to reduce agency
costs. Recall that agency costs are the costs that ?rms incur because employees
or other agents are not doing what they are supposed to be doing. Effectively,
?rms can create value by offering more bene?ts and keeping down the costs of
providing the bene?ts. We will revisit some of these factors when we explore the
role of new game activities.
Value Appropriation
Value appropriation is about who gets to pro?t from the value created. It is
about what slice of the pie one ends up getting. Referring to Figure 4.1, again,
the producer ?rm only keeps a fraction of the value created (?rm’s pro?t) while
the customer or supplier keeps the rest (consumer pro?t). There are ?ve reasons
why a ?rm that creates new value using new game activities may not be able to
appropriate all of the value created:
1 The ?rm may not have the complementary assets needed.
2 The ?rm may not be well-positioned vis-à-vis its coopetitors.
3 The ?rm may not have the right pricing strategy.
4 The value that the ?rm offers may be easy to imitate or substitute.
5 The ?rm may not have enough valuable customers that want the bene?ts
that it offers.
Complementary Assets
If the product that encapsulates the value created requires scarce and important
complementary assets to pro?t from it, the owner of the complementary assets
may be the one that captures the value and not the ?rm that created the value.
This is particularly true if the product is easy to imitate. Complementary assets
are all the other resources, beyond those that underpin the new game, that a
?rm needs to create and capture value. They include brands, distribution chan-
nels, shelf space, manufacturing, relationships with coopetitors, comple-
mentary technologies, access to complementary products, installed base, rela-
tionships with governments, and so on. Therefore a ?rm that invents or dis-
covers something (through its new game activities) may need to use other new
game activities to establish prior positions in complementary assets so as to
pro?t from the invention. In the music industry case, recording companies
and agents have complementary assets such as contacts, brands, and distribu-
tion channels. We will explore complementary assets in much more detail in
Chapter 5.
94 Strengths and Weaknesses
Relationships with Coopetitors
Another reason why a ?rm that creates value may not be able to capture all
of it is that the party with the most bargaining power is not always the one
that created the value or that makes the largest contribution towards value
co-creation. (In fact, the one with the most power might contribute the least
to value creation.) In the coopetition between Intel, Microsoft, and PC
makers that delivers value to PC users, Microsoft is the most pro?table but it
is doubtful that it creates the most value in that value system. (Creating value
is synonymous with working together to make a pie while appropriating
value is equivalent to dividing the pie.) The position vis-à-vis coopetitors
determines the share of the pie that each ?rm receives. If a ?rm’s suppliers or
buyers have bargaining power over the ?rm, it may have dif?culties capturing
the value that it has created. For example, if a ?rm has only one supplier of a
critical component, the supplier can charge so much for the component that
the ?rm’s pro?t margins will be reduced to zero—the supplier effectively
captures most of the value that the ?rm has created. Buyers with power can
also extract low prices out of the ?rm, reducing the amount of value that it
can capture. Thus, pursuing new game activities that increase a ?rm’s bar-
gaining power can better position the ?rm to appropriate the value created. A
classic example is that of Dell which we saw in Chapter 1. By bypassing
distributors to sell directly to businesses and consumers, it was moving away
from having to confront the more concentrated and powerful distributors to
dealing directly with the more fragmented end-customers who had less power
than distributors.
Good relationships with coopetitors can also help a ?rm to appropriate value
better. For example, as we saw earlier, if a ?rm works more closely with its
customers to help them discover their latent needs for its products, the willing-
ness to pay of these customers may go up, thereby increasing the ?rm’s chances
of appropriating more of the value it creates.
Pricing Strategy and Sources of Revenue
The third reason why a ?rm which creates new value may not be able to capture
all of it has to do with pricing and sources of revenue. The closer that a ?rm sets
its price to each customer’s reservation price, the more of the value created that
the ?rm gets to keep, if the higher price does not drive the customer to competi-
tors. Recall that a customer’s reservation price for a product is the maximum
price that it is willing to pay for the product. The higher a customer’s reserva-
tion price, the higher the chances that the price demanded will fall enough
below the customer’s reservation price to leave it some consumer surplus. Also,
the higher a customer’s reservation price, the better the chances that the price
demanded by the ?rm will not drive the customer away. The price demanded, in
turn, is a function of the relationship between the ?rm and the customer, espe-
cially the bargaining power of one over the other, and the ?rm’s pricing strat-
egy. The higher a ?rm’s bargaining power over its customer, the more that it can
extract higher prices from the customer, thereby raising the fraction of the value
that it keeps (pro?ts). Also, a ?rm that has good relationships with its customers
can better work with such customers to discover and meet their needs, thereby
Creating and Appropriating Value Using New Game Strategies 95
increasing the customer’s reservation price and lowering costs, all of which
increase the value created and appropriated.
Effectively, if a customer has a high reservation price but a ?rm sets its price
below the reservation price, the customer keeps the difference and walks away
with a higher consumer surplus while the ?rm leaves with a lower pro?t. Pricing
above customers’ reservation prices drives them away. Thus, a ?rm is better off
pursuing a pricing strategy that gets it as close as possible to a customer’s
reservation price, without driving customers to competitors. A ?rm’s sources of
revenue also determine the amount of revenues that it collects and in a way, the
value that it captures. New game activities that create new sources of revenue
can increase the value that a ?rm can capture. Take the case of Ryanair. In
addition to the revenues that it collects from airline tickets, it also receives
revenues from advertising, sales of snacks and duty free goods, and commis-
sions on hotel accommodation and car rental reservations made through its
website. Effectively, the primary value that Ryanair offers its passengers is ?y-
ing them from one place to the other. These other sources of revenue help it
appropriate more of the value that it creates in an indirect way.
Imitability and Substitutability
Imitability and substitutability can also curb the extent to which a ?rm can
appropriate all the value that it creates. If competitors are able to imitate the
value that a ?rm creates, its prices and the quantity that it sells are likely to
drop. If other ?rms can offer viable substitute products, customers can switch to
these substitutes if a ?rm’s prices are higher than they would like. This reduces
the value that the ?rm can appropriate.
Number of Valuable Customers
The number of valuable customers that a ?rm can attract with the value that it
offers also contributes towards how much value is captured. This depends on
the ratio of ?xed costs relative to variable costs. The lower the variable costs
relative to ?xed costs, the more that each extra unit sold is likely to bring in
more pro?ts than earlier units. By de?nition, valuable customers have a high
willingness to pay and therefore are likely to have higher reservation prices and
be more likely to buy more than one unit. Effectively, the number of customers
also matters; and so does the market or market segment that a ?rm targets, since
not all customers have the same willingness to pay for a given set of bene?ts or
cost the same to acquire and keep. Moreover, customers have to have enough
information about the products that ?rms offer to be able to choose which
bene?ts they want. Thus, it is also important to perform activities that identify
and target the right customers and that increase the number of customers who
like the bene?ts offered. One reason offered for Dell’s success in the mid to late
1990s was the fact that over 70% of the ?rm’s customers were businesses with
PC purchases of over $1 million. Such customers not only have higher reserva-
tion prices; they may also make for better targets for building switching costs.
Moreover, they are likely to cost less (per unit sold) to maintain than smaller less
dependable ones.
96 Strengths and Weaknesses
Coopetition and Value Creation
Since value created is the difference between the bene?ts that a customer per-
ceives and the costs to a ?rm of providing these bene?ts, value creation can be as
much a function of what the ?rm does as it is a function of what its coopeti-
tors—the customers, complementors, rivals, and suppliers with whom a ?rm
cooperates to create value and competes to capture it—do.
3
The quality of the
inputs from a ?rm’s suppliers impacts the quality of the bene?ts that the ?rm
can offer customers. For example, the bene?ts that a customer enjoys in a PC
are as much a function of how the PC maker designs, manufactures, and mar-
kets the product as they are a function of the quality of the microprocessor
(from suppliers Intel or AMD), and of the software from complementors
(Microsoft and others) as well as of how the customer uses the PC. The cost to a
?rm of providing bene?ts to its customers is also a function of its suppliers and
the relationship between the ?rm and these suppliers. Additionally, the extent
to which a customer perceives a product as meeting his or her needs is a func-
tion of the customer’s unique characteristics, including what the customer
wants the product for. Moreover, the price that a customer gets to pay a ?rm is a
function of the relationship between the customer and the ?rm. In fact, some-
times value is often created by coopetitors who cooperate through alliances,
informal understandings, joint ventures, venture capital investments, etc.
Effectively, a firm usually has to cooperate to create value and compete to
appropriate the value. In a fair world, each ?rm would capture value equivalent
to how much it created. (Your slice of the pie would be equivalent to your
contribution.) But often, ?rms with power in their value system capture more of
the value created in the system than their contribution would merit. Effectively,
a very important part of strategy is positioning oneself to capture as much value
in one’s value system as possible.
Example 4.1: Who Appropriates What in a Book Value System
In 2000, it was estimated that for each dollar a customer paid for a book, the
author received 10 cents, the publisher of the book got 32 cents, the printer
received 8 cents, while the distributor and retailer received 20 cents and 30 cents
respectively.
4
Pro?t margins for authors, publishers, printers, distributors, and
retailers were ?3.2%, 13.1%, 6.0%, 6.8%, and 17.3%, respectively.
5
How
much value did each player in the value chain appropriate? Are the players who
capture the most value really the ones that create the most value?
Solution to Example 4.1
Consider publishers. They received 32 cents of each dollar of sales and had
pro?t margins of 13.1%. The value appropriated by publishers is the pro?t that
they make from the value created. Therefore:
Pro?t margin =
Pro?t
Sales
=
Pro?t
$0.32
= 0.131 = 13.1%
Thus, Pro?t =$0.32 × 0.131 = $0.042. This is the value appropriated by
publishers. Publishers’ costs are $0.32 ? 0.042 = 0.278.
Creating and Appropriating Value Using New Game Strategies 97
Similarly, we can calculate the amounts appropriated by each player and its
cost. These numbers are shown in Figure 4.2. Also shown in the ?gure is the
percentage of value that each player appropriated. Retailers appropriated
47.6% of the value created, the most of any player. Why did retailers appropri-
ate so much value compared to other players? First, retailers controlled the
shelf space in the offline world and therefore had bargaining power over their
suppliers and buyers. They typically paid publishers only 50% of the suggested
retail price.
6
At some locations, such as universities and retail malls, book
retailers constituted local monopolies. Effectively, retailers have comple-
mentary assets and power over coopetitors, and good locations differentiate
them from rivals. Second, many retailers could resale old books, making good
pro?ts without lifting a ?nger. Publishers appropriated 38.5% of the value
created, second only to retailers. They had a great deal of power over the
average author, although famous authors commanded a lot of power over
publishers because of the pull that famous-author names establish with
consumers.
Distributors (including wholesalers) were next with 12.5% of the value
appropriated. They transported the books and often stored them in warehouses
until retailers needed them. The least value was appropriated by printers and
authors with 4.4% and ?2.9% respectively. Printers were highly fragmented
with little or no power over their suppliers or buyers. Authors were also highly
fragmented and therefore had little power over publishers (except famous
authors). Although famous authors commanded lots of money, the average
author lost money. He or she appropriated no value; rather, he or she had to
“pay” other members of the value system to take the book from him or her. He
or she “paid” the equivalent of 2.9% of the price of a book. Effectively, the
average author makes little or no money directly from books. Since most people
who buy books buy them for their content, it is doubtful that 47.6% of what
readers get out of a book comes from retailers. Effectively, some players cap-
tured more value than they created.
Figure 4.2 A Book Value Chain.
98 Strengths and Weaknesses
Example 4.2: Who Creates and Appropriates What Value in an iPhone
In 2007 when Apple shipped the ?rst iPhones, some ?nancial analysts estimated
that the cost of the components and ?nal manufacturing for the phone were
$234.83 and $258.83 for the 4 GB and 8 GB versions, respectively (Table 4.1).
7
The recommended retail prices for both versions (4 GB and 8 GB) were $499
and $599. The wholesale discount for electronic products was estimated to be
25%. The question is, how much of the value that customers saw in the iPhone
Table 4.1 Some Estimated Costs for the iPhone in 2007
Cost for 4GB iPhone
(US$)
Cost for 8GB iPhone
(US$)
Component Supplier US$ % US$ %
ARM RISC application
processor
Samsung, Korea 14.25 6.07 14.25 5.51
NAND flash memory Samsung, Korea 24 10.22 48 18.54
SDRAM (1GB) Samsung, Korea 14 5.96 14 5.41
3 chips: digital base band LSI,
transceiver LSI, and power
management unit
Infineon Technologies AG,
Germany
15.25 6.49 15.25 5.89
Touch screen module Balda AG, German, and
Tpk Solutions, Taiwan
27 11.50 27 10.43
LCD module Epson Imaging Devices
Corp., Sharp Corp. and
Toshiba Matsushita Display
Technology Co.
24.5 10.43 24.5 9.47
Bluetooth chip CSR plc of the UK 1.9 0.81 1.9 0.73
Wi-Fi base band chip Marvel Semiconductor Inc,
USA
6 2.56 6 2.32
802.11b/q 15.35 6.54 15.35 5.93
Accessories/packaging etc. 8.5 3.62 8.5 3.28
Final manufacturing Various contractors? 15.5 6.60 15.5 5.99
Royalties for EDGE 4.61 1.96 4.61 1.78
Operating system (OS X) Apple 7 2.98 7 2.70
Voice processing software 3 1.28 3 1.16
Camera module Altus-Tech, Primax, and
Lite on.
11 4.68 11 4.25
Battery 5.2 2.21 5.2 2.01
Mechanical components/
enclosure
12 5.11 12 4.64
Other hardware/software
components
25.77 10.97 25.77 9.96
Total cost of inputs 234.83 100.00 258.83 100.00
Source: iSuppli Corporation: Applied Market Intelligence. Author’s estimates.
Creating and Appropriating Value Using New Game Strategies 99
did Apple and each of its suppliers capture? How much value was created by
each actor? How much of it was created in the US?
Solution to Example 4.2
Value Captured
Recall that value captured = price ? cost of providing bene?ts. The retail price
for the 4GB iPhone was $499. Therefore, the wholesale price = (1 ? 0.25) ×
$499 = 374.25. (Distributors and retailers received $124.75 of the $499—i.e.
25% of the retail price). The cost of inputs for the 4 GB is $234.83 (from Table
4.1). Therefore, the estimated value captured by Apple = Price ? Cost = $374.25
? 234.83 = 139.42.
How much value was captured by Apple’s suppliers? Consider Samsung
which supplied at least three components. The problem here is that although we
know the prices of each component, we do not know Samsung’s cost for each
component. Firms do not release details of individual product costs. However,
they provide gross pro?t margins in their ?nancial statements, which we will
use for our estimates. Samsung’s gross pro?t margin in 2006 was 18.6; that is:
P ? C
P
= 18.6%
Therefore P ? C = P × 0.186 = value added.
For NAND Flash memory (Table 4.1), the value captured by Samsung = $24
× 0.186 = $4.46.
If the LCD module were provided by Sharp, we could also calculate the value
captured by Sharp using its 2006 gross pro?t margin of 22.6%. This value was
$24.5 × 0.226 = 5.54. If we assume that the ?rms that did the ?nal manufactur-
ing (assembly) for Apple had pro?t margins of 15%, then each received $15.5 ×
0.15 = 2.33 for every 4 GB iPhone that it manufactured.
Effectively, for each $499 that a customer paid for a 4GB iPhone, retailers
and distributors took $124.75, Apple captured $139.42, Samsung captured
$4.60 for the NAND ?ash memory alone, Sharp captured $5.54 for the LCD
module when it was bought from Sharp, each ?nal “manufacturer” (assembler)
received $2.33, and so on. The value captured by any of the other suppliers can
be similarly calculated.
Value Added
Recall that
Value created = bene?ts perceived by customers—cost of providing the
bene?ts;
= customer’s willingness to pay—cost of providing the
bene?ts;
= customer’s reservation price—cost of providing the
bene?ts.
100 Strengths and Weaknesses
One problem here is that it is not always easy to determine a customer’s reserva-
tion price or willingness to pay. In the case of Apple, for example, we know that
many of the customers who bought the iPhone could have paid a lot more than
the listed retail price; that is, their reservation prices for the product were higher
than the retail prices. However, we do not know exactly how much more each
one would have paid. What we can say is that the average reservation price of
customers was higher than the retail price that they ended up paying. Neither
do we know what Apple’s reservation prices for each of the components were.
The important thing for a strategist to remember is always to look for ways to
get as close as possible to each customer’s reservation price so as to extract as
much of the value created as possible, without driving the customer to competi-
tors. At the same time, a ?rm also tries to do the best to extract a price from its
suppliers that is below its reservation price, without adversely affecting the
ability of the supplier to keep supplying high quality components.
International Component to Value Creation and
Appropriation
One interesting thing to observe in the example above is that although each
contract manufacturer that assembled the iPhone for Apple only captured
$2.33 of every $499 that each customer paid for a 4GB iPhone, the manu-
facturer’s home country was credited with exports of $234.83, the factor cost
of the product assembled in the country. This is unfortunate because even
though the manufacturing country captured very little value, it was still seen as
the largest benefactor of the exports.
Consider the opposite example, where a large US exporter may be getting
more credit for exports than the value-added approach would suggest. In the
1980s, 1990s, and 2000s, Boeing Corporation was one of America’s largest
exporters. How much of the value that airlines saw in a Boeing 787 in 2007, for
example, was created in the USA? Boeing designed the aircraft and performed
the R&D and rigorous testing that are critical to aircraft success. The aircraft
was being assembled in Everett, Washington, USA. However, almost all of the
major components (subassemblies) that were put together in Everett—all of
them systems in themselves—were manufactured and tested in other countries
before being shipped to Everett for assembly.
8
For example, the wings, center
wing box, main landing gear wheel well, and forward fuselage were manu-
factured by Mitsubishi and Kawasaki Heavy Industries in Nagoya, Japan. The
other forward fuselage was produced in the US by Vought in South Carolina,
the center fuselage in Italy by Alenia, while the aft fuselage was produced in
Wichita, Kansas, US, by Spirit AeroSystems.
9
The horizontal stabilizers were
manufactured in Italy by Alenia Aeronautica. Passenger doors were made in
France by Latecoere while the cargo doors, access doors, and crew escape door
were made in Sweden by Saab. The ailerons and ?aps were manufactured in
Australia by Boeing Australia, while the fairings were produced in Canada by
Boeing Canada Technology. Finally, the 787 would be powered by the General
Electric (USA) GEnx and Rolls-Royce (UK) Trent 1000 engines.
Thus, although Boeing added value to the 787 by conceiving of and designing
the plane, integrating all the components, coordinating all the suppliers, and
assembling the subassemblies, the critical components of the airplane—such as
Creating and Appropriating Value Using New Game Strategies 101
the engines, fuselage, landing gear systems, wings, tail, etc.—were designed,
developed, tested and assembled by its suppliers. These ?rms added a huge
amount of the value that airlines and passengers saw in a 787. Moreover, in
designing the plane, Boeing also worked very closely with its customers—the
airlines that would buy the planes. Also, many of these coopetitors were outside
the USA. However, if a Japanese airline were to buy a 787, the full cost of the
plane would be credited to US exports to Japan. We might have a better picture
of what is going on when we think in terms of value created and appropriated
rather than products exported or imported.
New Game Activities for Creating and
Appropriating Value
New Game Activities and Value Creation
Recall that new game activities are activities that are performed differently from
the way existing industry value chain activities have been performed to create or
capture value. Also recall that value creation is about providing unique bene?ts
to customers while keeping the cost of providing the bene?ts low. Therefore,
value creation using new game activities is about performing value chain, value
network, or value shop activities differently to offer customers something new
that they perceive as bene?cial to them, and insuring that the cost of offering the
bene?ts does not exceed the bene?ts. The activities can be different with respect
to which activities are performed, when they are performed, where, or how?
(Note that where here can mean where along the value chain, where in geog-
raphy, where in a product space, where in the resource space, and so on.) The
new bene?ts can be new product features, a new brand image, better product
location, a larger network for products that exhibit network externalities, or
better product service. Such bene?ts can come from innovations in product
design, R&D, manufacturing, advertising, and distribution that improve the
bene?ts perceived by customers. A ?rm can also offer new bene?ts by being the
?rst in an industry to move to a particular market. This was the case with Wal-
Mart when it moved into small towns in the Southwestern USA that other
discount retailers had neglected. It was also the case when Ryanair moved into
secondary airports in European cities to which major airlines had paid no atten-
tion. New game activities can also create value by only reducing costs. For
example, a ?rm can drastically reduce its costs by reorganizing its business
processes so as to perform tasks more ef?ciently. In some ways, this is what
business process re-engineering has been all about—?rms re-organizing their
business processes to perform tasks more ef?ciently. Firms can also ?nd new
ways to learn from their past experiences or other ?rms and apply the new
knowledge to existing tasks to lower costs.
New game advertising activities can reveal the bene?ts of a product to more
customers in new ways, or change customers’ perception of the bene?ts from a
?rm’s products. In either case, such activities are likely to increase customers’
willingness to pay for a product and the number of such customers, thereby
increasing the total value created. P?zer was one of the ?rst in the cholesterol
drug market to conduct so-called direct-to-consumer (DTC) marketing of
its Lipitor cholesterol drug by advertising directly to patients, instead of to
102 Strengths and Weaknesses
doctors. This not only increased the number of people who knew something
about cholesterol and the bene?ts of cholesterol drugs; it may have also
changed P?zer’s drug’s image and customers’ willingness to pay for it.
Reverse Positioning: More Is Not Always Better
In using new game activities to create value for customers, a ?rm does not
always have to offer products with better attributes than those of competing
products. A ?rm can strip off some of the attributes that have come to be
considered as sacred cows by customers. In reverse positioning, a ?rm strips off
some of a product’s major attributes but at the same time, adds new attributes
that may not have been expected.
10
For example, in offering its Wii, Nintendo
did not try to outdo Microsoft’s Xbox 360 and Sony’s PS3 by offering a video
game console with the more computing power, graphical detail, and compli-
cated controls that avid gamers had come to consider as sacred cows. Rather,
Nintendo offered a product with less computing power, less graphical detail,
and easy-to-use controls. However, the Wii had “channels” on which news and
weather information could be displayed. In reverse positioning, some of the
customers who cannot do without the sacred cows that have been stripped are
likely to stay away from the new product; but the new product, if well con-
ceived, is likely to attract its own customers. There is self-selection in which
some customers gravitate towards the new product, despite the fact that it does
not have some of the sacred cows that some customers have come to expect. For
example, although many avid gamers did not care much for the Nintendo Wii,
many beginners, lapsed and casual gamers loved the machine. Effectively, more
is not always better. One does not have to outdo existing competitors on their
performance curve.
New Game Activities and Value Appropriation
Recall that value appropriation is about how much a ?rm pro?ts from the value
that has been created, and that how much a ?rm appropriates is a function of
?ve factors: availability and importance of complementary assets, the relation-
ship between a ?rm and its coopetitors, pricing strategy, imitability and substi-
tutability, and the number of valuable customers. Thus, any new game activities
that in?uence any of these factors can have an impact on appropriability. Take
technological innovation activities, for example. A pharmaceutical ?rm that
pursues and obtains protection (patents, copyrights, or trade secrets) for the
intellectual property that underpins its products may be effectively increasing
barriers to entry into its market space, reducing rivalry, and increasing switch-
ing costs for customers. Increased barriers-to-entry and reduced rivalry mean
that the ?rm can keep its prices high, since there is less threat of potential new
entry and less threat of price wars from rivals. Increasing switching costs for
customers also means less bargaining power for customers, and some chance of
the ?rm extracting higher prices from the customer. Defendable patents for
many pharmaceutical products are partly responsible for the ability of pharma-
ceutical ?rms to appropriate much of the value that they create.
eBay’s activities in online auctions also offer another example of how a ?rm
can use new game activities to create and appropriate value. The ?rm built a
Creating and Appropriating Value Using New Game Strategies 103
large and relatively safe community of registered users, and implemented auc-
tion pricing. The larger the size of such a safe community for online auctions,
the more valuable it is for each user, since each seller is more likely to ?nd a
buyer and each buyer is more likely to ?nd a seller in a larger network than in
a smaller one. Thus, users are less likely to switch to a smaller or less safe
network, thereby giving eBay some bargaining power. When it uses an auction
format, eBay gets closer to each buyer’s reservation price than it would if rivals
had networks with similar attributes or when it uses a ?xed-pricing format.
New Game Activities, Value Creation, and Appropriation
Although we have described value creation and value appropriation separately,
new game activities can and often result in both value creation and appropri-
ation. For example, when a pharmaceutical company develops a new effective
drug and obtains enforceable patents for it, the ?rm has effectively created value
and put itself in a position to appropriate the value. If the drug is very good at
curing the ailment for which it is earmarked, patients would prefer the drug
over less effective ones, and the ?rm has bargaining power over patients and can
obtain high prices where government regulations permit. Moreover, substitutes
have less of an effect because of the drug’s effectiveness, and the threat of
potential new entry and of rivalry have less of an effect on the ?rm because of
the enforceable patents.
Shifts in the Locus of Value Creation and Appropriation
So far, we have focused on how and why value is created and appropriated
during new games; but new games can also shift the locus of value creation and
appropriation along a value system. For example, in the mainframe and mini-
computer era, most of the value in the computer industry was created and
appropriated by vertically integrated computer ?rms such as IBM and DEC that
produced the microchips and software critical to their products. In the new
game ushered in by the PC, much of the value in the industry was appropriated
by Microsoft, a complementor and supplier, and Intel, a supplier. Effectively,
value creation and appropriation shifted from computer makers to their sup-
pliers and complementors. One of the more interesting examples of a shift in
value creation and appropriation during new games is that of Botox. Before
Botox, cosmetic procedures were performed primarily by surgeons who
charged high specialist fees for the procedure and their suppliers obtained little
or nothing per procedure. Surgery could last hours and patients were put under
anesthetic and after the surgery, it took weeks for the patient to recover fully.
After the FDA approval of Botox in 2002, many cosmetic procedures could be
performed by any doctor using Botox. A vial of Botox cost its maker, Allergan,
$40 and it sold it to doctors for $400, who marked it up to about $2,800.
11
Each vial could be used to treat three to four patients. The Botox procedure
lasted a few minutes and the patient could return to work or other normal
activity the same day. Effectively, the introduction of Botox substituted some of
a cosmetic surgeon’s skills with a product and shifted some of the value creation
and appropriation from cosmetic surgeons to Allergan, their supplier.
104 Strengths and Weaknesses
Latent Link Between Cooperation and Competition
On the one hand, most strategy frameworks are either all about competition or
all about cooperation. Porter’s Five Forces, for example, is all about competi-
tive forces impinging on industry ?rms. Even the versions of the Five Forces
that incorporate complementors say little or nothing about the cooperation
that may exist between industry ?rms and suppliers, buyers, rivals, and poten-
tial new entrants. On the other hand, models of cooperation between ?rms say
very little or nothing about the underlying implicit competition that exists
between the cooperating ?rms. As we argued earlier, where there is cooperation
there is likely to be competition, and where there is competition, there are
probably opportunities for cooperation. For two reasons, these two statements
are even more apropos in the face of new game activities. First, new game
activities, especially those that underpin revolutionary new games, usually have
more uncertainties to be resolved than non-new game activities. Such
uncertainties, especially when they are technological, are best resolved through
some sort of cooperation.
12
Thus, for example, a ?rm that is developing a new
product whose components are also innovations is better off cooperating with
suppliers of such components to resolve product development uncertainties
that they face rather than seeing each supplier only as an adversary over whom
the ?rm wants to have bargaining power.
13
Moreover, competitors in a rela-
tively young market have an incentive to cooperate to grow in the market.
Second, as we saw earlier in this chapter, pro?ting from new game activities
often requires complementary assets, many of which are often obtained
through some form of cooperation; and where there is cooperation to create
value, there is also competition, even if only implicit, to share costs and the
value created.
The Missed Opportunities During Cooperation and
Competition
Effectively then, each time ?rms miss out on an opportunity to cooperate during
competition, they may be missing out on making a larger pie; and each time a
?rm forgets about the implicit competition that is taking place during cooper-
ation, it may be reducing its share of the pie. For example, rather than use its
bargaining power over suppliers and force them to take low prices, a ?rm can
work with the suppliers to reduce their costs and improve the functionality and
quality of the components. In so doing, the ?rm may end up with better com-
ponents that cost less than the previous inferior ones and a supplier that is even
more pro?table and happier than before.
The Whole Grape or a Slice of the Watermelon
One mistake that is easy for coopetitors to make in the face of the competition
that often takes place during cooperation is to forget to think of one’s alterna-
tives. In particular, before dumping your partner because your percentage of the
pie is small relative to your partner’s share and your contribution, think very
carefully about who else is out there with whom you can create a pie. Will the
value that you create with this new partner be as large as the one that you can
Creating and Appropriating Value Using New Game Strategies 105
create with your existing partner? In leaving your existing partner for an out-
sider, you may be leaving 10% of a watermelon for 90% of a grape.
14
Value Creation Using the Internet: Crowdsourcing
An innovating ?rm usually has to interact or collaborate with outside ?rms to
be successful. This process of interaction and collaboration is vastly facilitated
by the use of the Internet and its game-changing value-creation possibilities. We
explore another example of how ?rms can take advantage of the game-
changing nature of the Internet to create value. We start with the captivating
case of Goldcorp Inc.
The Case of Goldcorp Inc.
Don Tapscott and Anthony Williams,
15
and Linda Tischler
16
offer a fascinating
account of how a ?rm can take advantage of a technological innovation such as
the Internet to pursue a revolutionary new game strategy. In 1999, things were
not going very well at Goldcorp Inc., a Toronto-based miner. Rob McEwen, the
?rm’s CEO, believed that the high-grade gold ore that ran through neighboring
mines had to run through his ?rm’s 55,000-acre Red Lake stake. However,
Goldcorp’s geologists had dif?culties providing an accurate estimate of the
value and location of the gold. McEwen took time out from work, and while at
a seminar for young presidents at the Massachusetts Institute of Technology
(MIT) in 1999, he stumbled on a session about the story of Linux and the open-
source phenomenon. He listened absorbedly to how Linus Torvalds and a group
of volunteers had built the Linux operating system over the Internet, revealing
the software’s code to the world and therefore allowing thousands of anonym-
ous programmers to make valuable contributions to building and improving the
operating system. It suddenly dawned on McEwen what his ?rm ought to do. “I
said, ‘Open-source code! That’s what I want!’,” McEwen would later recall.
17
He wanted to open up the exploration process to the world the way the open-
source team had opened up the operating system development process.
McEwen rushed back to Toronto and told his chief geologists his plan—to
put all of their geological data, going back to 1948, on a databank and share it
with the world, and then ask the world to tell them where to ?nd the gold. The
idea of putting their ultra-secret geological data out there, for the public to mess
with, appalled the geologists whose mental logic was deeply rooted in the super
secrecy of this conservative industry. McEwen went ahead anyway and in 2000
launched the “Goldcorp Challenge” with $575,000 in prize money for anyone
out there who could come up with the best estimates and methods for striking
the gold at Goldcorp’s Red Lake property. All 400 megabytes of the ?rm’s
geological data were put on its website.
The response was instantaneous and impressive. More than 1,400 engineers,
geologists, mathematicians, consultants, military of?cers, and scientists down-
loaded the data and went to work. Yes, it wasn’t just select geologists. As
McEwen would later recall, “We had applied math, advanced physics, intelli-
gent systems, computer graphics, and organic solutions to inorganic problems.
There were capabilities I had never seen before in the industry.”
18
The ?ve-judge panel was impressed by the ingenuity of the submissions. The
106 Strengths and Weaknesses
Top winner was a collaborative team of two groups from Australia: Fractal
Graphics of West Perth, and Taylor Wall & Associates of Queensland. They had
developed an impressive three-dimensional graphical model of the mine.
“When I saw the computer graphics, I almost fell out of my chair,” McEwen
would later recall.
19
The contestants identi?ed 110 targets, of which 50% had
not been previously identi?ed. Substantial quantities of gold were found in over
80% of the new targets that had been identi?ed. What is more, McEwen esti-
mated that using the crowd to solve the problem had taken two to three years
off the their normal exploration time, with substantial cost savings to boot.
The gold that Goldcorp had struck, together with its upgraded mines, now
enabled the ?rm to perform up to the potential for which McEwen had hoped
when he bought a majority share in the mine in 1989. By 2001, the Red Lake
mine was producing 504,000 ounces of gold per year, at a cost of $59 per
ounce.
20
Contrast that with a pre-“Gold Challenge” 1996 annual rate of 53,000
ounces at a cost of $360.
Looking to the future, McEwen saw more. “But what’s really important is
that from a remote site, the winners were able to analyze a database and gener-
ate targets without ever visiting the property. It’s clear that this is part of the
future,”
21
he would say.
Crowdsourcing, Wikinomics, Mass Collaboration?
Goldcorp’s outsourcing of the task of analyzing data to estimate the value and
location of gold on its site is a classic example of crowdsourcing. A ?rm is said
to be crowdsourcing if it outsources a task to the general public in the form of
an open call to anyone who can perform the task, rather than outsourcing it to a
speci?c ?rm, group, or individual. The task can be anywhere along any value
chain—from design to re?ning algorithms to marketing. Crowdsourcing has
also been called wikinomics, mass collaboration, and open innovation. It was
?rst coined by Jeff Howe and Mark Robinson of Wired magazine.
22
In 2008,
there was still some disagreement as to what name to give to this phenomenon
in which tasks are outsourced via open calls to anyone in the public who can
perform the tasks. The important thing is that the phenomenon is real and can
be expected to become more and more the center of new games. There are
numerous other examples. Threadless, founded in 2000, depends on the public
to design, select designs, market, and buy its T-shirts. InnoCentive, founded in
2002, acts as a B2B ?rm that outsources R&D for biomedical and pharma-
ceutical companies to other ?rms in other industries and other countries.
Examples of crowdsourcing are not limited to for-pro?t activities. Wikipedia,
the free online encyclopedia, lets anyone provide input. In June 2008, Encyclo-
pedia Britannica also decided to have the public edit its pages. The open source
project in which Linux was developed also falls into this category. Crowd-
sourcing has several advantages:
Public May Be Better
If the best solution to the problem whose solution is being sought requires
radically different ways of doing things, there is a good chance that the public
may hold a better solution than the ?rm seeking the solution. Why? The
Creating and Appropriating Value Using New Game Strategies 107
public is not handicapped by prior commitments, mental frames, and the not-
invented-here syndrome of the outsourcing ?rm that might prevent it from
taking the radical approach. The public is comprised of lots of people with
different backgrounds, mental models, and disciplines, and one of whom may
be the right one for the radical approach needed.
Solution May Already Exist
In some cases, the solution to a problem may already exist outside there, or
someone is already very close to solving the problem. Thus, going outside not
only saves time and money, it can save the ?rm from reinventing the wheel.
Breadth and Depth of Talent
Depending on the task and industry, the breadth and depth of talent out there in
the public may be better than what is available within the outsourcing organiza-
tion or within a speci?c entity chosen by a ?rm to solve the problem. Even the
best ?rms cannot hire everyone that they need. Some of the best talent may
prefer to live in another country, state, or city. Some people may thrive among a
different set of people than that available at the ?rm. Some may prefer to work
only when there is a challenging and interesting problem to solve, and therefore
?nd the con?nes of the outsourcing ?rm inhospitable.
Better Incentive for Competitors
Someone or group in the public may have a better incentive than the ?rm to
solve the problem. Some people may thrive only when there is the possibly of
showing off their skills in a contest. They want to be able to say, “I was the best
in the world.”
Cheaper and Faster
The ?rm gets to pay only for the best solutions. It is effectively paying only for
results. It does not have to pay for any deadwood. For this reason and the others
outlined above, the ?rm’s cost of crowdsourcing is likely to be lower than that
of internal development or cooperation with a speci?c ?rm or individual. The
solution is also likely to be arrived at in a much shorter time.
Signaling
By outsourcing a task to the public, a ?rm is signaling to its coopetitors that it is
going to engage in some activities. For example, if a ?rm’s competitor intro-
duces a new product and the ?rm wants its competitors to know that it has a
similar product on its way, it can crowdsource some of the activities or com-
ponents that go into the upcoming product. In so doing, the ?rm is telling its
loyal customers not to switch to its competitors, since it has a newer and better
product around the corner.
108 Strengths and Weaknesses
Disadvantages of Crowdsourcing
Crowdsourcing also has disadvantages. First, it is more dif?cult to protect one’s
intellectual property when one opens up to the public as much as one has to
when crowdsourcing. There are no written contracts or nondisclosure agree-
ments. Second, crowdsourcing may not be suitable for tasks that require tacit
knowledge since such knowledge cannot be encoded and sent over the Internet.
Tacit knowledge is best transferred in-person through learning-by-doing.
Crowdsourcing may not be ideal for long and complex tasks such as designing
and building an airplane. Such tasks require monitoring, continuous motiv-
ation, and other long-term commitments. Third, it may be dif?cult to integrate
the outsourced solution into an organization that suffers from not-invented-
here syndrome. Fourth, opportunistic competitors can target your calls with
malicious solutions that they know will not work, hoping that you will not be
able to catch them. These disadvantages can be mitigated through the right
management.
New Game Strategies for Profitability
Having explored value creation and appropriation, the question now is: in
pursuing a new game strategy, is there anything that a ?rm can do to increase its
chances of contributing the most to value creation and appropriation and there-
fore its pro?tability? After all, not all ?rms that pursue new game strategies do
well. Yes, it depends on (1) the ?rm’s strengths and handicaps, and (2) how it
performs its new value chain activities while taking advantage of the new
game’s characteristics (Figure 4.3).
Strengths and Handicaps
When a ?rm faces a new game, some of its pre-new game strengths remain
strengths while others become handicaps. These strengths and handicaps then
determine the extent to which the ?rm can perform value chain activities to
create and appropriate value, taking advantage of the characteristics of the new
game (Figure 4.3). Strengths and handicaps can be resources (distribution
channels, shelf space, plants, equipment, manufacturing know-how, marketing
know-how, R&D skills, patents, cash, brand-name reputations, technological
know-how, client or supplier relationships, dominant managerial logic, rou-
tines, processes, culture and so on), or product-market positions (low-cost, dif-
ferentiation, or positioning vis-à-vis coopetitors). A ?rm’s strengths and weak-
nesses in the face of a new game can determine its failure or success. For
example, even in the face of revolutionary technologies, some brands, distribu-
tion channels, and relationships with customers often continue to be strengths
for a ?rm.
23
(In Chapter 5, we will see how a ?rm can determine its strengths
and handicaps in the face of a new game.)
Value Chain and New Game Factors
Given a ?rm’s strengths and handicaps, the question becomes, how can the ?rm
create and appropriate the most value? To answer this question, recall from
Creating and Appropriating Value Using New Game Strategies 109
Chapter 2 that the extent to which activities—any value chain activities—are
likely to contribute optimally to value creation and appropriation is a function
of the extent to which the activities contribute to low cost, differentiation, more
customers, and other drivers of pro?ts; contribute to better position the ?rm
vis-à-vis its coopetitors; take advantage of industry value drivers; build or
translate distinctive resources/capabilities into new value; are parsimonious and
comprehensive. Let us call these factors on which value creation and appropri-
ation depends value chain factors, given that they are about value chain activ-
ities. Since the new game activities that are the cornerstones of any new game
strategy are also value chain activities, their contribution to optimal value cre-
ation and appropriation is also a function of these value chain factors. Add-
itionally, however, the contribution of new game strategies to value creation
and appropriation is also a function of new game factors—a function of the fact
that, as we saw in Chapter 1, new games generate new ways of creating and
appropriating new value; offer an opportunity to build new resources/capabil-
ities or translate existing ones in new ways into value; create the potential to
build and exploit ?rst-mover advantages; attract reactions from new and exist-
ing competitors; and have their roots in the opportunities and threats of an
industry or macroenvironment.
The contributions of a new game strategy’s value chain and new game factors
to value creation and appropriation are shown in Figure 4.3. The value chain
factor makes a direct contribution. However, the new game factor contributes
to value creation and appropriation only indirectly—it contributes by moderat-
Figure 4.3 New Game Activities and Value Creation and Capture.
110 Strengths and Weaknesses
ing the contribution of the value chain component. A moderating variable plays
the role that stirring tea plays. Stirring tea without sugar does not make the tea
sweet. But stirring plays a critical role in the sweetness of the tea when there is
sugar present. Effectively, whether the effect of value chain factors on value
creation and appropriation is large or small is a function of the new game
factors. We now explore how each value chain factor, moderated by new game
factors, impacts value creation and appropriation (Figure 4.3).
Contribute to Low Cost, Differentiation, More Customers, Better
Pricing, and Sources of Revenues
A ?rm can use new game activities, just as it can use any other value chain
activities, to contribute to low cost, differentiation, attracting more customers,
pricing better, and identifying or pursuing the right sources of revenues. How-
ever, since new games generate new ways of creating and/or capturing new
value, a ?rm can take advantage of these new ways by, for example, choosing
those activities that enable it to offer unique value to customers, or to position
itself better vis-à-vis its coopetitors. Doing so is tantamount to occupying a
unique product space or so-called “sweet spot” or “white space” in which there
is little or no head-on competition and therefore less rivalry. This creates an
opportunity for ?rms to better attract the right customers with the right value
and pursue the right pricing strategies and sources of revenue. Also, since new
games create opportunities for a ?rm to build and exploit ?rst-mover advan-
tages, a ?rm can build switching costs at customers if it is the ?rst to move to the
white space. For example, when Dell targeted volume-buying business cus-
tomers as the primary focus for its direct-sales/build-to-order business model, it
built its brand at these customers and performed extra customization tasks for
such ?rms—including the loading of ?rm-speci?c software—efforts that may
have built some switching costs at these customers. Switching costs decrease the
effect of rivalry, the power of buyers, and the threat of potential new entry and
substitutes. They can also increase a customer’s willingness to pay. Thus, build-
ing switching costs as a result of moving ?rst strengthens a ?rm’s position,
thereby improving its ability to create and appropriate value. Switching costs
are easier to build if the ?rm has strengths such as prior relationships with such
customers or a well-established brand.
In pursuing the right pricing strategy, a ?rm can also take advantage of ?rst-
mover advantages. For example, in pharmaceuticals, ?rms that are the ?rst to
discover a new drug in a therapeutic category usually set the price of the drug
very high since there is no similar drug in the market and there is usually a high
willingness to pay in countries where pharmaceutical prices are not regulated.
This practice is called skimming and is meant to allow a ?rm to collect as much
cash as possible before competitors move in with close substitutes. Effectively,
in attracting the right customers using the right bene?ts and pursuing the right
pricing strategies and sources of revenue, a ?rm can build ?rst-mover advan-
tages that will help to amplify its ability to create and appropriate value.
Creating and Appropriating Value Using New Game Strategies 111
Improve its Position vis-à-vis Coopetitors
If a ?rm uses new game strategies to offer its customers unique bene?ts, for
example, it improves its position vis-à-vis coopetitors. Additionally, because the
activities are new game, there is the potential to take advantage of ?rst-mover
advantages to further improve the position. For example, a ?rm can obtain
protection for its intellectual property (patents, copyrights, trade secrets). Such
protection raises barriers to entry into the ?rm’s product-market-space. Also,
because a ?rm’s strategy is new game, coopetitors are likely to react to it by
following or leapfrogging the ?rm, or pursuing any other activities that can
enable them to outperform the ?rm. If, in performing new game activities, a
?rm anticipates and takes into consideration the likely reaction of coopetitors,
the ?rm is more likely to cooperate better or compete with coopetitors. In
pursuing its regular new game strategies, Coke often anticipates what Pepsi’s
reaction is likely to be, and vice versa. In pursuing their regular, position-
building and resource-building new game strategies, Boeing and Airbus often
take each other’s likely reaction into consideration.
As we saw in Chapter 1, prior commitments that competitors make can
prevent them from performing new game activities. Thus, in creating and
appropriating value using new game activities, a ?rm can take advantage of its
competitors’ handicaps. For example, if the new game activity is counterintui-
tive and competitors are prevented by their dominant managerial logic from
understanding the rational behind the activity, a ?rm may want to concentrate
on convincing customers, not competitors, that the idea works. If competitors
are prevented by laws or regulation from performing any activities that would
allow them to catch up with a ?rst mover, the ?rst mover may want to ensure
that such laws or regulations are enforced.
We will have more to say about anticipating and responding to competitors’
likely reactions in Chapter 11 when we explore game theory, coopetition, and
competition.
Take Advantage of Industry Value Drivers
If a ?rm uses new game activities to take advantage of industry value drivers,
the new game factor can also amplify the impact of taking advantage of value
drivers on value creation and appropriation. For example, network size is an
important industry value driver in markets for products/services that exhibit
network externalities. A ?rm that pursues the right new game activities can earn
a large network size by virtue of value chain factors. But because the activities
are new game, the ?rm can take advantage of the opportunity to build new
resources, or build and exploit ?rst-mover advantages. The case of eBay is a
good example. It established a large community of registered users, giving it a
large network size; and because it was the ?rst in the online auctions business, it
was easier to build a brand that reinforced its large network size, making the
effects of its large network size even more valuable in creating and appropriat-
ing value.
A ?rm’s strengths in the face of a new game can also facilitate its ability to
take advantage of industry value drivers. For example, when IBM entered the
PC market, its PC standard quickly became the industry standard, laying the
112 Strengths and Weaknesses
foundation for what would become the Wintel network. One reason why IBM
won the standard (creating a lot of value for the Wintel network) was because it
brought in some important strengths: its brand name reputation and relation-
ships with customers and software developers. The fear of cannibalizing its
mainframe and minicomputer businesses may have negatively impacted IBM’s
ability to appropriate the value created in PCs.
Build and/or Translate Distinctive Resources/Capabilities into Unique
Value
Some of the best new game strategies have been those that were used to build
scarce resources for later use, taking advantage of the new gameness of the
strategies. For example, when Ryanair moved into secondary airports, it could
take advantage of the fact that the operating costs at these airports were low
relative to those at their primary counterparts; but because it was the ?rst to
ramp up its activities at many of these airports, Ryanair was able to take up
most of the gates and landing slots at the airports, thereby preemptively locking
up important resources that would anchor its operations. Once the ?rm had a
network of such airports, it became dif?cult for its competitors to replicate the
network. Because it was the ?rst to pursue digital animation technology, Pixar
had a chance to cooperate with Disney and take advantage of its storytelling
capabilities and distribution channels to complement its digital animation tech-
nology so as to create the likes of Toy Story and Finding Nemo.
Are Parsimonious and Comprehensive
It costs money to pursue a new game—to effect change. Therefore a ?rm should
perform only the activities that are necessary—the activities that contribute
enough towards value creation and appropriation, given their costs; that is, the
activities that a ?rm performs should be parsimonious. For example, Airbus’s
decision to build the A380 was to occupy the white space for long-range planes
that carry 500–800 passengers and operate at lower costs than existing planes
(20% less cost per passenger). This was a good new game strategy. However,
the company ended up performing some activities in a way that it should not
have performed them and that cost it dearly. For example, the ?rm ended up
with two incompatible computer-aided design (CAD) systems, one German and
the other French, that led to mistakes in the design of the A380’s wiring har-
nesses.
24
This necessitated redoing the CAD systems with their associated delays
and extra costs. Because of such activities, the ?rm was two years late in deliver-
ing the ?rst plane and racked up large cost overruns. Moreover, when word
of the mistake came out, the parent company’s stock (EADS’ stock) dropped
by 26%.
25
A ?rm must also make sure that it is performing the activities that it ought to
be performing. To determine which activities it ought to be performing, the ?rm
can perform an AVAC analysis and from it, perform the activities that reverse
the Noes into Yesses, and reinforce the Yesses.
To summarize, a ?rm’s ability to create and appropriate value in the face of a
new game depends on, (1) value chain factors that arise by virtue of the fact that
new game activities are value chain activities, and (2) new game factors
Creating and Appropriating Value Using New Game Strategies 113
that arise by virtue of the fact that new game activities have a new game com-
ponent. Value chain factors contribute directly to value creation and appropri-
ation while new game factors moderate this contribution. Both components rest
on a ?rm’s pre-new game strengths that remain strengths or become handicaps
in the face of the new game.
Key Takeaways
•
Strategy is about creating and appropriating value.
•
A ?rm creates value when it offers customers something that they perceive
as valuable (bene?cial) to them and the cost of offering the bene?ts does not
exceed them. The value appropriated (captured) is the pro?t that a ?rm
receives from the value it created.
•
As the case of many authors and musicians suggests, many ?rms or indi-
viduals that create lots of value get to appropriate only a small fraction of it.
A ?rm may not be able to appropriate all the value that it creates because: it
lacks complementary assets, does not have bargaining power over its
coopetitors, the value is easy to imitate, it has the wrong pricing strategy, or
it does not have enough valuable customers that want the bene?ts it offers.
•
Value creation is often undertaken by coopetitors, not one ?rm. Thus, ?rms
often have to cooperate to create value and compete to appropriate it.
Where there is cooperation, there is likely to be competition; and where
there is competition, there are opportunities to cooperate.
•
The value added by many exporting countries is often a lot less or more
than the export value attributed to them.
•
In the face of new game activities, there are likely to be opportunities for
cooperation during competition; and during cooperation, there is always
implied competition.
•
In the competition to appropriate value that takes place during cooperation,
it is important not to forget to think of what one’s alternatives are; that is,
before dumping your partner because your percentage of the pie is small,
think very carefully about who else is out there that you can create a pie
with. How much more pie will cooperation with your new partner create
and how much of it will you get? In leaving your existing partner for an
outsider, you may be leaving 10% of a watermelon for 90% of a grape.
•
A new game can shift value creation and appropriability along a value
system.
•
Firms usually have pre-new game strengths that can remain strengths or
become handicaps in the face of a new game.
•
Creating new value does not always mean outdoing competitors with prod-
ucts that have superior attributes. A ?rm can also locate in a unique market
position through reverse positioning. In reverse positioning, a ?rm strips
off some of a product’s major attributes but at the same time, adds new
attributes that may not have been expected.
•
The contribution of new game activities to a ?rm’s value creation and
appropriation depends on its strengths and handicaps in the new game, and
both the value chain factors and the new game factors of the new game
activities. The effect of the new game factor is a moderating one.
•
By virtue of being value chain activities, new game activities can:
114 Strengths and Weaknesses
1 Contribute to low cost, differentiation, and other drivers of
pro?tability.
2 Improve position vis-à-vis coopetitors.
3 Take advantage of industry value drivers.
4 Build and translate distinctive resources/capabilities into new value.
5 Be parsimonious and comprehensive.
•
The impact of each value chain factor on value creation and appropriation
is moderated by each new game factor. That is, the magnitude and direction
of the impact of each value chain factor on a ?rm’s ability to create and
appropriate value is a function of whether the ?rm:

Takes advantage of the new ways of creating and capturing new value
generated by change.

Takes advantage of opportunities generated by change to build new
resources or translates existing ones in new ways.

Takes advantage of ?rst-mover’s advantages and disadvantages, and
competitors’ handicaps that result from change.

Anticipates and responds to coopetitors’ reactions to its actions.

Identi?es and takes advantage of opportunities and threats from com-
petitive, macro and global environments.
Key Terms
Coopetition
Crowdsourcing
Customer’s reservation price
Industry value driver
New game factors
Reverse positioning
Skimming
Value appropriated
Value chain factors
Value created
Questions
1 Table 4.2 overleaf shows the eight most expensive components/inputs of the
30 GB Video iPod that Apple introduced in October of 2005. According to
Portelligent Inc, the product had 451 components, with a total cost of
$144.40.
26
The iPod retailed for $299. Assuming a wholesale discount of
25%, what is the value appropriated by Apple and each of the suppliers.
How much value is captured by each country? How much of that value is
added by each actor?
2 How can a ?rm take advantage of ?rst-mover disadvantages?
Creating and Appropriating Value Using New Game Strategies 115
Table 4.2 October 2005 Top 8 Most Expensive Components/Inputs of a 30GB iPod
Component/Input Supplier Firm’s country HQ Manufacturing
location
Price (US$)
Hard drive Toshiba Japan China 73.39
Display module Toshiba-
Matsushita
Japan Japan 20.39
Video/multimedia processor Broadcom USA Taiwan or
Singapore
8.36
Portal player CPU PortalPlayer USA US or Taiwan 4.94
Insertion, test, and assembly Inventec Taiwan China 3.70
Battery pack Unknown 2.89
Display driver Renesas Japan Japan 2.88
Mobile SDRAM 32 MB
memory
Samsung Korea Korea 2.37
Source: Linden, G., Kraemer, K.L., & Dedrick, J. (2007). Who captures value in a global innovation system? The case of
Apple’s iPod. Retrieved July 10, 2007, from http://www.teardown.com/AllReports/product.aspx?reportid=8.
116 Strengths and Weaknesses
Resources and Capabilities in the
Face of New Games
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
De?ne tangible, intangible, and organizational resources as well as capabil-
ities and core competences.
•
Begin to understand the strategic signi?cance of network externalities.
•
Understand the signi?cance of complementary assets in the face of new
games.
•
Use the AVAC (Activities, Value, Appropriability, and Change) framework
for exploring the pro?tability potential of resources/capabilities.
•
Understand how to narrow down the list of complementary assets, capabil-
ities, core competences, or any other resource to important ones.
•
Understand the basic role of resources as a cornerstone of competitive
advantage.
Introduction
To create value and position itself to appropriate the value, a ?rm needs
resources. For example, behind the Google search engines that some surfers
perceive as giving them more relevant search results than competitors’ engines
are skills and know-how in software and computer engineering, patents, trade-
marks, trade secrets, banks of servers, the Google brand, equipment, and other
resources without which the relevant searches and the ?rm’s ability to monetize
the searches would not be possible. To operate out of secondary uncongested
airports in the European Union (EU), Ryanair had to acquire the gates and
landing rights at these airports, build relationships with local of?cials, obtain
the airplanes, and build the right low-cost culture. A pharmaceutical company
such as Merck or Elli Lilly needs well-equipped R&D laboratories, scientists,
and patents to be able to produce blockbuster drugs such as Zocor or Prozac
that customers ?nd valuable. To make its cola drinks readily available to cus-
tomers whenever they want them, Coca Cola needs shelf space at its distribu-
tors and contracts with its bottlers. However, resources in and of themselves do
not customer bene?ts and pro?ts make. Firms must also have the capabilities or
ability to turn resources into customer value and pro?ts. For ExxonMobil to
make money, it needs resources such as exploration rights, sophisticated
exploration equipment, geologists as well as an ability to ?nd oil and turn it into
something that its customers want. In the face of new games, ?rms have an
Chapter 5
opportunity to build new valuable resources or translate existing ones in new
ways into new unique value.
In this chapter, we explore the critical role that resources and capabilities can
play in a ?rm’s value creation and appropriation. In particular, we explore the
role of resources in the face of new games. We start the chapter by de?ning
resources and capabilities, and by exploring what makes one resource more
pro?table than others. We then examine the role of resources in the face of new
games. In particular, we explore the role of complementary assets as a driver of
pro?tability during new games.
Resources and Capabilities
Resources
Creating and appropriating value requires resources (or assets) such as plants,
equipment, patents, skilled scientists, brand name reputation, supplier rela-
tions, geographic location, client relations, distribution channels, trade secrets,
and so on. Resources can be classi?ed as tangible, intangible, or organiza-
tional.
1
Tangible resources are the resources that are usually identi?ed and
accounted for in ?nancial statements under the category “assets.” They can be
physical, such as plants and equipment or ?nancial such as cash. Intangible
resources are the nonphysical and non?nancial assets such as patents, copy-
rights, brand name reputation, trade secrets, research ?ndings, relationships
with customers, shelf space, and relationships with vendors that are not
accounted for in ?nancial statements and cannot be physically touched.
2
Intangible resources are usually not identi?ed in ?nancial statements but can be
excellent sources of pro?ts. For example, a patent or trade secret that enables a
?rm to occupy a unique product space and therefore earn monopoly rents is not
listed as an asset in ?nancial statements. That is usually the case with important
drug discoveries in pharmaceuticals in the USA where patented drugs enjoy
intellectual property protection and can earn companies billions of dollars.
Intangible resources are also referred to as intangible assets or just intangibles.
Organizational resources consist of the know-how and knowledge embodied in
employees as well as the routines, processes, and culture that are embedded
in the organization.
Capabilities
Although resources are critical to value creation and appropriation, resources in
and of themselves are not enough to make money. A ?rm also needs to have the
ability to transform resources into customer bene?ts. Customers are not likely
to scramble to a ?rm’s doors because the ?rm has modern plants, geniuses, and
patents. The ?rm has to use the plants, geniuses, and the knowledge and protec-
tions embodied in its patents to offer customers something that they value.
Patients do not buy patents or skilled scientists from pharmaceutical com-
panies; they buy medicines that have been developed by skilled scientists using
knowledge embodied in patents and the patents help to give ?rms monopoly
rights over the patent life of the drug. Effectively, resources usually have to be
converted into bene?ts that customers want. A ?rm’s ability to transform its
118 Strengths and Weaknesses
resources into customer bene?ts and pro?ts is usually called a capability. For
example, a pharmaceutical company’s ability to turn patents and relationships
with doctors into blockbuster drugs and pro?ts is a capability. Capabilities
often involve the use or integration of more than one resource.
3
In the literature
in strategic management, there is some disagreement as to how to de?ne
resources, capabilities, and competences.
4
Some scholars de?ne them the way
we have here. Others argue that resources include assets, capabilities, and com-
petences. The central theme remains the same: that performing activities to
create value and position a ?rm to appropriate the value requires resources and
some ability to translate them into customer bene?ts. The names given to the
resources and their transformation should not matter that much.
Core Competences
The phrase “core competence” was coined by Professors C.K. Prahalad of the
University of Michigan and Gary Hamel of Strategos and the London Business
School to designate a resource or capability that meets the following three
criteria.
5
The resource or capability:
1 Makes a signi?cant contribution to the bene?ts that customers perceive in a
product or service.
2 Is dif?cult for competitors to imitate.
3 Is extendable to other products in different markets.
Core competences include technological know-how, relationships with coopeti-
tors, and an ability to integrate different activities or translate resources into
products. A popular example of core competence is Honda’s ability to build
dependable smooth-running internal combustion engines. It meets all three cri-
teria. First, each Honda engine makes a signi?cant contribution to the bene?ts
that customers perceive in the Honda product. Second, although other ?rms
have internal combustion engine capabilities, it is dif?cult to replicate the level
of Honda’s engine capabilities. Third, Honda has been able to use its engine
capabilities to offer motorcycles, cars, lawnmowers, marine vehicles, electrical
generators, and small jets. The phrase “core competence” is often used by
individuals and ?rms to refer to what one does very well. One implication of the
concept of core competence is that competition is not only important in the
product market that a ?rm occupies but also in the factor markets for com-
petences that a ?rm can build and leverage in many markets.
Network Externalities Effects
With the growing importance of technologies such as the Internet, computers,
cell phones, video games, and so on, resources that are associated with network
externalities effects have become increasingly important. In this section, we
explore network externalities.
Resources and Capabilities in the Face of New Games 119
Definition and Role of Size
The value of a product to customers usually depends on the attributes of the
product in question.
6
However, for some products, customer value depends not
only on product attributes but also on the network of consumers that use the
product or a compatible one; that is, a technology or product exhibits network
externalities effects if the more people that use it, the more valuable it becomes
to each user.
7
Telephones exhibit network externalities since their value to each
user increases with the number of people that are on the network. Applications
software products such as Adobe’s Acrobat (for creating and reading pdf ?les)
exhibit network externalities because the more people that own the software
that can read pdf ?les, the more useful is each user’s software for creating and
mailing pdf ?les. In an auction network, the more sellers that are in the net-
work, the more valuable that the network is to each buyer. Such network
externalities effects are called direct effects because the bene?ts that each user of
a product derives from the network of other users come directly from the net-
work—from interacting (economically or socially) with other actors within the
network.
Products that need complements also exhibit network externalities. Take
computers, for example. The more people that own computers of a particular
standard such as the Wintel standard, the more software that is likely to be
developed for them, since developers want to sell to the large number of users;
and the more software that is available for a computer standard, the more
valuable the computers are to users, since software is critical to computers. Such
externalities are called indirect externalities because the increased value experi-
enced by each user is indirect, through increased availability of complements.
How valuable is size to a network? Theoretical estimates of the value of
network size have been as high as N
2
and N
N
(where N is the number of users in
the network).
8
However, a larger network size does not always mean more
value for customers. For example, a network in which there is only one seller
and the rest are buyers (e.g. Amazon books) is not as valuable to each user as
one in which there are many sellers and many buyers (e.g. eBay). The value of a
network to each member may actually decrease with increasing size if each new
member is dishonest. In general, the structure and nature of a network may be
just as important as its size.
9
Structure
The structure of a network is the pattern of relationships between the players in
the network. In a consumer-to-consumer (C2C) auction network, any con-
sumer can be a seller or buyer. This structure contrasts with that of a business-
to-consumer (B2C) online retail network in which one seller sells to many
buyers. Thus, while both types of network are valuable to customers, the C2C
network is more valuable to each buyer than the B2C one, since buyers in the
latter network only have one seller from whom to buy while those in the former
have many sellers from whom to choose. A network with both sellers and
buyers belongs to a group of networks called two-sided networks. A two-sided
network has two distinct user groups that provide each other with bene?ts.
10
There are numerous other examples of two-sided networks. A credit card net-
120 Strengths and Weaknesses
work has two groups: cardholders and merchants. A video game network has
two groups: gamers and game developers. Users of pdf ?les consist of creators
of pdf ?les and readers of pdf ?les. In a single-sided network, there is only one
type of user. Examples include telephone networks, e-mail, and Faxes.
Nature of Network
The value of a network also depends on the conduct of the players within the
network. For example, the reputation of a network also matters. Although
the size of eBay’s network is large, one reason why some customers may ?nd the
network more valuable than another network of equal size is its reputation for
safety and its brand as the place for auctions. The company built the reputation
partly by rating sellers and buyers, a practice that may have selectively kept out
some potential opportunistic members and discouraged some members from
behaving opportunistically.
Exploiting Network Externalities
What if a technology or product exhibits network externalities? Although the
value of a network to users increases with the number of other users, it is
usually the provider of the network that makes most of the money from the
network. Google is the provider of its two-sided network of surfers who use its
search engine and advertisers who value the surfers’ eyeballs. Banks pro?t from
their networks of borrowers and depositors. The question is: what can a pro-
vider of the network infrastructure and service do to have a network that
increases its chances of pro?ting from the network? Firms can (1) exploit direct
network effects by building an early lead in network size and reputation, (2)
price strategically, and (3) take advantage of indirect network effects by boost-
ing complements.
Exploit Direct Network Effects by Building an Early Lead in Size and
Reputation
The idea here is simple. Since an early lead in a network market share can
escalate into a dominant market position, a ?rm may want to pursue the kinds
of actions that would give its products/service a critical market share or
installed base lead. One such action is to team up with other ?rms to ?ood the
market with one’s version of the product/technology. A classic example is that
of Matsushita, which freely licensed its VHS video cassette recording technol-
ogy, while competitor Sony kept its Beta technology proprietary. Effectively,
Matsushita ?ooded the market with VHS sets and may have tipped the scales
away from Sony’s Betamax, in favor of VHS.
11
Another tactic is to build an
early reputation as the safe place to sell or buy as eBay did.
Price Strategically
A ?rm’s pricing strategy can also play an important role in increasing the size of
its network. In one-sided networks, a supplying ?rm (provider of network) can
pursue penetration pricing in which it initially sells its network product/services
Resources and Capabilities in the Face of New Games 121
at very low prices and makes money by raising prices later or offering related
products for which customers have a higher willingness to pay. In two-sided
networks, the platform provider can set the price of the service/product low for
the group with a lower willingness to pay but with the potential to increase the
number of users on the other side. It can then charge the side with a higher
willingness to pay.
12
For example, surfers who conduct Web searches on Google
have a lower willingness to pay for the searches than advertisers’ willingness to
pay for searchers’ “eye balls.” Thus, searches on Google are free but advertisers
are charged. Adobe gave away its reader software to anyone who wanted to be
able to read pdf ?les, but charged anyone who wanted to create pdf ?les.
Exploit Indirect Network Effects by Boosting Complements
Since, early in the life of a network technology, there potentially exists a
chicken-and-egg cycle in which complementors prefer to develop complements
for the product with many users, and users want the product with many com-
plements, the cycle can be jumpstarted by boosting the number of complements.
Thus, for example, a supplier of the network product might produce some of
the complements itself, help the complementor distribute complements, co-
develop complements with complementors, or ?nance the activities of startup
complementors.
Example: Social Networking Websites
A social network is made up of individuals or organizations that are linked by
one or more factors such as values, types of economic exchange, friendship,
political orientation, social views, profession, likes and dislikes, and so on. In
2008, there were numerous social networking websites: Myspace, Facebook,
classmates.com, broadcaster.com, Mixi, Cyworld, Reunion, Tagged.com, and
Orkut, to name a few. One of the questions asked in 2008 was, how valuable
were these networks to users and to the owners of the websites?
Answer to Social Network Question
The size of each social network is important to each member. The question is,
how much? Each of these websites enables different groups of people within the
network to have their own subnetworks within the larger network. Each sub-
network can be made up of college friends, members of a certain church, people
living in the same area, etc. Once a subnetwork is formed, additional members
to the larger network do not necessarily increase the value of the network to
every subnetwork member. For example, a new member who joins the network
because of religious interests may not necessarily add value to members whose
primary af?liation is the college they attended. Contrast that with a C2C net-
work where the addition of each new member increases the value to each
member.
However, for several reasons, a social network may be very valuable to
advertisers and therefore to the owner of the website. First, because a sub-
network within a social network is usually made up of members with the same
values, interests, etc., they are likely to be a better subgrouping for marketers
122 Strengths and Weaknesses
than age groups. For example, there are likely to be more similarities among
doctors to whom one wants to market a health product than among the much-
coveted 18–34-year age group. Second, although members of a social network
may not be willing to watch ads, the effect of marketing on them can still be
high. Why? People are more likely to believe product recommendations from
friends, colleagues, and other people whom they trust and respect than they are
to believe advertisements. This is particularly true for experience goods—goods
whose characteristics are ascertained only after consumption since it is dif?cult
to observe their characteristics in advance. Thus, all that it takes is an ad that
will convince a few members of the subnetwork and the members can spread
the idea themselves. For example, doctors often depend more on opinion lead-
ers for prescription information than they do on direct advertising to them.
13
Thus, in marketing to a social network of physicians, one can focus on the
opinion leaders and they can recommend the product to the rest of their
network.
Effectively, since people are more likely to believe someone whom they trust
and respect than an ad from a ?rm, well-targeted social networks can be much
better places to pitch an idea than nonsocial networks. If someone who knows
your interests and whom you trust recommends a product to you, you are more
likely to believe the person than an advertiser. Third, each member of a social
network provides information about his/her interests and so on. This is infor-
mation that ?rms usually spend lots of money trying to collect. Thus, rather
than pay for keywords associated with products, as is the case with paid-
listings, an advertiser may be able to pay for key words related to customers’
interests and the characteristics of its subnetwork.
Role of Resources in the Face of New Games
Having de?ned resources and capabilities, we now turn to a basic question:
What is the role of resources and capabilities during value creation and
appropriation in the face of new games? Recall that new games are about
performing new value chain activities, or performing existing value chain activ-
ities differently. We can group the resources that a ?rm needs to pursue a new
game strategy into two categories: (1) The ?rst category is made up of the
resources that underpin the new activities or the ability to perform existing
activities differently. Since performing new activities or existing ones differently
usually results in an invention or discovery, or something new, we will call the
resources that underpin such activities invention resources. The resources that
Google used to develop the search engines that deliver more relevant searches
than competitors’ search engines fall into this invention resources category. (2)
The second category consists of complementary assets—all the other resources,
beyond invention resources, that a ?rm needs to create value and position itself
to appropriate the value in the face of the new game. Complementary assets
include brands, distribution channels, shelf space, manufacturing, relationships
with coopetitors, complementary technologies, installed base, relationships
with governments, and so on. Effectively, both invention resources and com-
plementary assets play important roles in a ?rm’s ability to pro?t from an
invention.
Resources and Capabilities in the Face of New Games 123
Complementary Assets
Professor David Teece of the University of California at Berkeley was one of the
?rst business scholars to explore the role of complementary assets in pro?ting
from inventions or discoveries.
14
He was puzzled as to why EMI invented the
CAT scan—an invention that was so important that Sir Godfrey Houns?eld
won the 1979 Nobel Prize in Medicine for its invention—and yet, GE and
Siemens, not EMI, the inventor, made most of the pro?ts from the invention. He
was also puzzled as to why R.C. Cola had invented diet and caffeine-free colas,
and yet Coke and Pepsi made most of the pro?ts from the two inventions.
Professor Teece argued that to make money from an invention or discovery, two
factors are important: complementary assets and imitability. Complementary
assets, as de?ned above, are all the other resources, beyond those that underpin
the invention or discovery, that a ?rm needs to create value and position itself to
appropriate the value in the face of the new game. For example, in pursuing its
direct-sales and build-to-order new game activities, Dell needed manufacturing
processes that would enable it to manufacture a customer’s computer in less
than two hours once the order had been received. It also needed good relation-
ships with suppliers who supplied components just-on-time, for example,
delivering monitors directly to customers. Later, Dell also needed a brand. In
pursuing DTC marketing for its Lipitor, P?zer also needed a sales force to call
on doctors, and manufacturing to produce the drug once doctors started pre-
scribing it. Dell’s manufacturing processes, brand, and its supplier relationships
are complementary assets. So are P?zer’s manufacturing capabilities and sales
force. Imitability comes into the pro?tability picture for the following reason. If
the invention or discovery from a ?rm’s new game activities can be imitated by
competitors, customers may go to competitors rather than the ?rm, thereby
reducing the ability of the ?rm to appropriate the value that it creates. These
two variables—complementary assets and imitability—form the basis for the
Teece Model, which we now explore.
The Teece Model: The Role of Complementary Assets and
Imitability
15
The elements of the Teece Model are shown in Figure 5.1. The vertical axis
captures the extent to which an invention or discovery can be imitated while the
horizontal axis captures the extent to which complementary assets are scarce
and important. When imitability of an invention or discovery is high and com-
plementary assets are easily available or unimportant, it is dif?cult for the
inventor (?rst mover) to make money for a long time (Cell I in Figure 5.1). That
is because any potential competitors that want to offer the same customer
bene?ts that the ?rm offers can easily imitate the invention and ?nd the com-
plementary assets needed. A new style of jeans for sale on the Internet is a good
example. It is easy to imitate new jeans styles and selling them on the Internet is
not unique or distinctive to any one ?rm. Thus, it is dif?cult to make money for
a long time selling a particular style of jeans on the Internet. Effectively, it is
dif?cult to make money in situations such as Cell I.
If, as in Cell II, the invention is easy to imitate but complementary assets are
scarce and important, the owner of the complementary assets makes money.
124 Strengths and Weaknesses
That is because even though competitors can imitate the invention, they cannot
easily replicate the complementary assets. More importantly, the owner of the
important complementary assets can easily imitate the invention but its com-
plementary assets are dif?cult to imitate. The invention of CAT scans by EMI
falls into this category. The invention was easy to imitate but complementary
assets such as relationships with hospitals, sales forces, brands, and manu-
facturing were scarce and important to selling the machines to hospitals. The
inventions of diet and caffeine-free colas by R.C. Cola also fall into this cat-
egory. Both inventions required brand name reputations, shelf space, market-
ing, and distribution channels which are important to making money from soft
drinks but are tightly held by Coca-Cola and Pepsi. Thus, Coke and Pepsi have
pro?ted the most from diet and caffeine-free colas. Light beer offers another
good example. The Miller Brewing Company and Budweiser did not invent
light beer even though they make the most money from it. It was invented by Dr
Joseph Owades at Rheingold Breweries. But because Miller and Budweiser had
the complementary assets, they ended up making more money from it than
Rheingold.
If imitability of an invention is low and complementary assets are important
and scarce, one of two things could happen (Cell III). If the inventor also has the
complementary assets, then it stands to make lots of money from its invention.
Patented pharmaceutical products in the USA are a good example because their
intellectual property protection keeps imitability low, and good sales forces,
ability to run clinical tests, and other complementary assets are important to
delivering value to customers are scarce. If the ?rm that has the scarce comple-
mentary assets is different from the inventor, both ?rms will make money if they
cooperate. If they do not cooperate, their lawyers could make all the money.
Finally, as in Cell IV, if imitability of the invention is low but complementary
assets are freely available or unimportant, the inventor stands to make money
(Cell IV). Popular copyrighted software that is offered over the Internet would
Figure 5.1 The Role of Complementary Assets.
Resources and Capabilities in the Face of New Games 125
fall into this category since its copyright protects it from imitation and the
Internet, as a distribution channel for software, is readily available to software
developers and other complementary assets are either not scarce or are
unimportant.
Effectively, ?rms with scarce and important complementary assets are often
the ones that pro?t the most from new game activities, whether they moved ?rst
in performing the new game activities or were followers. Having important
scarce complementary assets is one of the hallmarks of exploiters. Microsoft did
not invent word processing, spreadsheets, presentation software, windowing
operating systems, etc., even though it makes a lot of money from them. Its
complementary assets, especially its installed base of compatible software, have
been a primary driver of its success.
Strategic Consequences
An important strategy question is, what should a ?rm do if it found itself in one
of the situations depicted in Figure 5.1. For example, what should R.C. Cola
have done to pro?t better from its invention of diet cola, given that the inven-
tion was easy to imitate and complementary assets were scarce and important?
In that case (Figure 5.2, quadrant II), the ?rm may have been better off teaming
up with a partner that had the complementary assets. Teaming up can be
through a joint venture, strategic alliance, or a merger through acquisition. If an
inventor decides to team up, it may want to do so early before the potential
partner with complementary assets has had a chance to imitate the invention or
come up with something even better. The question is, why would a ?rm with
complementary assets want to team up with an inventor if it knows that it can
imitate the invention later? The inventor has to show the owner of the comple-
mentary assets why it is in their joint interest to team up. For example, R.C.
Cola could have gone to Pepsi and explained that teaming up with it (R.C.
Figure 5.2 Strategies for Exploiting Complementary Assets.
126 Strengths and Weaknesses
Cola) would allow Pepsi to have a ?rst-mover advantage in diet drinks before
Coke and therefore give Pepsi a chance at beating Coke.
Effectively, in Cell II where an invention (from new game activities) is easy
to imitate and complementary assets are important and scarce, the inventor
is better off teaming up with the owner of complementary assets through
strategic alliances, joint ventures, acquisitions, or other teaming-up mechanisms
(Figure 5.2).
If an invention is dif?cult to imitate and complementary assets are scarce but
important (Cell III of Figure 5.2), the inventor can pursue one of two strategies:
block or team-up. If the inventor also owns the scarce complementary assets, it
can block rivals and potential new entrants from having access to either. In a
block strategy, a ?rm defends its turf by taking actions to preserve the inimit-
ability of its invention or valuable resources. If another ?rm (other than the
inventor) has the complementary assets, both ?rms can team up using strategic
alliances, joint ventures, acquisitions, or other teaming-up mechanisms. In the
pharmaceutical industry, for example, many biotechnology startups usually
develop new drugs whose patents limit imitability. However, many of these
startups do not have complementary assets such as sales/marketing, and the
resources needed to carry out the clinical testing that is critical to getting a new
drug approved for marketing in the USA. Consequently, there is a considerable
amount of teaming up between biotech startups and the established large
pharmaceutical ?rms that have the complementary assets. Many startups offer
themselves to be bought. If the inventor of a dif?cult-to-imitate invention and
the owner of scarce and important complementary assets decide not to cooper-
ate and instead ?ght, there is a good chance that they will make their lawyers
rich—they dissipate rather than create value.
If an invention is dif?cult to imitate but complementary assets are abundant
or unimportant (Cell IV), a ?rm may be better off pursuing a block strategy in
which it tries to prevent potential competitors from imitating its invention or
strategy. If the invention is easy to imitate and complementary assets are abun-
dant or unimportant (Cell 1), a ?rm can pursue a so-called run strategy. In a run
strategy, the inventor or ?rst mover constantly innovates and moves on to the
next invention or new game activity before competitors imitate its existing
invention or new game activity.
Dynamics
There are two things to note about the strategies of Figure 5.2. First, in practice,
many ?rms pursue at least two of these strategies at any one time. For example,
many ?rms pursue both block and run strategies at any one time—they defend
their intellectual property for an existing product while forging ahead with the
next invention to replace the existing product being protected. Second, a ?rm
can sometimes go contrary to what Figure 5.2 suggests to lay a foundation for
future gains. For example, an inventor may decide to team-up in Cell IV, rather
than block as suggested by the framework, so as to win a standard and block
after winning the standard. Intel’s case offers a good example of both instances.
In the late 1970s and early 1980s, it encouraged other microprocessor makers
to copy its microprocessor architecture. When its architecture emerged as the
standard, Intel started blocking—it decided not to let anyone imitate its
Resources and Capabilities in the Face of New Games 127
technology again and sued anyone who tried to.
16
It also practiced the run
strategy by introducing a new microprocessor generation before unit sales of an
existing generation peaked. Effectively, Intel teamed up early in the life of its
microprocessor to win a standard. After winning the standard, it started block-
ing and running.
Limitations of the Teece Model
It is important to note that although the Complementary Assets/Imitability
model can be very useful, it has limitations. Like any model, it makes some
simplifying assumptions that may not apply to all contexts all the time. For
example, it assumes that the only two variables that underpin appropriability
are complementary assets and imitability. It leaves out the other determinants
of appropriability that we explored in Chapter 4 such as a ?rm’s position vis-à-
vis coopetitors, pricing strategy, and the activities to increase the number of
customers that buy a particular product. It is true that an inimitable product
and scarce important complementary assets can give their owner some bargain-
ing power over customers; but they may not give the ?rm bargaining power
over suppliers, complementors, or customers with monopoly power in their
industry. Moreover, even where a ?rm has unchallenged power over its coopeti-
tors, it may still leave money on the table if it has the wrong pricing strategy.
Profitability Potential of Resources and Capabilities
From what we have seen so far, resources and capabilities—be they invention
resources or complementary assets—are critical to creating and appropriating
value in the face of new games; but if you were to ask a ?rm to give you a list of
its resources, you would probably be handed a very long list. Thus, an import-
ant question is, how can a ?rm narrow down the list of resources to those that
have the most potential for pro?tability? How can a ?rm narrow its catalog of
competences to only those that are truly core? We need some way to narrow
down the list of potentially pro?table resources/capabilities. The AVAC frame-
work that we saw in Chapter 2 can be used to rank-order resources/capabilities
as a function of their potential to contribute to value creation and appropri-
ation. The idea is to evaluate the potential of each resource to contribute to a
?rm’s competitive advantage and rank it accordingly. Each resource is ranked
by answering the following questions and determining the strategic con-
sequence of having the resource (Table 5.1):
a Activities: does the ?rm have what it takes to ef?ciently perform the activ-
ities for building and/or translating the resource/capabilities into customer
bene?ts and/or positioning the ?rm to appropriate value? Is the ?rm per-
forming the right activities?
b Value: does the resource/capability make a signi?cant contribution towards
the bene?ts that customers perceive as valuable to them?
c Appropriability: does the ?rm make money from the value that customers
perceive in the bene?ts from the resource?
d Change: do the activities for building and exploiting the resource take
advantage of change (present or future) to create and appropriate value?
128 Strengths and Weaknesses
Activities
In assessing the pro?tability potential of a resource/capability, the ?rst ques-
tion is, does the ?rm have what it takes to ef?ciently perform the activities for
building and/or translating the resource/capabilities into customer bene?ts and/
or positioning the ?rm to appropriate value; that is, is the ?rm performing the
right activities? The idea here is (1) to identify the activities that the ?rm uses to
build or translate the resource into customer bene?ts and/or better position the
?rm to appropriate value, and (2) to examine the ?rm’s ability to perform these
activities by determining the extent to which each activity:
•
Contributes to low cost, differentiation, better pricing, reaching more cus-
tomers, and better sources of revenue.
•
Contributes to improving its position vis-à-vis coopetitors.
•
Takes advantage of industry value drivers.
•
Contributes to building new distinctive resources/capabilities or translating
existing ones into unique positions and pro?ts (including complementary
assets).
•
Fits the comprehensiveness and parsimony criteria.
Table 5.1 Rank Ordering Resources/Capabilities by Competitive Consequence
Resource/
Capability
Activities: Does the
firm have what it takes
to efficiently perform
the activities for
building and/or
translating its search
engine capabilities into
customer benefits
and/or positioning the
firm to appropriate
value?
Value: Does
the resource
make a
significant
contribution
towards the
benefits that
customers
perceive as
valuable to
them?
Appropriability:
Does the firm
make money
from the value
that customers
perceive in the
benefits from
the resource?
Change: Do
the activities
for building
and exploiting
the resource
take
advantage of
change to
create and
appropriate
value?
Strategic
consequence
Resource/cap-
ability 1
Yes Yes Yes Yes Sustainable
competitive
advantage
Resource/cap-
ability 2
Yes Yes Yes No Temporary
competitive
advantage
Resource/cap-
ability 3
Yes Yes No Yes Competitive
parity
Resource/cap-
ability 4
Yes Yes No No Competitive
parity
Resource/cap-
ability 5
No/Yes No Yes No Competitive
parity
Resource/cap-
ability 6
No No No No Competitive
disadvantage
Strategic
action
What can a firm do to reinforce the Yesses and reverse or dampen
the Noes, and what is the impact of doing so?
Resources and Capabilities in the Face of New Games 129
These are the Activities questions of an AVAC analysis.
Value
The next question is, does the resource make a signi?cant contribution towards
the bene?ts that customers perceive as valuable to them, relative to value from
competitors? This question is answered by exploring the Value component of
the AVAC framework. This means exploring the following questions:
•
Do customers perceive the value created by the strategy as unique?
•
Do many customers perceive this value?
•
Are these customers valuable?
•
Are there any nearby white spaces?
Appropriability
The next question is, does the ?rm make money from the value that customers
perceive in the bene?ts from the resource? Making a signi?cant contribution to
the value that customers perceive, relative to the value from competitors, is a
necessary condition for a resource to earn its owner pro?ts; but it is not a
suf?cient condition for making money. From the Appropriability component of
an AVAC framework, a ?rm will appropriate value if:
•
The ?rm has superior position vis-à-vis its coopetitors.
•
The ?rm exploits its position vis-à-vis its coopetitors and customer bene?ts.
•
It is dif?cult to imitate the ?rm.
•
There are few viable substitutes but many complements.
Change
The question here is, do the activities for building and exploiting the resource
take advantage of change to create and appropriate value? This question is
answered by exploring the following questions from the AVAC framework.
Do the activities for building and exploiting the resource:
•
Take advantage of new ways of creating and capturing new value?
•
Take advantage of opportunities to build new resources/capabilities and/or
translate existing ones in new ways into value?
•
Take advantage of the potential to build and exploit ?rst-mover
advantages?
•
Anticipate and respond to potential reactions from new and existing
competitors?
•
Take advantage of the opportunities and threats of an industry or
macroenvironment?
Competitive Consequence
An AVAC analysis enables a ?rm to identify and rank its resources by their
competitive consequences—by the extent to which each resource stands to give
130 Strengths and Weaknesses
the ?rm a competitive advantage. (To avoid repetition, we use the word
resource to mean resource/capability.) Table 5.1 shows six different resources
and the competitive consequence for a ?rm using each. Resource 1 is valuable to
customers, and the ?rm can appropriate the value from it. Moreover, the ?rm
has what it takes to perform the activities to build and exploit the resource
ef?ciently. The resource can also be used to take advantage of change (present
or future) to better create and/or appropriate value. The resource is thus said to
give the ?rm a sustainable competitive advantage. The more common case is
that of Resources 2, which gives a ?rm a temporary competitive advantage. The
resource is valuable to customers, and the ?rm has what it takes to ef?ciently
perform the activities to build and exploit the resource; but the resource is
vulnerable to change. During the period before the change, the ?rm has a
temporary competitive advantage.
Resource 3 is valuable to customers, the ?rm has what it takes to perform
ef?ciently the activities to build and exploit the resource, and it can take advan-
tage of change. The only problem with the resource is that there are other things
that make it dif?cult to appropriate the value from it. For example, the ?rm
using the resource may not have bargaining power over its suppliers and buyers,
or the ?rm’s pricing strategy may be leaving money on the table or driving
customers away. Therefore the ?rm cannot appropriate all the value that it
creates using the resource. The ?rm has competitive parity using the resource.
Resource 4 is valuable to customers, but the value is dif?cult to appropriate and
the resource is vulnerable to change. Thus, the best that Resource 4 can do for
its owner is to give it competitive parity. Resource 5 is neither valuable, nor
appropriable, nor can it withstand change. Moreover, the ?rm does not have the
ability to perform ef?ciently the activities for building and exploiting the
resource. Such a resource puts its owner at a competitive disadvantage since its
competitors can do better.
Strategic Action
The next step after an AVAC analysis is to identify what it is that a ?rm can do
to reinforce the Yesses and either dampen or reverse the Noes. The goal is to
move things towards a sustainable competitive advantage. For example, if a
?rm ?nds out that it cannot appropriate most of the value that it creates because
it has a bad pricing strategy, it can change the strategy. If a resource puts a ?rm
at a competitive disadvantage and the ?rm cannot reverse or dampen the Noes,
it may be better off getting rid of the resource. Effectively, an AVAC analysis
should help a ?rm decide which Yesses to reinforce, which Noes to dampen or
reverse, and which resources to dump so as to improve its ability to create and
appropriate value.
Example 5.1: Google’s Search Engine Capabilities in 2007
To illustrate the use of an AVAC analysis to assess the pro?tability potential of a
resource, we go through an example using Google’s search engine capabilities.
Resources and Capabilities in the Face of New Games 131
Activities
Does Google Have What it Takes to Perform Efficiently the Activities for
Building and/or Translating the Resource/capabilities into Customer Benefits
and/or Positioning the Firm to Appropriate Value?
Google performed the following activities in building and translating its search
capabilities into unique value. It developed and incorporated its PageRank
algorithm into its search engine and continued to improve the algorithm. It built
a brand from its relevant searches. It emphasized innovative management of
technology concepts such as encouraging its engineers to use 20% of their time
to work on projects of their own choosing (why not marketing?). It introduced
AdWords paid listings to monetize search engines. It teamed up with network
af?liates and provided them with search-engine technology in return for share
of pro?ts from advertising on the sites. These activities differentiated Google
from its competitors. For example, Google’s brand and customers’ perception
that its searches were more relevant than competitors’ searches differentiated
the value from its search engine. This differentiation also improved Google’s
position vis-à-vis some coopetitors. For example, some customers might believe
that switching to competitors would not give them the bene?ts that they per-
ceived as coming only from Google. The differentiation also reduced the poten-
tial threat of substitutes and made it even more dif?cult for any potential new
entrants who had dreams of entering the market and taking Google head on.
The industry value drivers for the search engine market are: the speed, rele-
vance, and comprehensiveness of searches as well as the R&D that goes into
them. By developing its PageRank algorithm that produced most relevant
searches, Google took advantage of the “search relevance” industry value
driver. Because of its brand, some customers perceived data from its engines as
being the most reliable. In addition to the intellectual property (patents, copy-
rights, and trade secrets) that underpinned its search engines, the ?rm also
cultivated one of the most recognizable brands in the world, earning it a verb in
some dictionaries—to google.
Google also did some cool things to keep the cost of its activities low. It used
Intel microprocessor-based commodity servers rather than the much more
expensive proprietary servers from IBM, Sun Microsystems, and others. Since
these servers consumed lots of electricity and generated a lot of heat, it also
located them near cheap sources of electricity in cold places. The ?rm is there-
fore able to deliver searches at lower cost that it would have been able to.
Value
Does the Resource Make a Significant Contribution Towards the Benefits that
Customers Perceive as Valuable to Them?
Google had two sets of customers: Internet users who performed searches, and
advertisers who advertised online. Users (surfers) valued the speed, relevance,
and comprehensiveness of searches made using Google’s search engine. In Feb-
ruary 2007, for example, 48.1% of the 6.9 billion monthly online searches
conducted by surfers used Google’s search engine, compared to 28.1% for
132 Strengths and Weaknesses
Yahoo, 10.5% for Microsoft, 5.0% for Ask.com and 4.9% for Time Warner.
17
Advertisers valued the billions of eyeballs that Google’s website received every
month. This amounted to many users to whom these advertisers could adver-
tise. While other factors such as Google’s brand may have had an effect on the
number of visitors to its search site, its search engine, especially its ability to
deliver relevant searches appears to have played a major role. Since Google’s
users cut across all demographics, it was dif?cult to say how valuable the users
were. However, its advertisers included very small ?rms who would ordinarily
not advertise in the of?ine world but who could advertise on Google’s sites or
third-party af?liates because of the low cost of servicing such small customers.
Potentially, there was some white space for search engines that answered ques-
tions rather than use key words to perform searches—something with more
intelligence.
Appropriability
Does the Firm Make Money from the Value that Customers Perceive in the
Benefits from the Resource?
Yes. Google’s search engine capabilities and associated complementary assets
made lots of money for Google in 2007. Google was one of the most pro?table
and most valuable (from a market capital point of view) companies in the
world. Things were not always that way. Even after its search engine became
the most popular, it still was not very pro?table. It was after it introduced paid
listings, an idea pioneered by Overture.com, that Google started to make
money. In paid listings, advertisers’ links are displayed above or alongside
search results.
There are several reasons why Google was able to appropriate the value
created by its search engine capabilities. First, Google had the complementary
assets to help it appropriate the value created by its search engine capabilities.
However, it is dif?cult to say exactly how much of that money came from its
search engine capabilities and how much from complementary assets such as its
brand, paid listings technology, relationships with af?liates, etc.
Second, although it was easy to develop a search engine that was comparable
to Google’s in performance, replicating the combination of the search engine,
the Google brand, video, images, and news services that it offered made it
dif?cult for rivals to duplicate all of what Google offered. As the Internet
evolves, the possibility that some ?rm can leapfrog Google is always going to be
there. It had no established record of retaliating against competitors although
some may view its introduction of free word-processing software as retaliating
against Microsoft for offering search engine services. Competitors did not have
any clear handicaps such as prior commitments or dominant managerial logic
to handicap their efforts to imitate Google. In the late 1990s, when the Web was
not overcrowded, companies could catalog and compile Web content without
the aid of search engines. With the proliferation of Web content, it was very
dif?cult to ?nd stuff on the Internet without a search engine in 2007. Hence,
there were no substitutes for search engines. Complements were things such as
computers and handheld devices that enabled individuals to search the Web.
Third, the relevance of searches from its search engine, coupled with Google’s
Resources and Capabilities in the Face of New Games 133
brand and other activities, also gave the ?rm power over many of its
coopetitors. For example, its brand and relevant searches attract surfers, whose
large numbers attract many advertisers. This gives Google more power over its
advertisers than would be expected in a market with four other competitors.
Fourth, in its paid listings business model, Google had customers (advert-
isers) bid for key words in an auction. Since auction pricing is one of the best
ways to get as close as possible to customers’ reservation prices, Google was
probably getting very close to customers’ reservation prices. The ?rm also had a
lot of information about its customers and could therefore price discriminate
using the information if it wanted to.
Change
Do the Activities for Building and Exploiting the Resource Take Advantage of
Change (Present or Future) to Create and Appropriate Value?
Existing Change came from the Internet and Google’s actions to take advantage
of the new technology.
The Internet and the growing Web traf?c on it made it increasingly dif?cult to
?nd things on it, thereby creating an opportunity to develop dependable search
engines that provided users with relevant search results. Google provided such
an engine. So did its competitors, resulting in a relatively unattractive market
(using Porter’s Five Forces analysis) in 2007. However, Google found a way to
make the market more attractive for itself and was therefore better able to
create and capture more value than its competitors. It monetized the engine
using paid listings and other complementary assets such as its brand.
Google was not the ?rst to develop search engines. It took advantage of
reduced marketing and technological uncertainty to, for example, use paid list-
ings to monetize its search engine. The intellectual property (patents, copy-
rights, and trade secrets) that Google built in developing its search engine, and
the preemption of perceptual space at the many surfers who preferred to use
Google’s search engine could be regarded as ?rst-mover advantages for the
activities that it was the ?rst to perform. So were the relationships that it built at
the af?liates whose sites used the Google search engine.
In offering complementary products, such as Gmail and GoogleMap, Google
may be anticipating the likely reaction of its competitors. Looking to the future,
as the Web evolves, there are likely to be many changes. For example, Google’s
advantage could be eroded by so-called specialist or vertical search engines.
Vertical engines address the specialized needs of niches or professionals rather
than the general broad-based needs of consumers as do the generalist engines
from Google and Yahoo do. For example, GlobalSpec.com is a pro?table spe-
cialist engine for engineers. A specialized engine for the pharmaceuticals indus-
try could target pharmaceutical advertising.
18
Table 5.2 provides a summary of
the strategic consequence of Google’s search engines capabilities.
134 Strengths and Weaknesses
Identifying the Right Complementary Assets
Since we have de?ned complementary assets as all other resources apart from
an invention or discovery that a ?rm needs to create and appropriate value, the
list of potential complementary assets for any particular invention or discovery
can be huge. Thus, we need some way to narrow down the list of potential
complementary assets. An AVAC analysis can also be used to rank order com-
plementary assets by their potential to contribute to value creation and
appropriation. The idea is to evaluate the potential of each complementary
asset to contribute to a ?rm’s competitive advantage and rank it accordingly. As
shown in Table 5.3, each complementary asset is ranked by answering the
following questions and determining the competitive consequence of having the
asset:
1 Activities: does the ?rm have what it takes to ef?ciently perform the activ-
ities for building and/or translating the complementary asset into customer
bene?ts and/or positioning the ?rm to appropriate value? What are the
activities?
2 Value: does the complementary asset make a signi?cant contribution
towards the bene?ts that customers perceive as valuable to them?
3 Appropriability: does the ?rm make money from the value that customers
perceive in the bene?ts from the complementary asset?
4 Change: do the activities for building and exploiting the complementary
asset take advantage of change (present or future) to create and appropriate
value?
Table 5.2 Strategic Consequence for Google’s Search Engine Capabilities
Activities: Does
Google have what it
takes to efficiently
perform the
activities for building
and/or translating
the resource/
capabilities into
customer benefits
and/or positioning
the firm to
appropriate value?
Value: Does
Google’s
search engine
capability
make a
significant
contribution
towards the
benefits that
customers
perceive as
valuable to
them?
Appropriability:
Does Google
make money
from the value
that customers
perceive in the
benefits from
its search
engine
capabilities?
Change: Do the
activities for
building and
exploiting
search engine
capabilities take
advantage of
change (present
or future) to
create and
appropriate
value?
Competitive
consequence
Search
engine
capabilities
Yes Yes Yes Yes/No Sustainable/
temporary
competitive
advantage
Strategic
action
In the 2000s Google took advantage of the changes from the evolving
Internet. It could:
1. do more to monetize searches on “partner” websites;
2. pay more attention to category killers;
3. do more to exploit the exploding Web traffic, especially from
video images which take up lots of bandwidth.
Resources and Capabilities in the Face of New Games 135
Each complementary asset is classi?ed by the potential competitive consequence
of building and exploiting the asset, from “sustainable competitive advantage”
down to “competitive disadvantage.” The more that the strategic consequence
from a complementary asset is a sustainable strategic advantage rather than a
strategic disadvantage, the more that a ?rm may want to pursue the comple-
mentary asset. In addition to telling a ?rm which complementary assets to
pursue, the analysis can also point out which Noes could be reversed to Yesses
or dampened, and which Yesses could be reinforced.
Strengths and Handicaps in the Face of New Games
Every ?rm brings to a new game some resources from its pre-new game
activities. Some of these resources, including complementary assets, continue to
be useful during the new game but others may not only be useless, they can
become handicaps. Identifying which resources might become handicaps can,
Table 5.3 Rank Ordering Complementary Assets
Complementary
asset
Activities: Does
the firm have
what it takes to
efficiently
perform the
activities for
building and/or
translating the
complementary
asset into
customer
benefits and/or
positioning the
firm to
appropriate
value?
Value: Does the
comple-
mentary asset
make a
significant
contribution
towards the
benefits that
customers
perceive as
valuable to
them?
Appropriability:
Does the firm
make money
from the value
that customers
perceive in the
benefits from
the
complementary
asset?
Change: Do the
activities for
building and
exploiting the
comple-
mentary asset
take advantage
of change
(present or
future) to
create and
appropriate
value?
Competitive
consequence
Complementary
assets 1
Yes Yes Yes Yes Sustainable
competitive
advantage
Complementary
assets 2
Yes Yes Yes No Temporary
competitive
advantage
Complementary
assets 3
Yes Yes No Yes Competitive
parity
Complementary
assets 4
Yes Yes No No Competitive
parity
Complementary
assets 5
No/Yes No Yes No Competitive
parity
Complementary
assets 6
No No No No Competitive
disadvantage
Strategic action What can firm do to reinforce the Yesses and reverse or dampen
the effect of the Noes
136 Strengths and Weaknesses
depending on the type of new game, be critical to winning. Identifying which
scarce valuable resource is likely still to remain valuable for the ?rm and which
one is likely to become a handicap consists of answering the two simple ques-
tions shown in Table 5.4:
1 Is the resource vital in the new game?
2 Is separability possible?
There are two primary determinants of which resource becomes a handicap or
strength: whether the resource is vital to the new game, and whether the
resource is separable. A resource is vital to a new game if it contributes signi?-
cantly to value creation and appropriability. It is separable if the ?rm has no
problems taking the resource away from the old game for use in the new game,
or leaving the resource behind when it is more likely to hurt in the new game
than help. A ?rm may be prevented from using a resource in a new game
because of prior commitments, contracts, agreements, understandings, emo-
tional attachments, or simply because the resource/asset cannot be moved from
the location of the old game to the location of the new one. In that case the
resource is inseparable from the old context. A ?rm may also want to separate
itself from a resource from its past, so as to move on but cannot because the
resource is inseparable.
To understand these arguments better, consider Resource 1 in Table 5.4. It is
vital in the new game and the ?rm can use it in the new game because there are
no prior contracts, agreements, understandings, or anything else that prevents
the ?rm from using the important resource in the new game. Thus the resource
is a strength for the ?rm. Most brands, advertising skills, and shelf space con-
tinue to be strengths for many ?rms even in the face of revolutionary new games
in which technologically radical new products are introduced. In pharma-
ceuticals, for example, a ?rm’s drug approval capabilities, sales force, and
brand usually continue to be strengths from one revolutionary drug to another.
Resource 4 is the exact opposite of Resource 1. The resource is useless to the
?rm in pursuing the new game but unfortunately for the ?rm, it cannot separate
itself from the resource and move on. Resource 4 is therefore a handicap. The
Compaq example which we saw earlier in this book illustrates instances of both
Resources 1 and 4. Compaq wanted to participate in the new game created by
Dell when the latter introduced the direct sales and build-to-order business
model, bypassing distributors. Compaq’s brand name reputation was a strength
in the new game since it could still be used in direct sales. The skills used to
Table 5.4 Is a Strength from a Previous Game a Strength or Handicap in a New Game?
Resource Is the resource vital in
the new game?
Is separability possible? In the new game, the
resource is a:
Resource 1 Y Y strength
Resource 2 Y N potential strength
Resource 3 N Y question mark
Resource 4 N N handicap
Resources and Capabilities in the Face of New Games 137
interact with distributors and old agreements with distributors were no longer
needed in the new game. However, Compaq could not get out of the agreements
with distributors. The agreements with distributors effectively became a handi-
cap to the ?rm’s efforts to follow Dell and sell directly to end-customers.
A ?rm’s dominant managerial logic is another example. It is usually a good
thing since dominant managerial logic makes what managers are supposed to
do become second nature to them; but in the face of some types of change, it can
become a problem. Take discount retailing, for example. Part of the dominant
managerial logic in the USA in the 1970s and early 1980s was that ?rms made
money in discount retailing by building large stores in big cities, so when Wal-
Mart was building small stores in rural areas of the Southwestern USA, K-Mart
and other competitors did not think much about Wal-Mart and continued to
believe in making money by building large stores in large cities. Wal-Mart
would go on to become the world’s largest company while K-Mart had to ?le
for bankruptcy. Another example is that of the French wine industry that dom-
inated the world market for centuries with wines that were made using no new
technologies and no sugar, and were classi?ed and named by French locations
such as Bordeaux, Champagne, Cote du Rhone, etc.
19
New entrants from South
Africa, Australia, and the USA entered some wine markets with wines that were
made using new technologies such as drip irrigation, reverse osmosis, computer-
ized aging, and oak chip ?avoring, and classi?ed their wines using grape type
such as merlot or chardonnay rather than location. The dominant thinking in
the French wine industry still continues to be that ?ne wines are made the old-
fashioned French way using no new technologies, even as French wine con-
tinues to lose market share in some markets to South African, Australian, and
US wine sellers. Another way to think of how inseparability can lead to handi-
caps is to think of personal relationships. When a person moves from an
important relationship to another, there may be things about the old relation-
ship that he or she would rather leave behind but that just hang around. That
might not help the new relationship.
There are two other cases in Table 5.4. Resource 2 is important in the new
game but because of prior commitments, agreements, or other inseparability,
the ?rm cannot use it in the new game. The resource is then a potential strength
since, with work, it could become separable. For example, a noncompete clause
in an important employee’s contract with a previous employer may prevent a
?rm from using the employee on some projects for some time. Resource 3 is not
important in the new game and the ?rm can get away from it. It is therefore,
neither a strength nor a handicap. It is a question mark.
A similar analysis can be performed for the product-market position (PMP)
that a ?rm brings to a new game. Here, the question is whether strengths in a
?rm’s previous product (low-cost, differentiated products, or both), and the
?rm’s position vis-à-vis its coopetitors—that a ?rm brings to a new game—
remain strengths or become handicaps. A ?rm’s PMP from a previous game
becomes a handicap in a new game if products from the new game potentially
can cannibalize the ?rm’s existing products from the previous game. If that is
the case, the ?rm may not invest in the new game for fear of cannibalizing its
existing products. A previous PMP can also become a handicap if the new game
is about luxury products while the previous PMP was about low-cost products,
since customers’ perception of the old product may negatively bias their
138 Strengths and Weaknesses
perception of the new one. On the other hand, the seller of a luxury product
that decides to sell a low-cost version in a new game may ?nd its old position a
strength in selling the new product. Since a ?rm’s position vis-à-vis coopetitors
is partially determined by its resources/capabilities, the analyses above for
resources can be used to analyze whether such positions become handicaps or
remain strengths.
Valuing Intangible Resources/Capabilities from New
Games
Suppose a ?rm builds new resources in the face of a new game and wants
quantitatively to estimate their value; how should the ?rm go about it? A
detailed AVAC analysis can tell a ?rm a lot about the pro?tability potential of its
resources but it does not quantify intangible resources (assets). Financial state-
ments only state the value of tangible assets such as plants, equipment, cash,
marketable securities, and inventories but say nothing about intangible assets
such as brands, patents, copyrights, trade secrets, installed base, client relations,
government relations, and so on. We explore two methods for getting a quick
feel for the value of such intangibles.
Assigning Numbers to Intangibles
Consider the simple but important balance sheet relationship of equation (1).
Assets = liabilities + shareholder equity (1)
An elementary manipulation of equation (1) gives
Assets ? liabilities = shareholder equity (2)
The relationship shown in equation (2) suggests that at any one time, the mar-
ket value of a ?rm (shares outstanding multiplied by share price) should be
equal to the ?rm’s assets minus its liabilities (equation (2)). The quantity
“Assets ? Liabilities” is also called the book value of the ?rm. Book value is
what would be left over for shareholders if a ?rm were to sell its assets and pay
its creditors. Therefore, according to equation (1), at any one time, a ?rm’s
book value should be equal to its shareholder equity or market value. As Table
5.5 shows, that is not always the case. Differences between book value and
market value range from Comcast’s $9.18 billion to ExxonMobil’s $354.65
billion. The difference between book value and market value for each ?rm
suggests two things: (1) that there is something else about the ?rm, something
other than the assets on its books, that makes investors believe that the ?rm will
keep generating free cash ?ows or earnings; and (2) that the stock market
overvalues the ?rm’s stock. If we assume that the market does not overvalue the
?rm’s stock, the difference between book value and market value is a measure
of intangible assets, since they are not captured in the book value relationship.
The ratio of market value to book value is also a measure of intangibles. In the
examples of Table 5.5, Microsoft’s intangibles in August of 2007 were a lot
more valuable than General Motors’ intangibles, since Microsoft’s market
value to book value was 8.5 while General Motors’ was ?5.1.
Resources and Capabilities in the Face of New Games 139
Using the difference between book value and market value to measure
intellectual capital has several shortcomings. First, ?rms that have not gone
public and business units cannot use the measure, since they have no market
value. Second, it is an aggregate measure since it estimates a value for all of a
?rm’s intangible resources. While it highlights the extent to which a ?rm’s value
depends on its intangible resources, it does not tell us much about the different
components of the capital and their relative contribution to the value. Thus,
while the measure can tell us whether P?zer depends more on intangible assets
than its competitors, it does not tell us how much of P?zer’s value is from its
cholesterol or hypertension technologies.
Numerical Example: Leveraging Effect of Intangible
Resources
We explore one more way of indirectly valuing intangible resources by con-
sidering a numerical example from personal computers.
Example 5.2
At an estimated development cost of $1 billion, Microsoft’s Windows XP oper-
ating system was released on October 25, 2001 and earned Microsoft an esti-
mated $55 to $60 per copy sold.
20
An operating system is a computer software
program that manages the activities of different components (software and
hardware) of a computer. From 1996 to 2001, Apple’s market share dropped
Table 5.5 Sample Values of Intangible Resources (all numbers, except rations, in $ billion)
S T W X Y Z
Company Market value on
August 22, 2007
Assets Liabilities Book value =
T ? W (Assets
liabilities)
S ? X =
Market value ?
book value
Market value
Book value
Intel 141.00 50.29 10.60 39.70 101.30 3.6
Microsoft 263.00 63.17 32.07 31.10 231.90 8.5
General
Electric
(GE)
397.00 738.53 621.51 117.02 279.98 3.4
Google 157.00 21.42 1.76 19.66 137.34 8.0
Wal-Mart 180.00 155.42 95.51 59.91 120.09 3.0
Pfizer 167.00 110.40 42.31 68.09 98.91 2.5
General
Motors
(GM)
18.00 186.53 190.09 ?3.56 21.56 ?5.1
JP Morgan
Chase
153.00 1,458.04 1,338.83 119.21 33.79 1.3
Cisco 182.00 53.34 21.86 31.48 150.52 5.8
ExxonMobil 462.00 228.32 111.97 116.35 345.65 4.0
Citicorp 237.00 2,220.87 2,093.11 127.75 109.25 1.9
Merck 109.00 44.18 24.71 19.47 89.53 5.6
Comcast 51.00 110.76 68.93 41.83 9.18 1.2
140 Strengths and Weaknesses
from 5.2% to 3.0%.
21
In 2001, 133.5 million desktops, notebooks, and PC-
based servers were shipped worldwide.
22
One estimate in 2007 had Apple’s
installed base of Macs at 4.5% of total PC-installed base.
23
For many busi-
nesses, the active PC life cycle was three years. Given this information, what is
the value of installed base to Microsoft and Apple? (Installed base is an
intangible resource.)
Answer: One way to get a feel for the value of installed base for each ?rm is to
perform a breakeven analysis. Let us start by making the calculations for
Microsoft.
Microsoft
Contribution margin per unit = P ? V
c
= ($57.50) (average of $55 and $60)
Breakeven quantity =
Fixed Cost
Contribution Margin
=
$1B
$57.5
= 17.39 million units (3)
Of the 133.5 million PCs that were sold in 2001, 3% or 4 million were Apple
machines. The remaining 97% or 129.5 million (10.8 million per month) were
Windows machines that use the Microsoft operating system; that is, 10.8 mil-
lion units of Microsoft’s operating system were sold each month for the remain-
ing two months of 2001 and beyond if we assume that sales of PCs remained at
about their 2001 levels for the coming years. Since Microsoft needed to sell
17.39 million units of the operating system to break even and it sold 10.8
million units a month, it would have taken the company
17.39M
10.8M
months = 1.6
months to break even; that is, it would have taken Microsoft 1.6 months to
recover the $1 billion that it spent on R&D to develop the operating system.
After the 1.6 months, the money coming in was largely pro?ts. Note that equa-
tion (4) could be used to calculate the breakeven time where breakeven quantity
is 17.39 million while the sales rate is 10.8 million per month.
Breakeven time =
Breakeven Quantity
Sales Rate
(4)
Apple
Suppose Apple developed an operating system at the same cost as Microsoft
and sold it at the same price. It too (Apple) would need to sell 17.39 million
units to break even. However, because Apple sold only 4 million units a year or
0.333 million per month, its breakeven time would be
17.39M
0.333M
months = 52.22
months. If Apple wanted to breakeven in the same 1.6 months as Microsoft, it
would have to sell each copy of its operating system at $1,856.76 or
52.22
1.6
($57.25).
The Microsoft advantage is largely because of its installed base—that is, the
millions of Windows PCs and their owners (businesses and consumers) who
have learned how to use the Microsoft operating system, bought software that
runs on it, are comfortable with the operating system and applications, and
prefer to stay with the Windows PCs rather than change to Apple. For similar
Resources and Capabilities in the Face of New Games 141
reasons, many Apple users do not want to switch from Apple to the Windows
camp either. Thus, after the PC active life of three years, many customers who
had Windows PCs buy new Windows PCs while many customers who had
Apple machines buy new Apple machines. Each new Windows machine means
a sale of a Windows operating system for Microsoft. Effectively, the installed
base of Windows machines is an intangible asset for Microsoft that is a key
driver of how many copies of its operating system it can sell, while the installed
base of Apple machines is an asset for Apple and a major driver of how many
Macs Apple can sell.
The importance of intangibles is also seen in Apple’s iTunes for iPod. Apple
launched a Windows version of its iTunes in October 2003. In just three and a
half days, over one million copies of the iTunes software for Windows had been
downloaded, and over one million songs purchased using the software.
24
In
April 2003, it had taken seven days for Apple to sell one million songs when it
launched iTunes on Apple machines. Effectively, even Apple stood to bene?t
from the Windows installed base.
Key Takeaways
•
Resources play a critical role in the creation and appropriation of value.
There are three types of resource: tangible, intangible, and human. Tangible
resources are the resources that are usually identi?ed and accounted for in
?nancial statements under the category, “assets.” Intangible resources are
the nonphysical and non?nancial assets such as patents, copyrights, brand
name reputation, trade secrets, research ?ndings, relationships with cus-
tomers, shelf space, and relationships with vendors that cannot be touched
and are usually not accounted for in ?nancial statements. Organizational
resources consist of the know-how and knowledge embodied in employees
as well as the routines, processes, and culture that are embedded in the
organization. A ?rm’s capabilities are its ability to turn resources into cus-
tomer bene?ts and pro?ts.
•
A core competence is a resource or capability that:

Makes a signi?cant contribution to the bene?ts that customers perceive
in a product or service.

Is dif?cult for competitors to imitate.

Is extendable to other products in different markets.
•
A technology or product exhibits network externalities if the more people
that use it, the more valuable it becomes to each user. Network externalities
effects can be direct or indirect.
•
Although the size of a network is important, size is not everything. The
structure of a network and the conduct of ?rms within the network also
contribute to the value that each user enjoys in a network.
•
Complementary assets can be critical to creating and appropriating value
using new game activities. Complementary assets are all the other resources,
beyond those that underpin a new game (an invention or discovery), that a
?rm needs to create value and position itself to appropriate the value.
•
The Teece model helps us to understand better why it is that many inventors
do not pro?t from their inventions. In the model, appropriating value from
142 Strengths and Weaknesses
an invention depends on (1) the extent to which the value can be imitated,
and (2) the extent to which complementary assets are important and scarce.
Inventors whose inventions are easy to imitate and require important and
scarce complementary assets do not make money from the inventions.
Rather, the owners of the complementary assets make the money. Depend-
ing on the level of imitability and the need and importance of comple-
mentary assets, a ?rm can use a run, block, and team up strategy to help its
efforts to pro?t from a new game. This model, while very useful, has some
limitations. For example, it leaves out the other factors that impact
appropriability: position vis-à-vis coopetitors, pricing strategy, number of
customers, etc.
•
Since each new game usually requires many complementary assets, it is
important to narrow down the list of the assets to those that are critical to a
?rm’s value creation and appropriation activities. An AVAC analysis can be
used for the narrowing-down exercise.
•
Intangible resources are usually not quanti?ed in ?nancial statements. One
way to get a feel for the value of a ?rm’s intangible resources is to estimate
the difference between the ?rm’s market capitalization and book value.
Another way is to zoom down on intangible resources that can be measured
and try to estimate their signi?cance to a ?rm.
•
An AVAC analysis can be used to assess the pro?tability potential of
resources. This analysis consists of answering the following questions:

Activities: Does the ?rm have what it takes to perform ef?ciently the
activities for building and/or translating the resource/capabilities into
customer bene?ts and/or positioning the ?rm to appropriate value?

Value: Does the resource make a signi?cant contribution towards the
bene?ts that customers perceive as valuable to them?

Appropriability: Does the ?rm make money from the value that cus-
tomers perceive in the bene?ts from the resource?

Change: Do the activities for building and exploiting the resource take
advantage of change (present or future) to create and appropriate value?
•
An AVAC analysis enables a ?rm to identify and rank its resources by their
competitive consequences—by the extent to which each resource stands to
give the ?rm a competitive advantage. A resource can give a ?rm a sustain-
able competitive advantage, temporary competitive advantage, competitive
parity, or competitive disadvantage.
•
An AVAC analysis helps a ?rm decide what to do to reinforce a sustainable
advantage, turn a temporary advantage into a sustainable advantage or turn
competitive parity into competitive advantage.
Key Terms
Capabilities
Complementary assets
Core competences
Intangible resources
Network externalities
Pro?tability potential of resources/capabilities
Resources and Capabilities in the Face of New Games 143
Resources
Single-sided networks
Structure of a network
Tangible resources
Teece Model
Two-sided network
Valuing intangible resources
144 Strengths and Weaknesses
First-mover Advantages/
Disadvantages and Competitors’
Handicaps
Reading this chapter should provide you with the information to:
•
Explain the advantages and disadvantages of moving ?rst.
•
Understand how to narrow down the list of potential ?rst-mover
advantages.
•
Understand that ?rst-mover advantages are usually not endowed on every-
one who moves ?rst; rather, they have to be earned.
•
Understand competitors’ potential handicaps.
•
Understand why ?rst movers sometimes win and why, sometimes, followers
win.
•
Understand the roles player by explorers, superstars, exploiters, and me-
toos in the face of new games.
Introduction
Consider the following. eBay was the ?rst online auction ?rm and went on to
dominate its industry. However, Google was not the ?rst search engine com-
pany but went on also to dominate its own industry. Coca Cola invented the
classic coke and went on to dominate the market for colas, with some help and
challenges from Pepsi. However, neither Coke nor Pepsi invented diet cola, even
though they dominate that market. Apple did not invent the MP3 player and yet
its iPod went on to dominate the market for MP3 players. The question is, why
is it that sometimes ?rst movers go on to dominate their markets but at other
times, followers (second movers) are the ones that go on to dominate their
markets? As we indicated in Chapter 1, whether a ?rst mover or follower wins
is also a function of whether it has the right strategy. In Chapters 4 and 5, we
started to explore what the right strategy is and is not, and will continue to do
so throughout this book. In this chapter, we look deeper into the advantages
and disadvantages of moving ?rst. We start the chapter by exploring what ?rst-
mover advantages are all about. Next, we explore ?rst-mover disadvantage—
also known as followers’ or second-mover advantages. In doing so, we are
reminded that ?rst-mover advantages and disadvantages are not automatically
bestowed on any ?rst mover. Rather, ?rst-mover advantages have to be earned
and disadvantages can be minimized. We conclude the chapter by exploring
why it is that sometimes ?rst movers win and sometimes, followers win.
Chapter 6
First-mover Advantages
A ?rst-mover advantage is a resource, capability, or product-market position
that (1) a ?rm acquires by being the ?rst to carry out an activity, and (2) gives
the ?rm an advantage in creating and appropriating value. A ?rm has an
opportunity to acquire ?rst-mover advantages when it is the ?rst to introduce a
new product in an existing market, create a new market, invest in an activity
?rst, or perform any other value chain, value network, or value shop activity
?rst, such as bypassing distributors and selling directly to end-customers.
1
First-
mover advantages come from six major sources (Table 6.1):
1 Total available market preemption.
2 Lead in technology, innovation, and business processes.
3 Preemption of scarce resources.
4 First-at-buyers.
5 First to establish a system of activities.
6 First to make irreversible commitments.
Total Available Market Preemption
If, in moving ?rst, a ?rm introduces a new product, it has a chance to do the
right things and capture as much of the total available market as possible before
followers start to move in. Since such a ?rm is the only one in the market, it has
a 100% share of the new product, no matter how many units it sells. Thus, the
emphasis here is in capturing as much of the total available market as possible
and selling as many units as possible before followers move in—that is,
Table 6.1 First-mover Advantages (FMAs)
Source of first-mover advantage FMA mechanism
Total available market preemption Economies of scale
Size (beyond economies of scale)
Economic rents and equity
Network externalities
Relationships with coopetitors
Lead in technology, innovation,
and business processes
Intellectual property (patents, copyrights, trade secrets)
Learning
Organizational culture
Preemption of scarce resources Complementary assets
Location
Input factors
Plant and equipment
First-at-buyers Buyer switching cost
Buyer choice under uncertainty
Brand (preemption of consumer perceptual space or mindshare)
First to establish a system of
activities
Difficult-to-imitate system of activities
First to make irreversible
commitments
Reputation and signals
146 Strengths and Weaknesses
emphasis is on preemption of total available market. Having captured as much
of the total available market as possible, the ?rm potentially enjoys ?ve advan-
tages: scale economies, size effects (beyond economies of scale), economic rents
and equity, network effects, and relations with coopetitors.
Scale Economies
There are economies of scale in production if the more of a product that is
produced, the lower the per unit cost of production. There can also be econ-
omies of scale in R&D, advertising, distribution, marketing, sales, and service if
the more units that are sold, the less the per unit cost of each activity. This
advantage derives largely from the fact that the (total) ?xed cost of each activity
can be spread over the larger number of units. For example, an ad slot on TV
costs the same for Coca Cola’s diet cola as it does for Shasta’s diet cola. Since
Coca Cola sells hundreds of millions of cans of its diet cola compared to a few
million cans for Shasta, Coke has lower per unit advertising costs compared to
Shasta. If a ?rm moves ?rst and performs the right activities, it can pre-
preemptively capture as much of the total available market as possible; and if
the ?rm’s industry and market are such that there are economies of scale, its per
unit cost of R&D, advertising, distribution, marketing, sales, service, etc. can be
lower. This lower per unit cost from economies of scale has several implications
for the different components of its ability to create and appropriate value.
If a ?rm that moved ?rst has captured as much of the total available market
as possible, and enjoys scale economies, rational potential new entrants know
that if they were to enter the market to compete head-on with the ?rst mover,
they would have to capture the same market share (as the ?rst mover) so as to
attain the same per unit costs as the ?rst mover. However, to do so would mean
to bring in the same capacity as the ?rst mover to the same market, thereby
doubling the capacity. This might result in a price war that lowers pro?ts for the
new entrant. Thus, rational potential new entrants might refrain from entering.
Effectively, if a ?rst mover can capture as much of the total available market as
possible, it can attain scale economies thereby creating barriers to entry for
some potential followers. These barriers to entry are more dif?cult to surmount
if the minimum ef?cient scale is large relative to the total available market and if
the ?rst mover has a system of activities or distinctive resources and capabilities
that are dif?cult to imitate. When we say that a ?rst movers’ preemption of total
available market raises barriers to entry, we do not mean that it is impossible
for new entrants to enter. New entrants do enter sometimes but pursue niche
markets. They would have a much more dif?cult time competing head-on with
a ?rst mover that has captured most of the total available market where econ-
omies of scale exist. Another exception is when a ?rm pursues a revolutionary
strategy and takes advantage of a technological innovation to move in, leap-
frogging the ?rst mover.
Size Effects Beyond Economies of Scale
A ?rst mover that pursues the right strategies and captures as much of the total
available market as possible has another advantage beyond economies of
scale—size. A large ?rm buys more from its suppliers than its competitors and
First-mover Advantages/Disadvantages and Competitors’ Handicaps 147
in some cases, can command considerable bargaining power over its suppliers.
For example, Wal-Mart’s size gave it a tremendous amount of power over its
suppliers in the mid-2000s.
2
Power play or none, it is also easier for suppliers to
cooperate with larger ?rms. For example, to have suppliers locate near a ?rm,
the ?rm needs to buy large enough output from the supplier to make it worth
the supplier’s investment in plants, equipment, and people to serve a customer
at a particular location. A large ?rm can also afford to undertake more inno-
vation projects, since it can spread its risk over more stable and less risky pro-
jects. Such innovations can allow a ?rst mover to keep any lead that it may have
attained.
Economic Rents and Equity
Before competitors move in, a ?rst mover is effectively a monopolist and can
collect economic rents if it formulates and executes a pro?table business model.
If it captures most of the total available market and keeps growing fast, that ?rst
mover’s market valuation (capitalization) may go up as investors anticipate
positive future cash ?ows from economic rents. Such money can serve the ?rst
mover well, especially in cases where capital markets are not ef?cient enough
and therefore ?nancing is not readily available to anyone who needs it. The ?rst
mover can use the money to buy ?edgling new entrants, make venture capital
investments, invest in more R&D, or acquire important complementary assets.
If a ?rst mover accumulates cash, a small new entrant is less likely to be tempted
to start a price war, since the ?rst mover has more cash to sustain losses.
The other side to a ?rst mover earning economic rents is that these rents are
likely to attract potential new entrants who want a share of these pro?ts. If the
?rst mover has accumulated enough cash or has enough equity, it can establish
a reputation for ?ghting or can take other measures such as forming alliances,
joint ventures, and so on, to fend off attacks.
Network Externalities
As we saw in Chapter 5, a product (or technology) exhibits network external-
ities if the more people that use the product or a compatible one, the more
useful the product becomes to users. An example is an auction network such as
eBay’s. The more registered users that eBay has in its community of registered
users, the more valuable that the network becomes to each user. That is because,
for example, the larger the network, the more that a potential buyer of an
antique is likely to ?nd the antique in the network, and the more that the seller
of an antique is likely to ?nd a buyer in the network. More people would
therefore tend to gravitate towards larger networks rather than smaller ones.
Therefore, if a ?rst mover has preemptively captured much of the available
market for a product or technology that exhibits network externalities, cus-
tomers are likely to gravitate towards its network or products, further increas-
ing the number of users of its network or products. Thus a ?rst mover that has
an initial lead can see that lead grow to an even larger lead. Products that
require complements such as computers also exhibit network externalities
effects. That is because the more users who own a particular computer or
compatible one, the more software that will be developed for it. The more
148 Strengths and Weaknesses
software that there is for the particular computer or compatible one, the more
users who will want the computer. Thus, a ?rst mover that has a large installed
base of products that require complements is likely to see more users gravitate
towards its products, further increasing its installed base and attracting yet
more customers.
A large network size or installed base has several implications for the differ-
ent components of a ?rm’s business model. First, since the larger a network, the
more valuable it is to customers, a large proprietary network can be a differen-
tiating factor for ?rst movers. Second, rational potential new entrants know
that if they were to enter, they would need a network as large as the ?rst mover’s
if they wanted to offer the same value to customers as the ?rst mover. However,
new customers tend to gravitate towards the larger network. Thus, a large
proprietary network acts as a barrier to entry for some potential new entrants.
Again, this does not mean that no ?rms enter the industry. Some usually enter
but compete in niche markets or use technological changes and innovation to
compete against the ?rst mover with the large network.
3
Also, a large network
acts as a barrier to entry only when it is proprietary. If it is open, as was the case
with Wintel PC, barriers to entry are lower. Third, since, all else equal, cus-
tomers would prefer a large network over a smaller one, customers within a ?rst
mover’s network would prefer to stay within the larger network than move.
Effectively, a large network constitutes switching costs for customers. Thus, a
?rst mover can dampen customer bargaining power by building in switching
costs for customers in the form of a large proprietary network. Fourth, a large
proprietary network also reduces rivalry between the owner of the network and
those of smaller networks. That is because its larger network differentiates it
from the smaller rivals. As we will see later in this book, other factors beyond
size sometimes also impact the value that customers perceive in a network.
Relationships with Coopetitors
In our discussion about ?rst-mover advantages so far, we have treated suppliers,
customers, buyers, rivals, and potential new entrants as competitors whose goal
is to sap pro?ts out of the ?rst mover. Often, as we saw in Chapter 4, these
actors are more than just competitors. They are coopetitors—the ?rms with
which one has to cooperate to create value and compete to appropriate it—and
relationships with them can be critical. A ?rst mover has an opportunity to
build relationships not only with coopetitors but also with institutions such as
government agencies or universities. Such relations can, among other things,
help the collaborators to win a standard or dominant design.
Lead in Technology, Innovation, and Business Processes
A ?rst mover often has an opportunity to establish leadership positions in busi-
ness processes, technology, and organizational innovation. These leadership
positions can be manifested in the quality and levels of intellectual property,
learning and culture that ?rms can integrate into their business models.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 149
Intellectual Property
Innovations in business processes, technology and organizational processes can
be a source of advantage to ?rms and consequently, some ?rms try to protect
them using patents, copyrights, trademarks, or trade secrets. For many prod-
ucts, patents do not offer their owners enough protection from imitation, since
they can be circumvented. Copyrights and trademarks are not protected by the
laws of many countries and when they are protected by law, there is often little
monitoring and enforcement of the law. Trade secrets often are revealed
through employees who move to other ?rms or through reverse engineering of
products. Despite these often-cited shortcomings of intellectual property pro-
tection, intellectual property often serves a useful purpose in the pro?tability of
a ?rst mover’s business model. First, in some industries and countries, patents
and copyrights give their owners reasonable protection for a period of time
during which they can collect monopoly rents from their invention or discovery.
For example, one reason why many so-called blockbuster pharmaceutical drugs
such as Lipitor bring in such high amounts of revenues is because they enjoy
patent protection during their patent lives. Once a drug’s patent protection runs
out and generics can be introduced, revenues from such drugs can drop by as
much as 86%.
Second, although many patents, copyrights, trademarks, and trade secrets
may not prevent entry, they can slow it down. Circumventing a patent, though
less costly than developing an original patent, can still be costly to get it right, if
one ever does. Third, even when intellectual property protection does not pre-
vent entry or slow it down, it can still be the source of revenues and pro?ts. The
case of Google and Overture is very illustrative of how intellectual property can
be used. Google developed a search engine that, using its PageRank algorithm,
delivered some of the most relevant search results. To more optimally make
money from its search capabilities, the company needed a better advertising
revenue model than pop-up ads. Overture, formerly known as Goto.com, had
invented and in July 2001, received a patent for a bid-for-placement mechan-
ism—an ad-placement mechanism that allows advertisers to bid for the place-
ment of ads next to or above search results.
4
In August of 2004, Google and
Yahoo (which had bought Overture in July of 2003) settled the lawsuit for 2.7
million shares of Google class A common shares.
5
On June 28, 2006 the 2.7
million shares were worth just over one billion dollars. Qualcomm’s case offers
another example. Most of the company’s pro?ts come from the royalties on its
patents. Effectively, ?rst movers can make money from their intellectual proper-
ties even when followers enter their market spaces. Third, a ?rst mover can use
its intellectual property as bargaining chips for other important resources that it
may need to pro?t from its inventions or discoveries. For example, a startup
that invents a new product needs marketing, manufacturing, distribution, shelf
space, and other complementary assets so as to pro?t from the invention. It can
use its intellectual property as a bargaining chip to gain access to such comple-
mentary assets. That is just what many biotech ?rms do.
150 Strengths and Weaknesses
Learning
In performing R&D, manufacturing, marketing, and other value-adding activ-
ities, a ?rst mover accumulates know-how and other knowledge. Although
some of this knowledge can spill over to potential competitors through
employee mobility, informal know-how trading, reverse engineering, plant
tours, and research publication, ?rst movers still do bene?t from their accumu-
lated learning in several ways. First, as suggested by the standard learning or
experience curve model, a ?rm’s production cost for a particular product drops
as a function of the cumulative number of units that the ?rm has produced since
it started producing the product. Thus, to the extent that the knowledge is
dif?cult to diffuse or the ?rm can keep it proprietary, the ?rm can have a cost
advantage over followers. This can reduce potential new entries since any new
entrant would have to accumulate as much knowledge in order to bring its costs
down to those of the ?rst mover. A ?rm can also use its accumulated knowledge
as a bargaining chip for complementary assets. The case of Pixar and Disney
illustrates this. Pixar was the ?rst to move into the digital animation movie
technology and used its know-how to gain access to Disney’s brand name repu-
tation in animation, storytelling, merchandising might, and its distribution
channels through an alliance that was bene?cial to both ?rms.
Organizational Culture
An organization’s culture is the set of values, beliefs, and norms that are shared
by employees.
6
Since a culture is embedded in a ?rm’s routines, actions, and
history, it is often dif?cult to imitate and takes time to cultivate. Moving ?rst
can give a ?rm the valuable time that it needs to build the culture. Where culture
is valuable, dif?cult to imitate, and rare, it can be a source of competitive
advantage.
7
It can lower costs or allow a ?rm to be more innovative than its
competitors, thereby differentiating its products. Southwest Airline’s culture
was often associated with its being the most pro?table airline in the USA in the
1990s and well into the 2000s. The company’s employees cared about each
other, were ?exible in the types of job that they were willing to perform, and
were happy to work harder for longer hours than employees at competing
airlines.
Preemption of Scarce Resources
A ?rst mover often has the opportunity to acquire important scarce resources,
thereby preempting rivals.
Complementary Assets
For many ?rms, moving ?rst usually means the invention of a new product or
the introduction of a new technology. To pro?t from such an invention or new
technology, a ?rm usually also needs complementary assets—all other assets,
apart from those that underpin the invention or discovery, that the ?rm needs to
offer customers superior value and be in a position to appropriate the value.
8
Recall that complementary assets include brand name reputation, distribution
First-mover Advantages/Disadvantages and Competitors’ Handicaps 151
channels, shelf space, manufacturing, marketing, relationships with coopeti-
tors, complementary technologies, and so on. Thus, a ?rm that moves ?rst has
the opportunity to preempt rivals and acquire complementary assets. Once such
critical resources are gone, there is not much that potential new entrants can do.
For example, ?rst movers Coke and Pepsi preempted most potential new
entrants in the soda business by taking up most of the shelf space in stores for
sodas. Preemption of complementary assets can constitute an important barrier
to entry. Since complementary assets are critical to pro?ting from inventions
and new technologies, rational potential new entrants who know that they
cannot obtain the necessary complementary assets are less likely to enter, or
when they enter, they are likely to seek alliances with those that have the assets.
Complementary assets such as brands can also differentiate a ?rst mover’s
products from those of followers.
Location
In many arenas, there is only so much room for so many competitors. Thus a
?rst mover that pursues the right strategies can preempt rivals by leaving little
room for followers. Take geographic space, for example. At airports, there is
usually a limited number of gates and landing slots. An airline that moves into
an airport early and introduces many ?ights can take up most of the gates and
landing slots, leaving followers to the airport with few gates and landing slots.
When Wal-Mart entered the market in the Southwestern USA, it saturated con-
tiguous towns with stores, leaving followers with very little space to build simi-
lar stores.
9
Effectively, it erected a barrier to entry since any potential new
entrant who expected to enjoy the same costs bene?ts from economies of scale
as Wal-Mart would have to build as many stores and distribution centers; but
doing so would result in overcapacity and the threat of a price war. Such a
potential threat of price wars would prevent rational potential new entrants
from entering. Establishing positions in geographic space does not have to be
through saturation of contiguous locations, as Wal-Mart did. The ?rst mover
can establish the positions in such a way that occupying the interstices will be
unpro?table for a follower.
10
For example, good market research might allow
the ?rst mover to pick out the more lucrative locations to occupy, leaving out
the less pro?table ones for followers.
Location preemption can also take place in product space. First movers can
introduce many products with enough variation in attributes to cover the
potentially pro?table product-attribute spaces, leaving very little or no so-called
“white space”—potentially lucrative product space that others can occupy.
Such a lack of white space can deter entry.
Input Factors
In some industries, ?rst movers may be able to attract talented employees and
with the right incentives, retain them when followers enter. In some situations,
moving ?rst and performing the right research can provide superior informa-
tion about resource needs and availability. Such information can enable a ?rst
mover to purchase assets at market prices below those that will prevail as
followers move in. (Note that the ?rst mover can also pro?t from such superior
152 Strengths and Weaknesses
information by buying options for the assets where such markets exist.) For
example, a mineral or oil company that goes to a developing country and
explores for mineral or oil deposits has superior information about the poten-
tial of the country, compared to local of?cials or competitors that have not yet
ventured into the country. Such a ?rm can secure access to such deposits by
signing contracts with local of?cials. Access to superior information can also
help ?rms in structuring contracts with employees.
Plant and Equipment
If a ?rm builds a plant to produce a particular product and the plant cannot be
pro?tably used for any other purpose, the ?rm is said to have made an irrevers-
ible investment in the plant. First movers who make irreversible investments in
equipment, plants, or any other major asset, signal to potential followers that
they are committed to maintaining higher output levels following entry by fol-
lowers. That is because their plants and equipment cannot be pro?tably used
elsewhere and therefore managers are likely to keep producing so long as the
prices that they charge are high enough to cover their variable costs. If followers
were to enter, such ?rst movers could engage in price wars so long as their prices
are high enough to cover their variable costs. Effectively, irreversible invest-
ments in plants and equipment can deter entry and can be a ?rst-mover
advantage.
First-at-customers
Customers play a critical role in the pro?tability of a business model and being
the ?rst to reach customers can give a ?rm opportunities to attain ?rst-mover
advantages. We explore three such potential advantages:
Switching Cost
A buyer’s switching costs are the costs that it incurs when it switches from one
supplier (?rm) to another. These include the costs of training employees to deal
with the new supplier; the time and resources for locating, screening, and quali-
fying new suppliers; and the cost of new equipment such as software to comply
with the supplier. Switching costs can also arise from incompatibility of a
buyer’s assets with the new supplier. For example, frequent ?yer miles accumu-
lated on one airline may not work on some other airlines. If buyers’ switching
costs for a ?rm’s products are high, the buyers are less likely to switch to
another ?rm’s products. Potential new entrants who know that buyers will not
switch are less likely to try to enter. Rivals who know that buyers are less likely
to switch are less likely to try to win customers using lower prices. Thus, if a
?rst mover can build switching costs at buyers before followers move in, it can
have an advantage. It is important to note that while switching costs can pre-
vent existing customers from switching to new ?rms, they usually have little
effect on new customers who have no switching costs to worry about. Thus, in
a growing market, followers can focus on new customers to increase their
market share.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 153
Buyer Choice Under Uncertainty
The information that customers have about the bene?ts from some products is
imperfect. Buyers of such products may therefore stay with the ?rst brand that
meets their needs satisfactorily.
11
This is particularly true for experience
goods—products or services whose characteristics are ascertained only after
consumption, since it is dif?cult to observe the characteristics in advance. For
example, because a drug’s ef?cacy and side effects can vary from patient to
patient and cannot be determined in advance, doctors tend to stick with the ?rst
drug that works for their patients and will not change to a follower’s drugs
unless there are compelling reasons. Such brand loyalty can be particularly
strong for low-cost convenience goods, where the search costs of ?nding
another product that meets a customer’s taste often exceed the bene?ts of chan-
ging brands. (Convenience goods are products such as soaps and pasta that one
purchases frequently and with minimum effort.) The effect is less strong for
search goods—products or services such as airplanes whose characteristics are
easy to evaluate objectively before purchase.
Brand Mindshare: Preemption of Consumer Perceptual Space
Research also suggests that pioneering brands can have a strong in?uence on
consumer preferences.
12
In some cases, the ?rst product introduced may actu-
ally receive disproportionate attention in the press and in consumer’s minds. A
case in question is Viagra, which received lots of free press from unlikely
sources such as TV comedians. A follower must have a superior product or have
to spend a lot more on building its brand to dislodge the ?rst product.
First To Establish a System of Activities
One of the more durable ?rst-mover advantages that a ?rm can have is a
dif?cult-to-replicate system of activities. Why is a system of activities dif?cult to
imitate? Although imitating some individual activities in such a system of activ-
ities may be easy, imitating a whole system can be dif?cult, since it entails
imitating not only the components of the system but the interactions between
the components. The extent to which it can be dif?cult to imitate a system of
new game activities is illustrated by the now familiar Dell example. Dell was the
?rst major PC maker to pursue direct sales and build-to-order. It established a
system of activities to support this strategy that followers found dif?cult to
imitate. In 1999, its CEO at the time, Kevin Rollins, was asked, “What is it
about the direct sales model and mass customization that has been dif?cult for
competitors to replicate?”
13
His response was:
It’s not as simple as having a direct sales force. It’s not as simple as just
having mass customization in plant or manufacturing methodology. It’s a
whole series of things in the value chain from the way we procure, the way
we develop product, the way we order and have inventory levels, and manu-
facturer and service support. The entire value chain has to work together to
make it ef?cient and effective.
154 Strengths and Weaknesses
Those complex systems of activities can pose problems for potential imitators.
As Rollins pointed out,
What is the competition looking at? So many of our competitors are really
looking at our business and saying, “Oh, it’s the asset management model—
seven days of inventory. That’s what we’re going to do,” rather than look-
ing at every one of 10 things and replicating them.
And we may add that replicating the interactions between the ten things can
also be dif?cult to replicate.
First to Make Irreversible Commitments
First-mover advantages can change not only the likely expectations of follow-
ers, they can also change their behavior. One goal of making irreversible
investments is to deter or slow down followers; but to have such an effect, there
must be something about the ?rst mover that suggests that it is committed to
that particular ?rst-mover advantage. For example, a ?rst mover can establish a
reputation for retaliating against any ?rm that infringes on its intellectual prop-
erty by suing anyone who attempts to violate its patents or copyrights. For a
commitment to be effective in deterring or slowing down competitors, it must
be credible, visible to competitors, and understandable.
14
A commitment is
credible if there is something about it that makes competitors believe in it and
the options that it creates or limits. The primary drivers of credibility are repu-
tation and irreversibility of the commitment. If a ?rm has a reputation for
?ghting the ?rst set of followers that ventures into its product market space, it is
likely to do so with the next set. Such a reputation for retaliation can deter likely
entrants. A commitment is irreversible if it is costly or dif?cult to walk away
from or undo. That would be the case, for example, if the assets that underpin
the commitment cannot be pro?tably redeployed elsewhere. The idea here is
that if a ?rst mover’s commitment is irreversible, it is more likely to stay and
?ght followers rather than accommodate them or exit. Commitments such as
physical plants are visible to many people but others such as commitment to a
culture are more dif?cult to observe. When commitments are not very visible,
signals can be used to indicate their presence. Signals can also be used to help
competitors understand the nature of a ?rm’s commitments. Effectively, a ?rm
that moves ?rst has the opportunity to make commitments that are credible,
visible, and understandable. Doing so can deter or slow down followers.
It is important to emphasize the fact that ?rst-mover advantages are not
automatically endowed on ?rms that move ?rst. First-mover advantages are not
the birthright of ?rms that move ?rst. They have to be earned.
Earning and Maintaining First-mover Advantages
Earning First-mover Advantages
A ?rm that performs an activity ?rst is not automatically bestowed with ?rst-
mover advantages just because it was the ?rst to perform the activity. Firms
usually have to earn ?rst-mover advantages. In other words, the fact that a ?rm
First-mover Advantages/Disadvantages and Competitors’ Handicaps 155
is the ?rst to introduce a new product does not mean that, for example, it
automatically captures most of the total available market thereby enabling it to
bene?t from economies of scale, get large enough to take advantage of its size,
earn pro?ts from its pioneering activities, build and exploit a large installed
base, or cultivate important and useful relationships with coopetitors. Neither
does moving ?rst mean that a ?rm automatically preempts the right resources/
capabilities and builds switching costs at customers. Attaining these advantages
entails performing the value chain activities with the effectiveness and ef?ciency
that it takes to increase one’s chances of creating and capturing the most value.
A ?rm also has to focus on the ?rst-mover advantages that it wants, anticipate
and respond to the reaction of followers, and pay attention to any opportunities
and threats of its environment. In other words, attaining ?rst-mover advantages
requires good strategies. It may be easier to perform some of these activities
because one has moved ?rst, but one still has to perform them well.
Total Available Market Preemption
When a ?rm moves into a market ?rst, the chances are that not all potential
customers are going to ?ock to its doors asking for its products. If the ?rm
wants to capture as much of the total available market as possible, it has to
perform the types of activities that locate as many customers as possible that
have a high willingness to pay, and whose acquisition and maintenance costs
are low, and provide these customers with the types of bene?ts that they want.
If customers do not get the bene?ts that they want, they may decide to wait
for followers or integrate vertically backward to provide their own needs. A
?rst mover will maintain its market lead only if it has built a system of activ-
ities to create and capture value, that is dif?cult to imitate, or has built valu-
able scarce dif?cult-to-imitate resources/capabilities that followers cannot
replicate.
Lead in Technology and Innovation.
Being the ?rst to introduce a new technology does not automatically endow a
?rm with intellectual property rights, stocks of knowledge, and the right organ-
izational culture. These advantages have to be pursued correctly. A ?rm that
wants the advantages of intellectual property protection has not only actively to
pursue the intellectual property ?rst, but also actively defend its property rights
when attempts are made to violate them. One reason why it took AMD a long
time to catch up with Intel was because Intel was also good at defending the
copyrights for the microcode of its microprocessors.
15
Learning is not automatic
either. A ?rm has to have the right structure, incentive systems, and processes to
learn well. Building a culture that is conducive to innovation also takes meticu-
lous work that is not guaranteed just because one moved ?rst.
Preemption of Scarce Resources
First movers are not automatically endowed with scarce resources. Wal-Mart
was able to preempt much of the discount retail space in the Southwestern
USA because of all the activities that it performed. If it had not saturated
156 Strengths and Weaknesses
contiguous small towns with discount stores, built matching distribution cen-
ters, and established a Wal-Mart culture, it may have been easier for competi-
tors to move in. If Ryanair had not ramped up ?ights to each of the secondary
airports into which it moved, established good relationships with local of?cials,
and obtained as many gates and landing slots as possible, it might have been
easier for other airlines to move into the same airports that it ?ew into. To
preempt scarce resources, a ?rm has to pursue them diligently.
First-at-Customers
The fact that a ?rm was the ?rst to introduce a product does not mean that the
?rm will reach all the right customers and build all the switching costs possible.
The right customers have to be pursued with the right switching costs. Firms
have to pursue the right branding messages and so on.
First to Establish a System of Activities
The fact that a ?rm is ?rst to perform a series of activities does not mean that the
?rm will automatically be endowed with a system of activities that is dif?cult-
to-imitate and that gives it a competitive advantage. The activities in the system
have to be consistent with the positions that they underpin.
16
For example, if a
?rm is a low-cost competitor, it cannot pursue the type of high-cost activities
that are usually pursued by ?rms that offer luxury goods. The activities should
also reinforce rather than neutralize each other’s effect. For example, if a ?rm
tries to build a luxury brand through advertising but offers products that do not
match the image that it is trying to create, it has a problem. The activities should
be consistent with the ?rm’s existing distinctive resources or those that it wants
to build. It would not make sense for Toyota to try to produce a new car that
does not use its lean manufacturing practices, unless it were experimenting with
newer and better processes. Finally, establishing the right system of activities
may also require that one takes advantage of industry value drivers. Recall that
industry value drivers are those industry factors that stand to have a substantial
impact on the bene?ts (low-cost or differentiation) that customers want, and
the quality and number of such customers.
Which First-mover Advantages Should One Pursue?
The list of ?rst-mover advantages that we have outlined is rather long. The
question is, which of them should a ?rm pursue? After all, not all ?rst-mover
advantages are important to every ?rm. One way to narrow down the list to
those that make a signi?cant contribution to value creation and appropriation
is to use an AVAC analysis to rank order the advantages by the extent to which
they contribute to value creation and appropriation. As shown in Table 6.2,
each advantage is classi?ed by answering the following questions:
1 Activities: Does the ?rm have what it takes to perform the activities to build
and exploit the ?rst-mover advantage? What are these activities and how do
they contribute to value creation and capture?
2 Value: Does the ?rst-mover advantage make a signi?cant contribution
First-mover Advantages/Disadvantages and Competitors’ Handicaps 157
towards the value that customers perceive as unique compared to what
competitors offer?
3 Appropriability: Does the ?rst-mover advantage make a signi?cant contri-
bution to pro?ts?
4 Change: Does the ?rst mover advantage take advantage of change to create
and appropriate value?
As shown in Table 6.2, each ?rst-mover advantage is classi?ed by the potential
competitive consequence of pursuing the particular ?rst-mover advantage, from
“sustainable competitive advantage” down to “competitive disadvantage.” The
more that the strategic consequence from a ?rst-mover advantage is a sustain-
able strategic advantage rather than a strategic disadvantage, the more that a
?rm may want to pursue the ?rst-mover advantage. In addition to telling a ?rm
which ?rst-mover advantage to pursue, the analysis can also point out which
Noes could be reversed to Yesses or dampened, and which Yesses should be
strengthened.
First-mover Dis advantages
There are also disadvantages to moving ?rst. These ?rst-mover disadvantages
are also called follower advantages.
17
Followers sometimes stand to bene?t
from free-riding on the spillovers from ?rst movers’ investments, resolution of
Table 6.2 Rank Ordering First-mover Advantages
First-mover
advantage
Activities: Does
the firm have
what it takes to
perform the
activities to build
and exploit the
first-mover
advantage?
Value: Does the first-
mover advantage make
a significant
contribution towards
the value that
customers perceive as
unique compared to
what competitors offer?
Appropriability:
Does the first-
mover advantage
make a significant
contribution to
profits?
Change: Does
the first-mover
advantage take
advantage of
change to
create and
appropriate
value?
Strategic
consequence
Advantage 1 Yes Yes Yes Yes Sustainable
competitive
advantage
Advantage 2 Yes Yes Yes No Temporary
competitive
advantage
Advantage 3 Yes Yes No Yes Temporary
competitive
advantage
Advantage 4 Yes Yes No No Competitive
parity
Advantage 5 No/Yes No Yes No Competitive
parity
Advantage 6 No No No No Competitive
disadvantage
Strategic
action
What can a firm do to reinforce the Yesses and reverse or dampen the Noes, and what is
the impact of doing so?
158 Strengths and Weaknesses
technological and marketing uncertainty, changes in technology or customer
needs, and ?rst-mover inertia.
Free-riding on First-mover’s Investments
First movers, especially those that pioneer new products, sometimes have to
invest heavily in R&D to develop the new product, in training employees for
whom the technology and market are new, in helping suppliers better under-
stand what they should be supplying, in developing distribution channels, and
in working with customers to help them discover their latent needs. Followers
can take advantage of the now available knowledge from ?rst movers’ R&D,
hire away some of the employees that the ?rst mover trained, buy from sup-
pliers who have a better idea about what it is that they should be supplying, use
proven distribution channels and go after customers who may be willing to
switch or new ones who are waiting for a different version of the pioneer’s
product. Effectively, a follower’s costs can be considerably lower than those of
the ?rst mover on whose investments the follower free rides. The fact that these
free-riding opportunities exist does not mean that every follower can take
advantage of them. Whether a follower is able to take advantage of these
opportunities is a function of the imitability of the ?rst mover’s product and the
extent to which the follower has the complementary assets for the product.
18
It
is also a function of the business models that the ?rst mover and follower
pursue.
Resolution of Technological and Marketing Uncertainty
In some cases, ?rst movers face lots of technological and marketing uncertainty
that must be resolved. This uncertainty is gradually resolved as the ?rst mover
works with suppliers, customers, and complementors to better deliver what
customers want. For example, the emergence of a standard or dominant design
can drastically reduce the amount of uncertainty since ?rms do not have to
make major costly design changes and suppliers know better what to supply.
Followers who enter after the emergence of a standard or dominant design, for
example, do not have to worry as much about what design to pursue or whether
a market exists or not, as the pioneer did. Many PC makers such as Dell moved
into the PC business only after it had been proven that the technology and
market were viable. Thus, when Dell entered the PC market, it had already been
proven that there was a market for business customers. All Dell had to do was
decide to focus on the business customers. Whether followers can erode a ?rst
mover’s competitive advantage depends on what the pioneer did when it moved
?rst. A ?rst mover that pursues the right strategies can win the standard or
dominant design, and therefore have a say as to the extent to which followers
can pro?t from the standard or dominant design.
Changes in Technology or Customer Needs and First-mover
Inertia
Technological change or a shift in customer needs that requires a ?rst mover to
change can give a follower an opening if the ?rst mover’s inertia prevents it
First-mover Advantages/Disadvantages and Competitors’ Handicaps 159
from changing. For example, if a technological change makes it possible to
introduce a new product that potentially replaces a ?rst mover’s product, the
?rst mover is not likely to be in a rush to introduce the new product for fear of
cannibalizing its existing product.
Competitors’ Handicaps
When a ?rm moves first and enjoys ?rst mover advantages, it is because its
competitors (present and potential) decided not to move ?rst or to follow
immediately. The question is, what is it about some ?rms that would make them
not move ?rst or not move at all despite the potential ?rst-mover advantages?
Put differently, if there are so many advantages to moving ?rst, the questions is,
what is it about a ?rst mover’s competitors that prevents them from moving
?rst? We explore ?ve factors that can prevent competitors from moving ?rst or
following: competitors’ dominant logic, lack of strategic ?t, prior commit-
ments, resources and capabilities (or lack of them) (strengths and weaknesses),
and the fear of cannibalization.
Dominant logic
Every manager has a set of beliefs, biases, and assumptions about the structure
and conduct of the industry in which his or her ?rm operates, what markets her
?rm should focus on, what the ?rm’s business model should be, whom to hire,
who the ?rm’s competitors are, what technologies are best for the ?rm, and so
on.
19
This set of beliefs, biases, and assumptions is a manager’s managerial logic
and de?nes the frame within which a manager is likely to approach manage-
ment decisions. Managerial logic is at the core of a manager’s ability to search,
?lter, collect, evaluate, assimilate new information, and take decisions using the
newly acquired information.
20
Depending on organizational values, norms, cul-
ture, structure, systems, processes, business model, environment (industry and
macro), and how successful the ?rm has been, there usually emerges a dominant
managerial logic—a common way of viewing how best to do business in the
?rm. Also called mental map, managerial frame, genetic code, corporate genet-
ics, and corporate mindset, dominant logic is very good for a ?rm that has been
performing well so long as there are no major changes; that is, dominant man-
agerial logic is usually a strength. In the face of an opportunity to take advan-
tage of new information by pursuing a new game activity and thereby moving
?rst to, say, offer a new product, a ?rm is likely to pass over such an opportun-
ity if it lies outside its managers’ dominant logic—outside manager’s beliefs,
biases, and assumptions about how best to do business. Thus, competitors’
dominant logic may be one reason why a ?rst mover and not its competitors is
the one that moves ?rst. Competitors’ logic may prevent them from seeing the
?rst-mover advantages and moving effectively to exploit them.
Strategic Fit
Competitors’ dominant logic may be such that they can understand the bene?ts
of moving ?rst but management might still decide not to move ?rst. That would
be the case, for example, if moving ?rst does not ?t the ?rm’s strategy. Exploit-
160 Strengths and Weaknesses
ers with valuable scarce complementary assets often pursue a so-called follower
strategy and wait for others to introduce a new product ?rst. They then quickly
imitate the product and use their scarce complementary assets to overcome the
?rst mover and pro?t from the ?rst mover’s inventions. IBM pursued such a
follower strategy in the 1970s, 1980s, and 1990s. It did not invent the personal
computer but used its brand name reputation and installed base of customers
and software developers to gain temporarily about 60% of the PC market share
before seeing that share drop dramatically and eventually getting out of the
market. It also waited until Apollo Computers and Sun Microsystems had
developed the computer workstation business before it entered and used its
installed base of customers and brand to quickly attain an important market
share. As we saw in Chapter 5, the British music record company invented CAT
scans but GE and Siemens used their complementary assets to make most of the
pro?ts from the invention.
Prior Commitments
Even if it is in the interest of a competitor to move ?rst in performing the new
game activity or follow a ?rst mover, the competitor may still be prevented from
taking action because of prior commitments that it made in its earlier activities.
We examine two types of commitment: relationship-related and sunk cost-
related.
Relationship-related Commitments
Relationship-related commitments are commitments such as contracts, net-
work relationships, alliances, joint ventures, agreements, understandings within
political coalitions, and venture capital investments that involve more than one
party. Sometimes, performing a new game activity requires a ?rm to get out of
or modify the terms of prior relationship-related commitments. If the new game
is not in the interest of the other party, the party might refuse to cooperate.
Compaq’s case offers an interesting example. To follow Dell’s direct sales and
build-to-order new game strategy, Compaq wanted to adopt a build-to-order
model and sell directly to customers, bypassing distributors. Citing previous
agreements, distributors refused to cooperate and Compaq had drastically to
modify its proposed new business model.
Sunk Cost-related Commitments
In sunk cost-related commitments, a ?rm makes irreversible investments in
plants, equipment, capacity, or other resources, sometimes to signal its com-
mitment to stay in a market or a particular business. Irreversible investments
are those investments whose costs are sunk, that is, investments whose costs
have already been incurred and cannot be recovered.
21
If performing a new
game activity requires resources that are different from a ?rm’s irreversible
investments but existing PMPs remain competitive, staying with one’s irrevers-
ible investments, rather than investing in the new game activities, may appear
to be the pro?table thing to do. Why? For the incumbent, investing in the
new game activity requires new investments and this money must come from
First-mover Advantages/Disadvantages and Competitors’ Handicaps 161
somewhere else, since the ?rm’s existing investments are sunk and therefore
their costs cannot be recovered and reinvested in the new game activity. Thus, if
the ?rm pursues the new game activity, it must incur all the new costs. If it stays
with its existing activities, it does not have to spend any new money, since its
products from the sunk investments are still competitive. If products from the
new game activities improve at a faster rate than those from existing activities,
there may come a time when customers start migrating to new game products
and the ?rm that stuck with the sunk investments will see its market share
eroded.
Resources and Capabilities
In some industries, performing a new game activity often requires distinctive
resources that competitors may not have. Developing a new microprocessor or
operating system can require billions of dollars and many very skilled engineers.
These are scarce resources and capabilities that few ?rms have. Thus, competi-
tors may not be able to compete with a ?rst mover because they do not have the
resources or capabilities needed to compete. For example, many countries can-
not afford a car industry because they do not have what it takes to build and run
one pro?tably. This is the old barriers to entry story.
Fear of Cannibalization
Firms are not likely to pursue a new game activity if to do so cannibalizes their
existing products, especially if the new products have to be priced lower than
the ones that they are cannibalizing. For a while, Sun Microsystems was not
eager to introduce Linux Intel-based servers, since the latter costs less to buy,
use, and service than Sun’s UNIX-based servers. Intel-based servers eventually
won the battle.
Multigames
As we ?rst suggested in Chapter 1, a new game does not take place in isolation.
Rather, each new game is usually preceded by, followed by, or is concurrent
with another game. Thus, a ?rm that wants to play a current game well may
have to take into consideration the likely reaction of ?rms from the preceding,
following, and concurrent games. Depending on the differences between the
current and preceding games, ?rms from a preceding game may ?nd out that
some of their strengths in the preceding game have become handicaps in the
current game. Firms that were not in the preceding game can take advantage of
such handicaps. However, many strengths from preceding games often remain
strengths. This is the case with many complementary assets. Firms that move
?rst in the current game can build and take advantage of ?rst-mover advan-
tages. At the same time, these ?rms have to be aware of the fact that in the
following game some of their ?rst-mover advantages as well as disadvantages
may become handicaps. Thus, these ?rms may be better off anticipating the
likely reaction of players in the following game and responding accordingly
to them.
162 Strengths and Weaknesses
Types of Player: A Framework
Not all the ?rms that pursue new games in any particular market move at the
same time. Nor do all players pursue the right new game strategies. Thus, we
can categorize players as a function of when they pursue new game strategies
and the extent to which they pursue the right strategies. Such a classi?cation can
help a ?rm understand where it stands strategically, relative to its competitors
in the face of a new game, as a ?rst step towards understanding what it needs to
do next. It can help an entrepreneur understand what strategic spaces might be
good ones to pursue. The classi?cation results in four types of player: explorers,
superstars, exploiters, and me-toos (Figure 6.1).
Explorers
An explorer is a ?rm that moves ?rst in performing a set of new game activities
but does so largely for the fun of it. It is more of an explorer than an exploiter.
Its activities are driven, not so much by a clear strategy for creating and
appropriating value, but by what it just happens to ?nd itself doing or enjoys
doing. Explorers may pursue the activities more to make a difference than to
make money. They may also pursue the activity for knowledge’s own sake.
They often create value or establish a foundation for creating value but do not
appropriate it. They help reduce technological and market uncertainty and pave
the way for exploiters (see below) to come in and take advantage of the founda-
tion for value creation and make money. Many inventors (?rms and indi-
viduals) fall into this category. AT&T which invented the transistor and inven-
tors such as Tesla, are good examples. Another example is Xerox, which,
through its Xerox Palo Alto Research Center, invented, among other things,
Figure 6.1 Types of Player.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 163
laser printing, Ethernet, the personal computer graphical user interface (GUI)
paradigm (or windows), and object-oriented programming, but never made
much money from them. This is not to say that some explorers do not appropri-
ate the value that they have created. Some do make money but the money does
not come through a deliberate attempt to create and appropriate value.
Superstars
A superstar is a ?rm that moves ?rst in pursuing a new game strategy and
diligently performs those activities that substantially improve its chances of
building and exploiting ?rst-mover advantages, countering ?rst-mover dis-
advantages, and taking advantage of competitors’ handicaps. Usually, a super-
star has a clear strategy for how to create and appropriate value when it moves
?rst. Like explorers, a superstar is interested in exploring new ways of creating
value; but unlike explorers, superstars are also genuinely and purposefully
interested in exploitation—in creating and appropriating value. A superstar
works hard at performing new game activities and taking advantage of both the
value chain and new game factors of its new game activities. It does the right
things and does them right. With some luck, such a ?rm can not only gain a
competitive advantage, it can also change the structure of its industry to its
advantage. It can become the superstar of its industry. Largely because the
superstar has built the right ?rst-mover advantages and is taking advantage of
them, followers usually have a dif?cult time catching up with or leapfrogging
the superstar. Moreover, a superstar may also have countered potential ?rst-
mover disadvantages, and taken advantage of potential competitors’ handicaps.
This does not mean that a superstar’s competitive advantage is forever. Merck
was a superstar when it performed the relevant R&D to discover and exploit
Mevacor, the ?rst cholesterol drug from the group of cholesterol drugs called
statins that would revolutionize cholesterol therapy. Wal-Mart was a superstar
when it established its discount retailing operations in rural southwestern USA.
Dell was a superstar when it established direct sales and build-to-order in the
PC market. Ryanair was a superstar when it established its low-cost airline
activities in the EU. Superstars usually make money, but not necessarily all the
time. Their deliberate pursuit of value creation and appropriation increases
their chances compared to those of an explorer. However, because superstars
often face the huge technological and marketing uncertainties associated with
moving ?rst, they are not always likely to appropriate most of the value that
they have created.
Exploiters
An exploiter is a follower that waits for explorers and superstars to move ?rst
and reduce technological and market uncertainty, and then enters. An exploiter
usually has or can quickly develop the ability to take advantage of ?rst-mover
disadvantages better to create and/or appropriate value than ?rst movers.
Exploiters usually do not invent or discover anything but can make most of the
money from inventions or discoveries. They usually have complementary
assets—all the other assets, apart from those that underpin the inventions or
discoveries, that ?rms need to create and appropriate value. Examples of
164 Strengths and Weaknesses
exploiters abound. General Electric and Siemens did not invent the CAT scan
but made most of the money from it. Coke and Pepsi did not invent diet or
caffeine-free cola but made most of the money from them. Microsoft did not
invent many of the products from which it makes money. iPod was not the ?rst
MP3 player but dominated the market in 2007. Like superstars, exploiters have
clear strategies for creating and appropriating value. In doing so, however, they
take advantage of their complementary assets and ability to exploit ?rst-mover
disadvantages. They usually know when to enter and what to do when they
enter. Some entrepreneurs see exploiters as an important part of their exit strat-
egies, since they can sell themselves (and their technologies and ideas) to the
exploiters for good money. Others see exploiters more as piranha.
Me-too
Me-too players are followers who have no clear strategy for taking advantage
of ?rst-mover disadvantages better to create and appropriate value than ?rst
movers. Many of them are incumbents who are forced to defend their competi-
tive advantages from attacking ?rst movers or exploiters but do not quite know
how. Some are ?rms that take advantage of ?rst-mover disadvantages to create
or enter niche markets. In that case, they may have clear strategies for attacking
the niche in question but not for toppling ?rst movers or exploiters. Many
suppliers of generic pharmaceuticals are me-too players.
Competition and Coopetition
It is important to note that the success of each player type depends on the
competition that it faces. Superstars are less likely to shine brightly if they start
executing their strategies at about the same time that other ?rms with more
valuable and scarce complementary assets enter the market. They are also less
likely to do well if exploiters enter the market before the superstars have had a
chance to build ?rst-mover advantages. If explorers are never challenged by
exploiters or superstars, they may make money simply because they do not have
strong competitors. Exploiters are less likely to make money if they enter the
market at about the same time that other exploiters enter or enter after super-
stars have had a chance to build ?rst-mover advantages. Me-toos can do well if
they enter niche markets and neither superstars nor exploiters bother to chal-
lenge them. Effectively, the competition that a player faces plays an important
role in the extent to which the player can make money.
A player’s performance may also depend on the extent to which it is better
able to cooperate with other players in creating and appropriating value. An
explorer that is more capable of invention may team up with an exploiter that
has complementary assets in order to form a team with a better chance of
winning than either player alone. Exploiters and superstars can also team up to
exploit their complementary assets, especially if each player comes from a dif-
ferent country that has something unique to offer.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 165
Applications of the player-type framework
Although the player-type framework is very simple, it has some potentially
powerful applications. It is versatile, and can be used to provide an elementary
but useful look at a ?rm’s new game strategies (1) for different products, (2) in
different countries, and (3) over a time period.
Explore Different New Game Product Strategies
It is not unusual that, at any one time, one ?rm can be an exploiter for one
product, an explorer for another product, and a superstar or me-too for yet
another. Managers can use the player-type framework to explore the different
strategies that underpin each of these products and make some decisions on
what to improve. Figure 6.2 offers an example of how the framework can be
applied to a computer maker. In the year 2000, the company offered three
products: Laptops, servers, and MP3 players. Each circle in Figure 6.2 is pro-
portional to sales revenues or pro?ts at 2000 prices. The earlier a ?rm intro-
duced a product before its next major competitor, the higher the circle. The
more that the ?rm was seen as having gotten the new game strategy for the
product right, the more the circle would lie to the right. Thus, in both 2000 and
2007, the ?rm was an explorer when it came to strategies for its laptops; but in
2007, it behaved a little more like a superstar, since the laptop circle moved to
the right, (the ?rm was still an explorer). The strategy also appears to have paid
off since its 2007 revenues were higher than 2000 revenues. As far as servers
were concerned, the ?rm behaved as a superstar. Its revenues increased from
2000 to 2007 as the ?rm appeared to have ?ne-tuned its strategy. Finally, the
?rm appeared to have improved its strategy for MP3s from 2000 to 2007 as an
exploiter but its revenues dropped. Why the drop? It is possible that competi-
tion increased even as the ?rm improved its strategy. While very simple, this
analysis is still a good starting point for a management discussion about
whether to continue offering all three products, focus on one or two, and if so,
whether to still do so as a superstar, exploiter, or explorer, or maybe even as a
me-too.
Performance of Different New Game Strategies in Different Countries
The framework can also be used to examine a multiproduct/service ?rm’s strat-
egies in different countries or regions. Consider a ?rm that pursues different
strategies in the EU, China, and the USA (Figure 6.3). Again, the area of the
circle is proportional to the revenues or pro?ts that the ?rm earns in each region
in the period being explored. In the EU, the ?rm does well as an explorer and an
exploiter, somewhat well as a me-too, but not so well as a superstar. Such a ?rm
could be a fast-food company such as McDonald’s or Kentucky Fried Chicken
that operates as an explorer in some countries where it is usually the ?rst fast-
food company in each of the locations where it opens its stores, an exploiter in
others, and so on. In China, the company acts as a superstar, exploiter, and me-
too. It is more successful as an exploiter and me-too than as a superstar (each
has a larger circle area than the me-too). The ?rm could also be a fast-food
company or a retailer that has different strategies for different regions of China.
166 Strengths and Weaknesses
Figure 6.2 Different New Game Product Strategies.
Figure 6.3 Player Types in Different Countries.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 167
In the USA, the ?rm offers four different products, with each one re?ecting a
different player type. The ?rm does best as a superstar, followed by being an
exploiter and then an explorer. Being me-too works the least. Such an analysis
can be a good starting point for whether to continue trying to be all things to
each country/region or focus on only being a superstar, explorer, exploiter, or
me-too.
History of Firm’s New Game Strategies
In the third example, a ?rm can use the framework to explore where it has been
and how well it has performed as a superstar, explorer, exploiter, and me-too
(Figure 6.4). Such a ?rm could be a pharmaceutical company that introduced
different drugs using different strategies. In the example, the ?rm started out in
the 1980s as an explorer and offered two products that did relatively well; but
the product for which the ?rm had more of a strategy than the other (the one to
the right in the explorer quadrant) had more revenues. In the 1990s, the ?rm
decided to try being a superstar and me-too in addition to being an explorer. Its
revenues as a superstar were much higher than those as an explorer and me-
too. In the 2000s, the ?rm had become an exploiter and was doing very well.
This analysis is also a good starting point for managers to discuss what next for
the company. It suggests, for example, that the ?rm might want to continue
being an exploiter, assuming that everything else—e.g. competition—remains
the same. One other thing that the results suggest is that the ?rm may
have been riding a technology life cycle. At the onset of such a cycle, the
Figure 6.4 A Firm’s Evolution from Explorer to Exploiter.
168 Strengths and Weaknesses
environment is usually more conducive to explorers and superstars. As
uncertainty unravels, exploiters and me-toos move in. We will have more to say
about technology life cycles in a later chapter when we explore disruptive
technologies.
First Movers Versus Followers: Some Conclusions
To conclude this chapter, we return to the question that was posed at the begin-
ning of the chapter: why is it that ?rst movers sometimes go on to dominate
their markets and at other times, followers are the ones that go on to dominate
their markets? The answer to this question is a combination of the following
?ve reasons:
1 First-mover advantages have to be earned and exploited diligently.
2 The owner of scarce important complementary assets usually has an edge.
3 First-mover disadvantages can be minimized.
4 Competitive, macro, and global environments.
5 Type of player and its business strategy.
First-mover Advantages have to be Earned and Exploited
Diligently
As we saw earlier, ?rst-mover advantages are not automatically bestowed on
whoever moves ?rst. They have not only to be built by pursuing the right new
game activities, they also have to be exploited by pursuing the right activities.
If ?rst movers do not diligently pursue and exploit ?rst mover advantages, they
leave room for followers, especially exploiters, to come in and possibly domin-
ate. For example, if a pharmaceutical company wants the bene?ts of patent
protection, it has to pursue the types of activity that will not only allow it to
discover something worth patenting but also to apply for and obtain the
patent in the right countries. Moreover, the ?rm also has to turn its patents
into medicine that patients can take, since patents do not cure illnesses. Per-
haps more importantly, to perform these activities effectively and ef?ciently
often requires distinctive resource/capabilities that not all ?rst movers
have. For example, not all pharmaceutical companies have the R&D skills,
knowledge base, and know-how to discover the types of compound that can
be patented.
Effectively, if a ?rst mover cannot earn and exploit ?rst-mover advantages—
either because it did not know which activities to pursue or did not have or
could not build the necessary distinctive resources/capabilities—there is room
for followers to come in and do well, especially followers that already have the
right complementary assets or can build them quickly.
Owner of Scarce Important Complementary Assets has an
Edge
To pro?t from a new game, a ?rm usually needs complementary assets. Thus, if
a ?rm moves ?rst to invent or discover something, other ?rms that enter the
market later can make most of the pro?ts from the invention or discovery if they
First-mover Advantages/Disadvantages and Competitors’ Handicaps 169
have scarce important complementary assets that the ?rst mover does not
have. Effectively, whoever has scarce important complementary assets, be it a
?rst mover or follower, has a better chance of being the one to pro?t from a
new game.
Can Minimize or Exploit First-mover Disadvantages
If a ?rst mover is able to minimize the effects of ?rst-mover disadvantages, it has
a better chance of doing well. If it does not, it leaves room for followers to take
advantage of them. Take, for example, the fact that followers often can free ride
on the ?rst mover’s investments by taking advantage of the R&D knowledge
generated by the ?rst mover, hiring from the ?rst mover, going after its cus-
tomers, and so on. The ?rst mover can reduce these negative effects by better
protection of its intellectual property or by entering into the right agreements
with employees or customers. Such measures, coupled with ?rst-mover advan-
tages, may be able to give the ?rst mover a better chance. If this is not possible, a
follower can take advantage of ?rst mover disadvantages. A follower can not
only free ride on ?rst movers’ R&D, it can also take advantage of the reduced
technological and marketing uncertainty as well as any changes in technological
change or customer needs that may have occurred since the ?rst mover made
commitments as to which activities to perform.
The Competitive, Macro, and Global Environments
Whether the ?rm that goes on to dominate a market is a ?rst mover or follower
is also a function of its competitive environment—of its rivals, suppliers, cus-
tomers, potential new entrants, and substitutes. For example, if the ?rst mover
is a new entrant that uses a disruptive technology to attack incumbents, there is
a good chance that it will defeat incumbents. If the industry has plenty of white
space in the market, ?rst movers have more opportunities to create unique value
for customers and build ?rst-mover advantages than if they were in a more
crowded market space. A dominant buyer can force a ?rm to ?nd second
sources for the products that the buyer buys, effectively neutralizing some of the
?rm’s ?rst-mover advantages. For example, in the 1970s and 1980s, IBM usu-
ally required that chipmakers who supplied it with chips had to cooperate with
at least one other chipmaker to help it also supply the same chips.
The extent to which some ?rst-mover advantages amount to something
depends on the macroenvironment—on the political, economic, technological,
social, and natural environments. For example, if the political/legal environ-
ment in a country is such that there is no respect for intellectual property protec-
tions, a ?rst mover cannot rely on patents or copyrights as a ?rst-mover advan-
tage. This increases the chances that a follower can free ride on ?rst movers’
investments in R&D, manufacturing, and marketing. If the rate of techno-
logical change is high, ?rst movers’ commitments are more likely to make it
dif?cult for them to adjust to technological changes, allowing followers to have
a better chance. In some countries, there are restrictions on how many ?rms can
enter some industries. First movers in such industries are therefore more likely
to do well than very late followers.
170 Strengths and Weaknesses
Type of Player and Business Strategy
Whether a ?rst mover or follower wins in the face of a new game is also a
function of whether the ?rm is pursuing the game as an explorer, superstar,
exploiter, or me-too. Many exploiters prefer to wait until some other ?rms have
moved ?rst and both technological and marketing uncertainties have been dras-
tically reduced before they enter. Recall that an exploiter is a follower that waits
for ?rst movers to reduce technological and market uncertainty, and then
enters. Even if exploiters accidentally discover or invent something, they usually
still wait until someone else has developed the invention further and tried to
commercialize it, thereby proving that there is a market for it. IBM and Micro-
soft are good examples. Such ?rms usually have the right distinctive dif?cult-to-
imitate complementary assets. They usually also develop the skills and know-
how to quickly develop and commercialize a product once they decide that
technological and market uncertainty have dropped enough for them to enter.
And after pursuing such strategies for a long time, they may develop com-
petences in excelling as followers. Thus, when exploiters face explorers, espe-
cially in the face of changing technologies or consumer tastes, the former are
more likely to win than the ?rst movers.
Similarly, superstars are usually at the forefront of inventions and pursuing
the right strategies to allow them to create and appropriate value. Recall that a
superstar is a ?rm that moves ?rst in pursuing a new game and diligently per-
forms those activities that substantially improve its chances of building and
exploiting ?rst-mover advantages, countering ?rst-mover disadvantages, and
taking advantage of competitors’ handicaps. Superstars usually develop com-
petences for moving ?rst and pursing the types of strategy that give them a good
chance of doing well. Intel was a superstar when it invented the microprocessor,
the EPROM memory device, and advanced its microprocessor technology at a
pioneering rate by introducing a newer generation of its microprocessors before
unit sales of an older one had peaked. Superstars are particularly likely to do
well if they face only explorers or me-toos. One of the biggest problems for
superstars is that they usually face huge technological and marketing
uncertainty alone, while exploiters are waiting in the wings.
Explorers are also likely to have developed competences for creating value
(e.g. inventing or discovering things) but not for appropriating it. Recall that an
explorer is a ?rm that moves ?rst in performing a set of new game activities but
does so largely for the fun of it, or because that’s what it just happens to be
doing. It is more of an explorer than an exploiter and therefore has no purpose-
ful plan for building and exploiting ?rst-mover advantages. That is not to say
that explorers do not have ?rst-mover advantages. They sometimes stumble on
?rst-mover advantages but miss out on many others that they could have built
and exploited. If there are many exploiters or superstars around, then an
explorer’s chances of doing well are decreased. Me-toos develop competences
for pursuing niches and can do well if exploiters and superstars decide to leave
such niches alone.
Effectively, if a ?rm’s strategy is predicated on its moving ?rst and it has
developed underpinning resources/capabilities to back it, it is likely to move
?rst and go on to dominate its market. If its strategy is to be a follower and it
has the resources/capabilities to back it, it is likely to do well as a follower.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 171
What Does this Mean for Managers?
In the face of a new game, a ?rm that moves ?rst may want to:
1 Go through the list of ?rst-mover advantages and disadvantages that were
summarized in Table 6.1, and note (catalog) the ones that are relevant for
the industry and markets in which the ?rm competes or intends to compete.
2 Screen the advantages to those that make (1) a signi?cant contribution to
value creation and appropriation, and (2) the ?rm is capable of ef?ciently
performing the activities to build and exploit the advantage. An AVAC
analysis can be used for this step.
3 Build and exploit the chosen ?rst-mover advantages while anticipating and
countering any ?rst-mover disadvantages.
A follower may want to:
1 Catalog the ?rst-mover disadvantages and determine the extent to which it
has what it takes to exploit them.
2 Find out where the ?rst mover was not able to build ?rst-mover advantages
and take advantage of the holes left.
3 Look for where ?rst-mover advantages may have become handicaps and
exploit that. For example, a ?rst mover may have made commitments to
coopetitors that it cannot get away from. Recall the case of Compaq and
Dell. Compaq was one of the ?rst to preemptively take up positions with PC
distributors. When Dell (a follower) came along, distributors did not have
any more capacity to take on another PC maker. When Dell went direct, and
Compaq wanted to follow suit, distributors would not let the latter get off
that easily.
Example 6.1: The Value of Ef?cient Exploitation of First-mover
Advantages
In 1997, the cholesterol drug Lipitor was granted FDA approval. This was one
year earlier than expected, because of several measures that Warner Lambert, its
inventor, had taken. Table 6.3 shows a forecast of sales up to the expiration of
the patent life of the drug in 2011. When a drug’s patent expires, the price of the
drug can drop by as much as 86% as a result of the introduction of generic
versions. The number in parentheses in 2010 is the projected sales if the patent
did not expire. How much money did the ?rm save by obtaining FDA approval
one year earlier?
Solution to Example:
When a US ?rm obtains a patent for a drug, it is gaining a ?rst-mover advan-
tage, since the patent gives it intellectual property protection. However, the
clock for the patent life starts running from the time the ?rm ?les for the patent.
Thus, if a ?rm does not pursue the right activities for turning the discovery (for
which the patent is granted) into an approved drug that customers want, the
patent life could expire without it making money. The more quickly a ?rm can
172 Strengths and Weaknesses
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get the drug approved and to doctors and patients, the more time that it has to
exercise its monopoly power before the patent life expires and generics move in.
This example illustrates how much money can be at stake. In Table 6.4, two sets
of sales numbers have been shown: sales generated when FDA approval was
granted in 1997 and those generated if FDA approval had been one year later
in 1998.
The NPV of revenues in 1997, given that FDA approval was in 1997 is $44.5
billion (Table 6.4). The NPV of revenues in 1997 dollars if the drug had been
approved one year later is $36.86 (Table 6.4). Therefore, extra revenues earned
as a result of getting FDA approval one year earlier (in 1997 dollars) are $44.50
billion ? $36.86 billion = $7.64 billion. Thus, by performing the type of activ-
ities that allowed Lipitor to be approved one year earlier, Warner Lambert stood
to make an extra $7.64 billion, in 1997 dollars, over the life of its patent.
Effectively, Warner Lambert was better able to exploit its ?rst-mover advan-
tages as far as Lipitor was concerned.
Key Takeaways
•
A ?rst-mover advantage is a resource, capability, or product-market pos-
ition that (1) a ?rm acquires by being the ?rst to carry out an activity, and
(2) gives the ?rm an advantage in creating and appropriating value. In
moving ?rst to pursue a new game strategy, a ?rm usually has an opportun-
ity to build and take advantage of ?rst-mover advantages.
First-mover Advantages include:
•
Total available market preemption:

Economies of scale

Size (beyond economies of scale) advantages

Economic rents and equity

Network externalities (installed base)

Relationships with coopetitors
•
Lead in technology and innovation

Intellectual property (patents, copyrights, trade secrets)

Learning

Organizational culture
•
Preemption of scarce resources

Complementary assets

Location

Input factors

Plant and equipment
•
First-at-Buyers

Buyer switching cost

Buyer choice under uncertainty

Brand (preemption of consumer perceptual space)
174 Strengths and Weaknesses
•
First to establish system of activities

Dif?cult-to-imitate or substitute system of activities
•
First-to make irreversible commitments
Earning First-mover Advantages
•
First-mover advantages are not automatically endowed on whoever moves
?rst. They have to be earned, often by performing value creation and
appropriation activities effectively and ef?ciently.
•
Can use an AVAC analysis to narrow down the number of ?rst-mover
advantages to the few that stand to make a signi?cant contribution to the
?rm’s competitive advantage.
•
Moreover, ?rst-mover advantages also have to be exploited to be
meaningful.
First-mover Disadvantages (followers’ advantages) include:
•
Followers can free ride on ?rst-mover’s investments.
•
Followers enter a market when technological and marketing uncertainties
have been considerably resolved.
•
Followers can also take advantage of changes in technology or customer
needs that have occurred since ?rst movers moved. First movers may also
face inertia.
Competitors’ Handicaps include:
•
Competitors may have developed dominant managerial logics in the old
game.
•
The new game may not ?t a competitor’s strategy.
•
It may be dif?cult for competitors to get away from prior commitments
made in the old game.
•
Competitors may not have the types of resources that are needed to play the
new game.
•
The fear of cannibalizing their existing products may prevent some ?rms
from moving ?rst or from following a ?rst mover.
Why is it that First Movers Sometimes Go On to Dominate their Markets and at
Other Times, Followers are the Ones that Go On to Dominate their Markets?
Because of one or more of the following reasons:
•
First-mover advantages have to be earned and exploited well. Thus, when
?rst movers (superstars and explorers) do not perform the types of activity
that will enable them to earn and exploit ?rst-mover advantages, followers
(exploiters and me-toos) have a chance to move in and do well.
•
Followers may have critical complementary assets that ?rst movers do not.
•
First-mover disadvantages can be minimized. Therefore, when ?rst movers
(superstars and explorers) do not minimize ?rst-mover disadvantages, fol-
lowers have a chance to exploit them.
First-mover Advantages/Disadvantages and Competitors’ Handicaps 175
•
Industry factors, such as the number of competitors in a market, may favor
one type of ?rm over another. Whoever is favored—?rst mover or fol-
lower—is likely to win.
•
Macroenvironmental and global factors such as government regulations
may favor ?rst movers over followers, or followers over ?rst movers.
•
The type of player and business strategy of the player can also determine
whether a ?rst mover or follower wins. In industries with very good exploit-
ers, ?rst movers’ chances are usually considerably reduced.
What Does All This Mean to Managers?
•
In the face of a new game, a ?rm that moves ?rst may want to:

Catalog potential ?rst-mover advantages and disadvantages, and note
the ones that are relevant for the industry and markets in which the ?rm
competes or intends to compete.

Screen the advantages to those that make (1) a signi?cant contribution
to value creation and appropriation, and (2) the ?rm is capable of ef?-
ciently performing the activities to build and exploit the advantage. An
AVAC analysis can be used for this step.

Build and exploit the chosen ?rst-mover advantages while anticipating
and countering any ?rst-mover disadvantages.
•
A follower may want to:

Catalog the ?rst-mover disadvantages and determine the extent to
which it has what it takes to exploit them.

Find out where the ?rst mover was not able to build ?rst-mover advan-
tages and take advantage of the holes left. Use AVAC.

Look for where ?rst-mover advantages may have become handicaps
and exploit them.
Explorers, Superstars, Exploiters, and Me-toos
•
Firms can be grouped as a function of when they pursue new game strat-
egies and whether they pursue the right strategy or not:

Explorers: move ?rst but have no clear strategy for creating and
appropriating value, for building and taking advantage of ?rst-mover
advantages and disadvantages, and for exploiting competitors’
handicaps.

Superstars: move ?rst and have a clear strategy for creating and
appropriating value, for building and taking advantage of ?rst-mover
advantages and disadvantages, and for exploiting competitors’
handicaps.

Exploiters: followers that use their complementary assets and other
resources/capabilities to take advantage of ?rst movers’ disadvantages
and other opportunities to better create and appropriate value than ?rst
movers.

Me-Toos: followers that, unlike exploiters, have no clear strategy for
beating ?rst movers at their game. Are sometimes niche players.
176 Strengths and Weaknesses
Key Terms
Competitors’ handicaps
Dominant logic
Exploiters
Explorers
First-mover advantages
First-mover disadvantages
Follower’s advantage
Irreversible commitments
Me-toos
Second-mover advantages
Superstars
Switching costs
First-mover Advantages/Disadvantages and Competitors’ Handicaps 177
Implementing New Game
Strategies
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Understand the signi?cance of new game strategy implementation.
•
Get introduced to the relationship between strategy, structure, systems,
people and environment (S
3
PE).
•
Understand some of the different roles that individuals can play during new
games.
•
Recall the de?nitions of functional, matrix, network and M-Form organiza-
tional structures.
•
Explore what structure, systems and people a ?rm may need in the face of a
regular, position-building, resource-building or revolutionary strategy.
Introduction
Every new game strategy has to be executed well if its full potential is going to
be realized. Executing a new game strategy involves organizing people to carry
out the set of new game activities—it is about who works for whom, how to
measure and reward performance, how information should ?ow in the organ-
ization, who to hire, what culture one would like to see develop and so on. For
example, when Dell decided to pursue a build-to-order and direct sales strategy,
it had to structure its organization to ?t the new strategy, put in the right
systems to measure and reward performance, hire the right people, and try to
build the right culture. To perform all the activities that enabled it to provide
relevant searches, and monetize them using a paid-listing revenue model,
Google used an organizational structure that ?t its informal tech culture,
developed its own incentive systems, and hired the right type of technical and
other personnel. Effectively, to execute its new game strategy successfully, a
?rm needs an organizational structure, systems, and people that re?ect not only
the strategy but also the environment in which it is being pursued. Strategy
implementation is about the relationships among the strategy, the structure of
the organization that must execute the strategy, the systems and processes that
complement the structure, and the people that must carry out the tasks in the
given environment. We explore some of these relationships using a strategy,
structure, systems, people, and environment (S
3
PE) framework (Figure 7.1).
1
Chapter 7
The S
3
PE Framework
The idea behind the S
3
PE framework is simple. Strategies are formulated and
carried out by people; and people do differ. Moreover, the tasks that people
must perform to execute a new game strategy vary from strategy to strategy.
Therefore, not only do individuals need to perform different roles in the face of
a new game strategy; what they need to motivate them to be effective at per-
forming the tasks differs from task to task, from individual to individual, indus-
try to industry, and country to country. Therefore, the type of people that a ?rm
hires, who reports to whom, how performance is measured and rewarded, and
information systems needed, depend on the type of new game strategy and
environment in which the ?rm operates.
2
Effectively, some organizational struc-
tures, systems/processes and people would be more suitable for some strategies
than others, given the environments in which the strategies must be executed.
The objective, in executing a new game strategy in a given environment, is
therefore to ?nd those structures, systems, and people that best ?t the set of
activities that a ?rm chooses to perform, how, where, and when it performs
them. We quickly explore each component of the S
3
PE framework before turn-
ing to the impact of new games on them.
Figure 7.1 Strategy, Structure, Systems, People, and Environment (S
3
PE) Framework.
Implementing New Game Strategies 179
Strategy
Recall that a ?rm’s strategy is the set of activities that it performs to create and
appropriate value. A ?rm’s structure, systems and people usually follow its
strategy, although there may be cases where structure, systems and people drive
strategy; that is, the structure, systems, and people (S
2
P) part of a ?rm are
usually dictated by the ?rm’s strategy.
Structure
While a ?rm’s strategy is about the set of activities that the ?rm performs to
create and appropriate value, a ?rm’s structure tells us who reports to whom
and who is responsible for which activities.
3
An organizational structure has
three primary goals. First, the structure of an organization should facilitate
timely information ?ows to the right people for decision-making while pre-
venting the wrong people from getting the information. Second, an effective
structure requires the ability to be able to joggle differentiation (in the organ-
izational structure sense) and integration. A ?rm’s manufacturing and market-
ing units are maintained as separate functions because each one necessarily has
to specialize in what it does in order to be both ef?cient and effective in carrying
out its activities. Giving each unit the opportunity to specialize in what it does
so as to be the best at it, is what differentiation is about. However, to ef?ciently
and effectively develop and offer customers unique bene?ts, a ?rm’s different
functions often have to interact across functions; that is, the value creation and
appropriation activities of a ?rm’s different functions must be integrated if it is
going to perform well.
4
Third, a ?nal goal of an organizational structure is to
coordinate interactions between units to effect integration. A new product
launch would be more effective if the product development and marketing
groups coordinated their activities—telling each other what they are doing,
when and using information from each other as inputs.
Firms use variants of the following four organizational structures to effect
differentiation, integration, and coordination: functional, multidivisional
(M-form), matrix, and networked.
Functional Structure
In a functional structure, employees are organized by the function that they
perform in the organization, with employees in marketing or sales reporting to
supervisors or managers who are also in marketing or sales functions,
employees in engineering and manufacturing reporting to supervisors or man-
agers who are also in engineering and manufacturing, and so on. Formal report-
ing and communications is primarily within each functional unit, usually up
and down the organizational hierarchy. Each functional unit gets its directions
from corporate headquarters via the functional head. The functional organiza-
tion has several advantages. First, since employees are organized by function,
there is de facto division of labor that enables employees to acquire in-depth
function-speci?c knowledge, skills, and know-how—to specialize in the func-
tional tasks that differentiate the group from other functions. Second, since
each functional unit has people with similar knowledge and know-how that are
180 Strengths and Weaknesses
grouped together and may be located in the same physical location, they can
communicate more often and are therefore more likely to develop in-depth
knowledge of their functional area. The functional structure also has some
disadvantages. First, when tasks entail considerable coordination with other
functional units, a functional unit is likely to have subpar performance because
of its limited knowledge of and lack of direct communication lines with other
units. Second, the more specialized each functional unit, the more dif?cult it
becomes for headquarter’s management to know what is going on within each
function. This is compounded by the fact that the different functional units do
not communicate directly with each other. Third, because of the differences in
their skills, experiences, and capabilities, functional departments may have
goals that are not consistent with cooperating with other functions.
M-form or Divisional Structure
In an M-form or multidivisional structure, employees are organized by divi-
sions or business units rather than by function, as is the case with the functional
structure.
5
The divisions can be organized by the type of product that each
division offers (product line), by the type of customer, by the geographic scope
that the ?rm covers, or by the brand name that the ?rm offers. Authority in the
M-form structure is decentralized to the divisions in contrast to the functional
structure where authority is centralized at corporate headquarters. Each unit
usually has pro?t-and-loss responsibility. The multidivisional structure has two
major advantages. First, since each division has pro?t-and-loss responsibility,
there is better accountability for the ?rm’s performance. Second, since man-
agement responsibility is not as centralized as in the functional structure, man-
agers in the M-form only need focus their attention on their division. This is a
more manageable task since each manager is more likely to have the type of in-
depth knowledge of his/her product line, brand, customer, or geographic scope
that they need to manage the business better. The major disadvantage of the
divisional structure is that ?rms may not be able to build as much in-depth
knowledge of functional areas such as R&D as they would in a functional
structure.
Matrix Structure
The goal of a matrix structure is to capture some of the bene?ts of both the
functional and divisional structure. It is a type of hybrid structure between
function and divisional, and therefore comes in many different forms. In one
form, individuals from different functional areas are assigned to a project, but
rather than report only to a project or functional manager, each employee
reports to both a functional and a project manager. The idea is to (1) have cross-
functional coordination that is needed to carry out projects that require skills
and knowledge from different functional areas, (2) maintain some performance
accountability at the project level, and (3) allow project members to keep in
close touch with their functional areas so as to bene?t from intra-functional
learning, especially in industries where deep functional knowledge is important.
The matrix structure has three major advantages. First, the structure captures
some of the bene?ts of both the functional and divisional structures. Second,
Implementing New Game Strategies 181
since employees have one foot in their functional areas and the other in their
project group, they can bring the latest thinking from their functional areas to
the project and vice versa. Third, since the rate of change of technological or
market knowledge is likely to vary from one function to another, employees can
spend time on project management commensurate with the rate of change of
the knowledge in their functional area. This can lead to more ef?cient use of
personnel. Fourth, some employees may be able to work on more than one
project, thereby helping cross-pollinate not only functional knowledge but also
project knowledge. The matrix structure has some disadvantages. First, since
physical colocation with fellow project members can be critical to project
performance, and physical colocation with functional colleagues can also be
critical to functional learning, employees in a matrix structure may have to
physically colocate in both their project and functional areas. This can be costly
and inef?cient, since an employee cannot be physically present in two different
places at the same time. Second, since project members in the matrix organiza-
tion have to report to both a functional and project manager, they may have to
manage two bosses at the same time. When there is a con?ict, employees may
have dif?culties deciding where their allegiance falls—whether to the project
manager or functional manager. Third, the matrix structure can be more costly
than the functional one since the structure requires some duplication of effort.
For example, having both a functional and a project manager means one too
many managers. Finally, the matrix structure is still much less accountable than
the divisional organization.
Network or Virtual Structure
In the network or virtual structure, ?rms outsource all the major value-adding
activities of their value chains and coordinate the activities of their contractors.
6
The emergence of this organizational form has been facilitated by advances in
technological innovation such as the Internet. In such a structure, the coordinat-
ing ?rm contracts a market research ?rm to perform market research for a
particular product or idea, ?nds a design ?rm to design the product, buys the
components from suppliers, and ?nds another ?rm to manufacture the product.
The network structure has several advantages. First, a ?rm can avoid making
major investments in assets, since it outsources all the major value-adding activ-
ities of its value chain. Second, in industries with a high rate of technological
change that often renders existing capabilities obsolete, having a virtual struc-
ture means that a ?rm does not have to worry about important assets being
rendered obsolete since it has not invested in any.
7
Such a ?rm has the ?exibility
to switch suppliers, or manufacturers, or distributors whenever it ?nds one that
can exploit the new technology better. The network structure has two major
disadvantages. First, it is dif?cult to have a competitive advantage when one
does not perform major value-adding activities. However, whether this is a
disadvantage depends on the ?rm’s core competence. If a ?rm has a strong
brand or architectural capabilities that are valuable, scarce, and dif?cult to
imitate, the ?rm may still be able to make money since it can offer customers
something that competitors cannot. Second, contracting out all major activities
deprives a ?rm of the ability to learn more about creating value along the
value chain.
182 Strengths and Weaknesses
Systems
Organizational structures are about who reports to whom and what activities
they perform, but say very little about how to keep employees motivated as they
carry out their assigned tasks and responsibilities in executing a strategy.
8
Sys-
tems are about the incentives, performance requirements and measures, and
information ?ow and accountability mechanisms that facilitate the ef?cient and
effective execution of strategies. We can group systems into two: organizational
systems/processes and information systems.
Organizational Systems/Processes
Organizational systems are about how the performance of individuals, groups,
functional units, divisions, and organizations is sought, monitored, measured,
and compensated. They include ?nancial measures such as pro?ts, market
share, cash ?ows, gross pro?t margins, stock market price, return on invest-
ment, earnings per share, return on equity, and economic value added (EVA).
Organizational systems also include reward systems such as pay scales, pro?t-
sharing, employee stock option plans (EOPs), bonuses, and non?nancial
rewards such as recognition with certi?cates or having one’s name engraved
somewhere on a product that one helped develop. Systems also include so-
called processes. A ?rm’s processes are the “patterns of interaction, coordin-
ation, communication, and decision making [that] employees use to transform
resources into products and services of greater worth.”
9
These patterns of
communication, interaction, coordination, and decision-making are a function
of the type of strategy, organizational structure, and incentive system in place.
For example, in a process it called chemicalization, Sharp Corporation com-
pulsorily transferred the top 3% of the scientists from each of its divisional
R&D groups between laboratories every three years. This process forced top
scientists to interact with scientists in other laboratories, exchanging knowledge
that may not be easily transferred through memos or scienti?c publications.
Even if the information could be transferred through journals, it may get to
other Sharp scientists too late to give the company a competitive advantage.
Being transferred was also a signal that a scientist was good—an important
reward in some scientists’ books. Moreover, visiting other laboratories gave the
Sharp scientists an opportunity to build social networks that could come in
handy later. Another example is “Google’s 20% rule,” the fact that at Google,
employees were encouraged to spend 20% of their time on innovative projects
that had very little or nothing to do with their of?cially assigned projects.
Benchmarking, total quality control (TQM), re-engineering, and x-engineering
are also processes that ?rms have used to implement a new game strategy more
effectively and ef?ciently.
Information Systems
Although a good organizational structure, coupled with the right organiza-
tional systems, can result in a reasonable amount of internal information ?ow,
information systems can also be used to facilitate the ef?cient ?ow of informa-
tion to the right targets at the right times for decision-making. For discussion
Implementing New Game Strategies 183
purposes, we can group information ?ow systems into two: (1) the information
and communication technologies that allow electronic information to be
exchanged and (2) the physical building layouts that facilitate in-person, some-
times unplanned, interaction. Digital networks such as the Internet make it
possible for anyone anywhere in an organization anywhere in the world to have
access to some types of information anywhere within the organization.
10
For
example, during product development, information on the status of products,
ideas for better products, and so on, are available to anyone anywhere in the
world with permission and access to the company’s Intranet. Information sys-
tems can be used to supplement or complement information ?ows that take
place by virtue of the structure of the organization.
Although a great deal of information can be exchanged electronically over
the Internet, some types of information still need in-person, face-to-face inter-
action. For example, it is dif?cult to feel the aura and smell of a new car or
painting via the Internet. Moreover, chanced physical encounters can lead to
ideas that planned electronic encounters might not. Professor Tom Allen’s
research suggests that the physical layout of buildings can play a signi?cant role
in the amount of communication that takes place between people and therefore
can have a signi?cant impact on innovation.
11
Buildings that are designed to
facilitate physical in-person interaction can facilitate the ?ow of new ideas. If
different organizational units of a ?rm—e.g. marketing, R&D, and oper-
ations—are located in the same physical space, eat in the same cafeteria, share
the same bathrooms, and bump into each other often, they are more likely to
exchange new ideas than if they were located in different buildings or
regions. Effectively, the way a building is designed can facilitate or augment the
integration of different units and ideas that a good organizational structure is
supposed to.
People
People are central to any strategy since they conceive of, formulate, and execute
strategies. The extent to which a ?rm’s employees can thrive within its organ-
izational structure, are motivated by the performance and reward systems that
it has put in place, or effectively use the information systems that it established,
is a function of the ?rm’s organizational culture, resources and capabilities, and
the types of employee.
Culture
What is culture? Uttal and Fierman de?ned organizational culture as:
“a system of shared values (what is important) and beliefs (how things
work) that interact with the organization’s people, organizational struc-
tures, and systems to produce behavioral norms (the way we do things
around here).”
12
Professor Schein of MIT also de?ned culture as:
“the pattern of basic assumptions that a given group has invented, dis-
184 Strengths and Weaknesses
covered, or developed in learning to cope with its problems of external
adaptation and internal integration, and that have worked well enough to
be considered valid, and, therefore, to be taught to new members as the
correct way to perceive, think, and feel in relation to these problems.”
13
A ?rm’s culture is critical to its ability to create and appropriate value.
14
Basic-
ally, people within an organizational structure and associated systems, develop
shared values (what is important) and beliefs (how things work). These shared
values and beliefs then in?uence who else is hired or stays in the organization,
how it is reorganized and how the systems change or do not change. The results
of these interactions are behavioral norms (the way we do things) which then
determine how well a strategy is implemented or formulated. If the structure,
systems, and people are just right, the norms can lead to a system of activities
that is dif?cult to imitate. One reason why Ryanair’s employees work 50%
more than employees at other airlines for only 10% more pay and still like
working there may be because of its culture. If it is not right, culture can be a
competitive disadvantage.
Resources and Capabilities
In Chapter 5, we argued that a portion of a ?rm’s resources and capabilities
resides in the people within the ?rm and those with whom it has to interact.
Thus an important part of the “people” component of the S
2
P E are the
resources and capabilities that are embodied in people.
Types of People
Quite simply, not everyone is meant for every job. Nor is every reward system
going to motivate every employee. Thus, in executing a strategy, it is important
to get the right people to perform the right tasks. In the mid-2000s, Google’s
advertisements for new hires re?ected its overt focus on hiring largely the math-
ematically and intellectually gifted.
15
However, when Southwest Airlines hired
people, it was more interested in their attitude than in their skills.
Environment
For two reasons, a ?rm’s structure, systems, and people (S
2
P) are also a function
of its competitive and macroenvironments. First, as we have seen on several
occasions, a ?rm’s strategy is a function of the competitive forces that impinge
on it as well as of the macroenvironment in which it creates and appropriates
value; and since structure, systems, and people (S
2
P) follow strategy, it must be
the case that a ?rm’s S
2
P also depend on its competitive and macroenviron-
ments. Second, each of structure, systems and people depends on the environ-
ment in its own right. For example, in fast-paced industries where technologies
and markets change rapidly, a ?rm needs to be able to maintain deep know-
ledge of the technologies that underpin its products and of the markets that it
must serve. One good choice of structure in such fast-paced environments is a
matrix structure, since it allows employees who are working on a project to
have one foot in the project group and another in their functional groups. In
Implementing New Game Strategies 185
countries where people’s identities are closely tied to the ?rms that employ
them, employees may be more willing to do whatever it takes for their company
to win. Countries with well-educated workforces offer ?rms more opportun-
ities to hire the types of employee that they need for high value-adding jobs.
S
3
PE in the Face of New Games
New games have an impact on structure, systems, and people. We explore this
impact and what a ?rm can do to improve its chances of doing well in the face
of the impact.
Impact on Structure, Systems, and People (S
2
P)
The impact of a new game on a ?rm’s structure, systems, and people (S
2
P) is a
function of the type of new game—of whether the new game is regular,
position-building, resource-building, or revolutionary (Figure 7.2).
Regular New Game
In a regular new game, only incremental changes are made to existing resources/
capabilities and product-market positions (PMPs). Moreover, these incremental
changes in resources and positions build on existing ones. Therefore, in the face
of a regular game, any changes that incumbents have to make to their pregame
resources and positions in a regular game are incremental. Since structure, sys-
tems, and people follow strategy, any changes that need to be made to an
Figure 7.2 What Should a Firm Do?
186 Strengths and Weaknesses
incumbent’s structure, systems, and people (S
2
P) are also incremental. Take
culture, for example. Those incumbent values (what is important) and beliefs
(how things work) and behavioral norms (the way we do things around here)
that worked prior to the new game still work during the game. Incumbents’
“patterns of interaction, coordination, communication, and decision making”
are likely to still work. The introduction of diet cola was a regular new game
and both Coke’s and Pepsi’s S
2
P did not change when they introduced the
product.
Revolutionary New Game
A revolutionary new game is the exact opposite of a regular new game. The
resources needed and the resulting PMPs are radically different from what
incumbents had prior to the game. Thus, the strategies that ?rms pursue in the
face of the new game are likely to be radically different from those that incum-
bents pursued prior to the new game. Since structure, systems, and people (S
2
P)
follow strategy, we can expect to see some big changes in S
2
P. For example,
because the changes are radical, a ?rm with a functional structure (with its
vertical ?ow of information) may have to migrate to a matrix or network organ-
ization to accommodate the large intra- and interorganizational horizontal
information ?ows that take place in the face of a radical innovation. Incumbent
values (what is important), beliefs (how things work), and behavioral norms
(the way we do things around here) that worked prior to the new game are not
likely to work during the new game. In fact, as we show later, these values,
beliefs, and norms may become handicaps. Pregame processes—“patterns of
interaction, coordination, communication, and decision making”—are also
likely to be rendered useless and may become handicaps. Consider the case of
online auctions, a revolutionary new game compared to of?ine auctions. Of?ine
auctions take place at a particular place and time, for a certain duration, and the
number of items and of attendees are usually limited. The number of people that
attend the auction is important and location is king. Those who attend can
usually touch and feel the product being auctioned. Online auctions go on 24-
hours a day and anyone from anywhere in the world can bid for objects which
can be delivered after the sale is made. The size and character of the network of
sellers and buyers are king. An organizational structure for running an of?ine
auction company that operates various sites in a country is likely to have elem-
ents of the M-form structure with units that focus on one or more locations
where auctions take place. By contrast, location is not central to an online
auction. Thus, an online auction ?rm may use the M-form organization but
with each unit focusing on a product or service category such as collectibles,
antiques, and automobiles, rather than location. It may also use a network
organization.
What is important to an of?ine auction ?rm revolves around the location
where the auctions take place while for an online auction ?rm, what is import-
ant revolves around the number of users that can visit a website to buy or sell,
and a reduction in the level of fraud. The norms (the way we do things around
here) that arise from interactions in an of?ine ?rm are likely to be very different
from those at its online counterpart; so are the processes—“patterns of
interaction, coordination, communication, and decision making.” Effectively,
Implementing New Game Strategies 187
pregame S
2
Ps that are often rendered obsolete can become handicaps in the face
of some revolutionary games.
Position-building New Game
In a position-building new game, the new product replaces existing products
and/or the ?rm’s position vis-à-vis coopetitors is radically different from the
pregame position. If the market addressed by the new game is the same as the
pregame market, an incumbent’s S
2
P may not have to change that much. For
example, when Intel introduced the Pentium that replaced the 486, it did not
have to restructure its organization to better address the PC market in which the
Pentium was replacing the 486s. However, if the market is different, some
important elements of S
2
P may have to change. The PC used the same technol-
ogy as minicomputers but in addition to addressing the minicomputer market,
it also addressed the home computer market. The market for consumers was
very different from the business market that minicomputers had addressed
before the PC. Clearly, selling to this new market required something different
from incumbents’ sales norms. IBM created a separate unit to develop and
sell the PC.
Resource-building New Game
In a resource-building new game, the resources/capabilities that a player needs
to play the game are radically different from pregame resources/capabilities but
existing products can still compete in the new game. Thus, as far as the activities
for building products are concerned, S
2
P requirements should be similar to
those for revolutionary games—they are likely to require changes in structure,
systems, and people. Take the example of an electric razor, which requires a
radically different technology from that for mechanical razors. A ?rm that has
been supplying mechanical razors but wants to enter the electric razor market
may need a unit or units that re?ect the fact that the design, development, and
manufacturing for electric razors are very different from those for their mechan-
ical counterparts.
Roles that People Play During Innovation
Given the impact of new games on a ?rm’s structure, systems, and people (S
2
P),
the question becomes, what should a ?rm do in the face of new games as far as
structures, systems, and people are concerned? Before we explore this question,
it is important to describe quickly what the literature on innovation says about
the roles that people can play in the face of an innovation to better exploit it.
Top Management Team and Dominant Managerial Logic
Each manager brings to every new game a set of beliefs, biases, and assumptions
about the new game, the market that his/her ?rm serves, whom to hire, what
technologies the game needs, who the other players in the game are, and what it
takes to create and appropriate value in the game.
16
These beliefs, assumptions,
and biases are a manager’s managerial logic. They de?ne the mental frame or
188 Strengths and Weaknesses
model within which a manager is likely to approach decision-making.
17
Depending on the new game, a ?rm’s strategy, structure, systems, processes,
values, norms, and how successful it has been, there usually emerges a domin-
ant managerial logic, a common way of viewing how best to create and
appropriate value in the ?rm.
18
Dominant managerial logic is usually good for a
?rm that has the right strategy and has taken the right measures to implement it.
However, during new games in which a new strategy, structure, systems, pro-
cesses, values, or norms are needed, pregame dominant managerial logic that
had worked so well can become a handicap. Managers may be stuck in the old
values (what was important), and old beliefs (how things worked), and
behavioral norms (the way we did things around here), and not be able to move
into the new values (what is important in the new game), new beliefs (how
things should work in the new game), and behavioral norms (the way we should
be doing things around here now).
Champions
Formulating and implementing a strategy to win in a new game usually requires
a champion. A champion for a new game strategy is someone who articulates a
vision of what the strategy is all about, and what’s in it for the ?rm and
employees who are engaged in formulating and implementing the strategy.
19
By
evangelically articulating a captivating vision of the potential of the strategy to
the different players, a champion can help other employees to understand the
rationale behind the strategy, especially how value will be created and
appropriated, thereby motivating and inspiring the same employees who will
implement the strategy. A ?rm often has also to champion the strategy to its
coopetitors—the other players in the new game. In fact, in many revolutionary
and position-building games, a ?rm has to articulate a vision of a new product
to customers and help them discover their latent need for the product. Steve
Jobs is usually a great champion for Apple’s products.
Sponsors
A sponsor of a new game strategy or innovation is a senior-level manager who
provides behind-the-scenes support for it.
20
This senior-level manager is like the
godfather who protects the new product or new game strategy from political
enemies. By acting as a sponsor, the top manager is also sending a signal to
political foes of the new game strategy or product, that they would face the
wrath of a senior manager and sponsor. In so doing, a sponsor is also sending a
message to the champion and other key individuals who are working on the
strategy that they have the support of a senior manager. In some cases, the
champion is also the sponsor. Steve Jobs plays both the role of champion and
sponsor for some key products.
Gatekeeper and Boundary Spanners
In many ?rms, especially those with functional organizational structures, each
employee is likely to have deep knowledge of his/her unit and little or no know-
ledge of the other units. Moreover, each unit may have its own culture,
Implementing New Game Strategies 189
language, needs, and history that have an effect on the information that the unit
can or cannot share. For example, an R&D department may have its own
acronyms, scienti?c jargon, and culture that marketing and manufacturing do
not understand. Marketing and manufacturing may see R&D scientists as
snobs that live in an ivory tower. Boundary spanners are individuals that span
the “hole” between two units within a ?rm, acting as a transducer for informa-
tion between units. They take information from one department and translate it
into what people in another department can understand.
21
They understand the
idiosyncrasies of their units and those of other units and can take unit-speci?c
questions, translate them into a language that other departments can under-
stand, obtain answers, and translate them into something that their home units
can understand. While boundary spanners span the holes between units within
the same ?rm, gatekeepers span the holes between different companies.
Project Manager
If a new game strategy entails developing a new product, project managers can
play important roles. Project managers are responsible for plotting out who
should do what and when so as to complete a project that meets or exceeds
requirements. A project manager is to meeting schedules what a champion is to
articulating a vision of the potential of a strategy. He or she is the central
nervous system of information that has to do with who is supposed to do what
and when and what has been done so far, its cost, and so on. Project managers
have been classi?ed as heavyweight or lightweight based on the managers’ span
of control.
22
A heavyweight project manager is one with extensive authority
and responsibility for the project from concept creation through design to
manufacturing to marketing and making money, including the project’s
budget.
23
A lightweight project manager’s authority and responsibilities are not
as extensive as those of the heavyweight project manager—his or her authority
is usually limited largely to engineering functions with no authority or
responsibility over concept creation and other market-related aspects of the
product such as budgeting. Professors Kim Clark and Takahira Fujimoto found
that the use of heavyweight project managers helped to reduce product devel-
opment lead times, total engineering hours (and therefore cost), and improved
design quality for Japanese automobile companies.
24
What Should Firms Do About Their Structures, Systems, and
People?
Now we can return to our question: given the impact of new games on a ?rm’s
structure, systems, and people (S
2
P), what should a ?rm do in the face of new
games as far as structures, systems, and people are concerned? What a ?rm does
depends on (1) which of the components of its pregame S
2
P are strengths or
handicaps in the face of the new game, (2) the type of new game—whether the
new game is regular, position-building, resource-building, or revolutionary.
190 Strengths and Weaknesses
Which PreGame S
2
P Components are Strengths or Handicaps?
Every player in a new game brings to the game some components of its S
2
P—
values, beliefs, norms, information systems, performance measures, patterns of
interaction, communications and coordination, and reward systems, and func-
tional, matrix, network, or M-Form structure—from its pregame era that can
be strengths or handicaps in the new game. For example, a ?rm’s culture
(values, beliefs, and norms) can be strengths in the face of certain new games
but become a handicap in the face of other games. To determine which com-
ponents of a ?rm’s S
2
P become a handicap and which ones remain or become
strengths, we use the same framework that we used in Chapter 5 to determine
which of a ?rm’s pregame strengths become handicaps or remain strengths
(Table 7.1). Whether a component of an S
2
P is a strength or handicap in a new
game depends on whether the component is vital to the new game, and whether
the component is separable (Table 7.1). A component is vital to a new game if it
contributes signi?cantly to value creation and appropriation. It is separable if
the ?rm has no problems taking the component away from the old game for use
in the new game, sharing the component, or leaving the component behind
when it is more likely to hurt in the new game than help.
Consider Component 1 in Table 7.1. It is vital in the new game and the ?rm
can use it in the new game because nothing from its past prevents it from doing
so. Thus the component is a strength for the ?rm in the face of the new game.
For example, if a ?rm’s pregame norms (they way we did things around here)
are the same kinds of norms that the new game requires, the norms are a
strength. The way makers of diet cola advertised the drink when it was ?rst
introduced was very similar to the way regular cola had been advertised. Thus,
when Coke introduced its diet cola, the advertising norms needed effectively to
advertise the drink used the same norms as before the introduction. Thus its
pregame strengths constituted a new game strength for the ?rm.
Component 4 is the exact opposite of Component 1. The component is use-
less to the ?rm in pursuing the new game but unfortunately for the ?rm, it
cannot separate itself from the resource and move on. Component 4 is therefore
a handicap. Again, take the example of a norm. If the new game calls for doing
things differently, but a ?rm is still stuck in its old norms (the way we used to do
things) and cannot move on to the new way of doing things, the old norms are
likely to become handicaps, since it is dif?cult for a ?rm quickly to get rid of its
norms and acquire new ones. Handicaps can not only prevent a ?rm from
Table 7.1 Is an S
2
P Component from a Previous Game a Strength or Handicap in a New
Game?
S
2
P component Is the resource vital in the
new game?
Is separability possible? In the new game, the
component is a:
Component 1 Y Y strength
Component 2 Y N potential strength
Component 3 N Y question mark
Component 4 N N handicap
Implementing New Game Strategies 191
playing a new game well, they can prevent a ?rm from entering the game. As we
argued in Chapter 6, a ?rm’s dominant managerial logic is a good example. In
the face of some types of change, a ?rm’s dominant managerial logic can
become a handicap. For example, some executives who had been hired from old
media such as TV and magazines to help with advertising on websites may have
been prevented from understanding new business models, such as paid listings,
because they were blinded by the old media logic of capturing the attention of
viewers and retaining it long enough to advertise to them. Such a logic would
not work when the activity being monetized is conducting a search on the
Internet. Surfers usually want to perform a search quickly and move on. Paid
listings work very well for such surfers since they can quickly perform the
search and move on, for example, to make purchases or do something that
might interest advertisers. The belief that to advertise, one’s audience must be
able to spend lots of time on one’s medium may have prevented some old media
executives from inventing paid listings.
Component 2 is important in the new game but because of prior commit-
ments, agreements, or other inseparability, the ?rm cannot use it in the new
game. The component is therefore a potential strength since, with work, it
could become separable. For example, a ?rm may have the right systems and
processes to get a new product designed, built, and manufactured but the fear of
cannibalizing existing products may prevent the ?rm from using the systems
and processes. Component 3 is not important in the new game and the ?rm can
get away from it. It is therefore neither a strength nor a handicap. It is a ques-
tion mark.
Type of New Game
What a ?rm does in the face of a new game, as far as its S
2
P is concerned, also
depends on the type of new game—it depends on whether the new game is
regular, position-building, resource-building, or revolutionary (Figure 7.2).
Since any changes that need to be made to an incumbent’s S
2
P in the face of a
regular new game are incremental, incumbent ?rms can keep their pregame S
2
P
or build on them. Effectively, pregame S
2
Ps are strengths in the face of a regular
new game. If the new game is revolutionary, a ?rm may want to use an autono-
mous unit that has its own structure, systems, and people. Why an autonomous
unit? As we saw above, pregame values (what was important before the new
game), beliefs (how things worked), and behavioral norms (the way we did
things around here) are not likely to work in the face of a revolutionary new
game; and since it takes time to change values, beliefs, and behavioral norms, if
they can be changed at all, maintaining the same S
2
P is not likely to help. An
autonomous unit with its own structure, systems, and people can more quickly
build the types of values, beliefs, and norms that are needed to successfully
create and appropriate value in the face of a revolutionary game. Moreover,
having an autonomous unit prevents elements of the pregame S
2
P from handi-
capping the efforts of the unit. Effectively, pregame S
2
Ps can be handicaps in the
face of revolutionary new games and should be avoided using an autonomous
unit. In addition to creating an autonomous unit, a ?rm that is playing a revo-
lutionary game may also want to use champions, sponsors, and gatekeepers.
The existence of a sponsor reminds upper level management that the autono-
192 Strengths and Weaknesses
mous unit is important and no one should think of messing with it. Since things
are usually in a state of ?ux early in the life of a revolutionary game, a champion
can help articulate a vision of what the game is all about and what needs to be
done to win. Gatekeepers act as transducers between the autonomous unit and
the rest of the ?rm as well as outside organizations.
If the new game is a position-building game, a ?rm can use a market-
targeting project unit whose primary responsibility is to make sure that the
needs of the market are incorporated into the new product on time. Such a
focus on the market is particularly important if the market for the product is
new. Why not use an autonomous unit? Since the product in the new game
must still be built using pregame technological resources/capabilities, using an
autonomous unit would mean moving the resources//capabilities to the new
unit or duplicating them, either one of which can be very costly. In other
words, in the face of a position-building new game, resource-related S
2
Ps are
strengths that could be useful in the new game and forgoing such strengths can
be costly. The case of IBM and the PC illustrates this. When IBM decided to
enter the PC market, it formed an autonomous group to design, manufacture,
and market the product. Because the PC group was autonomous, it decided to
use an Intel microprocessor and a Microsoft operating system when other
units at IBM could have used their existing computer resources to quickly
build the two components. Effectively, IBM missed out on the two com-
ponents of the Wintel world that appropriate the most value created. However,
by not using an autonomous unit, a ?rm runs the risk of being handicapped by
old market-targeting values, beliefs, and norms. These handicaps can be iden-
ti?ed as we showed above, and avoided. To complement the project unit, a
?rm also needs sponsors, champions, and boundary spanners. A sponsor
would signal to all units that the program is important and therefore the
project unit can get the support that it needs. A champion would articulate the
bene?ts of the project for the different units that must corporate with the
project group. Boundary spanners would span the hole between the project
unit and other units.
If the new game is a resource-building game, a ?rm can use a product-
targeting project unit whose activities are geared towards building the new
resources/capabilities and using them to build the new product. As is the case
with position-building games, there are advantages and disadvantages to using
a project unit rather than an autonomous unit. By using a project unit, a ?rm
can more easily take advantage of marketing and other buyer-focused capabil-
ities than using an autonomous unit since in a resource-building game, the PMP
does not change much. At the same time, by not using an autonomous unit, a
?rm risks being handicapped by the values, beliefs, and norms from the
resources that are being displaced. These handicaps can also be identi?ed. The
task could also be crowdsourced.
Key Takeaways
•
A new game strategy is not likely to attain its full potential unless it is
well implemented. Implementing a new game strategy is about getting the
relationships among strategy, structure, systems, people, and environ-
ment right. To execute its new game strategy successfully, a ?rm needs an
Implementing New Game Strategies 193
organizational structure, systems, and people (S
2
P) that re?ect not only the
strategy but also the environment in which the strategy is being pursued.
•
An organizational structure is about who reports to whom and performs
what activities when. It has three primary goals:

An organizational structure should facilitate timely information ?ows
to the right people for decision-making while preventing the wrong
people from getting the information.

An effective structure requires the ability to be able to joggle differen-
tiation (in the organizational structure sense) and integration.

An effective organization should help coordinate interactions between
units to effect integration.
•
Firms use variants of the following four organizational structures to effect
differentiation, integration, and coordination: functional, multidivisional
(M-form), matrix, and networked structures.
•
Systems are about the incentives, performance requirements and measures,
and information ?ow and accountability mechanisms that facilitate the ef?-
cient and effective execution of strategies. They are about what it takes to
motivate employees.
•
The extent to which a ?rm’s employees thrive within its organizational
structure, is motivated by the performance and reward systems that it has
put in place, or effectively used the information systems that it established is
a function of the ?rm’s organizational culture, and the types of employee.
•
Culture is “a system of shared values (what is important) and beliefs (how
things work) that interact with the organization’s people, organizational
structures, and systems to produce behavioral norms (the way we do things
around here).”
25
•
Since structure, systems, and people follow strategy, and strategy is a func-
tion of the environment, it must be the case that structure, systems, and
people are a function of the environment.
•
The impact of a new game on a structure, systems, and people (S
2
P) is a
function of the type of new game—it is a function of whether the new game
is regular, position-building, resource-building, or revolutionary

If the new game is regular, the S
2
P needed is about the same as the one
before the game, or an enhanced version of it.

If the new game is revolutionary, the S
2
P required is likely to be radically
different from existing ones.

If the new game is position-building, the market-targeting S
2
P of the
new game is likely to be radically different from the pregame one.

If the new game is resource-building, the product-targeting S
2
P of the
new game is likely to be radically different from the pregame one.
•
During innovation or a new game, people play different important roles.

Top management plays the leadership role but the dominant manage-
ment logic that is a strength when there is no major change can become
a handicap in the face of revolutionary, position-building, or resource-
building new game.

A champion for a new game strategy is someone who articulates a
194 Strengths and Weaknesses
vision of what the strategy is all about, what’s in it for the ?rm and
employees who are engaged in formulating and implementing the
strategy.

A sponsor of a new game strategy or innovation is a senior-level man-
ager or godfather who provides behind-the-scenes support for it.

Boundary spanners are individuals who span the “hole” between two
units within a ?rm, acting as a transducer for information between
units.

Gatekeepers span the holes between different companies.

Project managers are responsible for plotting out who should do what
and when so as to complete a project that meets or exceeds
requirements.
•
What a ?rm does in the face of a new game as far as its structure, systems
and people (S
2
P) are concerned depends on (1) whether the ?rm’s pregame
S
2
P is a strength or handicap in the face of the new game, (2) the type of new
game being pursued:

In the face of a regular new game, an incumbent is better off keeping its
pregame S
2
P.

In the face of a revolutionary new game, a ?rm may be better off creat-
ing an autonomous unit to be used to pursue the new game.

If the new game is position-building, a ?rm may want to create a
market-targeting project unit.

If the new game is resource-building, the ?rm may be better off creating
a product-targeting project unit.
Key Terms
Champions
Coordination
Culture
Differentiation (in the organizational structure sense)
Dominant managerial logic
Functional structure
Matrix structure
M-form structure
Multidivisional structure
Network structure
Organizational systems
Processes
Project managers
S
3
PE framework
Sponsors
Implementing New Game Strategies 195
Opportunities and
Threats
Chapter 8: Disruptive Technologies as New Games
Chapter 9: Globalization and New Games
Chapter 10: New Game Environments and the Role
of Governments
Chapter 11: Coopetition and Game Theory
Part III
Disruptive Technologies as New
Games
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Explain what disruptive technologies are all about.
•
Understand what makes some technologies more disruptive than others and
why that matters.
•
Explain how incumbents can tell when to expect new technologies to erode
their competitive advantages.
•
Explain why incumbents, even very successful ones, often lose out to
attackers that use disruptive technologies.
•
Offer incumbents and new entrants advice on what to do in the face of
disruptive technologies.
Introduction
In 2008, millions of people could make free high-quality international phone
calls, something that had been unheard of only a decade earlier. One major
reason for these free calls was voice over Internet protocol (VOIP) technology—
a technology for routing phone calls over free Internet networks. VOIP threat-
ened the very future of the telephone business as the traditional phone com-
panies had come to know it. To many of these traditional phone companies,
VOIP represented a threat. To new startups such as Skype, VOIP was a great
opportunity. This phenomenon in which existing business models are threat-
ened and often rendered obsolete by a new technology is nothing new. Electric
refrigerators replaced kerosene refrigerators which had replaced hauled ice as a
means of keeping foods and medicines cold. PCs replaced mainframe and mini-
computers. Internal combustion engine automobiles replaced horse-driven
carts. iPods and other MP3 players replaced Walkmans, ?at-panel displays dis-
placed cathode ray tube (CRT) displays, and online auctions replaced of?ine
auctions. In some instances, such as the case of contact lenses and eye glasses,
the displacements were only partial. As the partial listing of Table 8.1 suggests,
the list of such displacements is long.
Effectively, almost every product we use today is the result of technological
innovation, and each innovation has created opportunities for some companies
and threats for others. One of the ?rst things that business scholars observed
about these technological changes in which new technologies displaced estab-
lished ones was that many incumbent ?rms were displaced by new entrants.
Chapter 8
(Incumbents in the face of a technological change are ?rms that offered prod-
ucts using the established technology before the new technology was intro-
duced.) For example, the major players in personal computers (PCs) today were
neither major players in mainframes nor in minicomputers. This observation by
business scholars raised some interesting questions:
1 How can incumbents tell when to expect innovations that stand to erode
their competitive advantages? Knowing when to expect these innovations
would help ?rms to strategize better.
2 Why is it that incumbents (some of them very successful) often lose
out during these technological changes? Just what types of change are
these?
3 What can these incumbents do to pro?t better from such changes?
Table 8.1 The New Replacing the Old: A Partial List
Today’s technology Ancestral technologies
Airplanes Sail boats, steam boats, trains
Automobiles Horse-driven carts
Computers Spike abacus, slide rules
Contact lenses Eye glasses
Cotton, silk, polyester, nylon Grass, bark, animal hides
Digital audio player (MP3) Record player, eight track, cassette tape, compact disc
Digital photography Artists, film-based photography
Discount brokers Traditional brokers
Digital video disk (DVD) Veneer records, magnetic tapes, compact discs
Electric and gas stoves Firewood cooking spaces
Electricity Whale oil (for lighting), wood, coal, gas
Electronic banking Brick-and-mortar-based banking
Flat panel displays Cathode ray tube (CRT) for computer screens, TVs, etc.
Genetically engineered insulin Pig pancreas-derived insulin
Indoor plumbing Outdoor services
International ATMs Traveler’s checks
Internet radio TV Radio, TV
iPod Walkman
Jet engines Propeller engine
Mechanical cash registers Electronic point of sale registers
Money and financial services Barter system
PCs Minicomputers
Refrigeration Hauled ice
Small Japanese cars Large American cars
Steel Brick and stone
Telephone Smoke signals, drums, people, telex
Electronic watches Mechanical watches
200 Opportunities and Threats
4 What should new entrants do to be successful? (After all, not all new
entrants are successful.)
In this chapter, we explore these questions. In particular, we explore Foster’s
S-curve and Christensen’s disruptive technologies models. We then integrate the
results from these models with the concepts of new game strategies that we have
seen so far to present more complete answers to the four questions raised above.
Throughout this chapter, we will use the words “product” and “technology”
interchangeably, although they are not always the same. For example, we will
talk of the PC as being a disruptive technology when we really mean the tech-
nologies that go into making a PC.
Foster’s S-curve
Managers were interested in the ?rst question—how can incumbents tell when
to expect innovations that stand to erode their competitive advantages—for
obvious reasons. If they could tell, ex ante, when to expect these disruptive
technologies, managers would be better prepared for them and might even
prevent new entrants from eroding their ?rm’s competitive advantages. One of
the ?rst business scholars to explore this question was Dr Richard Foster of
McKinsey.
1
He argued that a ?rm can predict when it has reached the limit of its
technology life cycle (and therefore can expect a radical technological change)
using knowledge of the technology’s physical limits.
2
Effectively, by observing
the evolution of an established technology, a ?rm can tell when a new radical
technology is around the corner about to displace the established technology.
One way to model this evolution is through what would later be known as
Foster’s S-curve. In this S-curve, the vertical axis represents the rate of advance
of a technology while the horizontal axis captures the amount of effort put into
developing the technology (Figure 8.1). Technological progress starts off
slowly, then increases very rapidly and then diminishes as the physical limits of
Figure 8.1 S-curves Showing Physical Limits of Technologies.
Disruptive Technologies as New Games 201
the technology are approached. Eventually, diminishing returns set in as the
return on efforts becomes extremely small. A new technology whose underlying
physical properties allow it to overcome the physical limit of the established
technology must be used if one is to keep meeting the needs of customers.
Effectively, when the returns on efforts become very small, that is a signal that a
new technology is around the corner. This is especially the case when the rate of
progress is not keeping up with demand. Consider, for example, the emission
control technology in automobiles. Early in the life of pollution control tech-
nologies, the reductions in emissions were substantial; but as time went on, the
increases in improvement relative to the amount of effort put into development
became smaller. According to Foster’s S-curve model of predicting the arrival of
new technologies, this low rate of increase in reductions in emission is a signal
that other technologies, such as hybrid or electric car technologies, are around
the corner as potential replacements for existing internal combustion engine
technologies whose physical limits are being reached (Figure 8.1). By the way, a
technology S-curve is usually not the same thing as a product S-curve. The
vertical axis of the product S-curve is sales while the horizontal axis is time.
Moreover, a technology S-curve usually has many product life cycles within it.
As a predictor of when to expect a radical innovation, the S-curve has some
limitations. It is dif?cult to tell exactly when to invest in the new technology and
when to drop the established one. It is also dif?cult to tell just how much better
the new technology will be. Moreover, the model does not say much about what
managers should do to be able to exploit the new technology when they eventu-
ally face it. More importantly, the focus of Foster’s curve was on “more is
better” in which ?rms pursued technologies to outdo existing product per-
formance characteristics. However, many potentially advantage-eroding tech-
nologies are not necessarily those that begin by outdoing existing product
performance characteristics. The disruptive technologies model and the con-
cepts of this book address these shortcomings.
Disruptive Technologies: The Phenomenon
The disruptive technologies framework, developed by Professor Clayton Chris-
tensen of the Harvard Business School, offered some answers to the ?rst three
questions: how can incumbents tell when to expect technologies that stand to
erode their competitive advantages? Why is it that incumbents often lose out
during these technological changes? What can these incumbents do to pro?t
better from such changes?
Characteristics of Disruptive Technologies
Professor Christensen introduced the phrase disruptive technologies. These are
technologies that exhibit the following three properties.
3
1 They create new markets by introducing a new kind of product or service.
(The dimensions of merit for products in the new market usually are differ-
ent from those in the established market.)
2 The new product or service costs less than existing products or services, and
therefore is priced less.
202 Opportunities and Threats
3 Initially, the new product performs worse than existing products when
judged by the performance metrics that mainstream existing customers
value. Eventually, however, the performance catches up and addresses the
needs of mainstream customers.
Characteristics of Potentially Displaceable Established
Technology
In addition to these characteristics of the disruptive technology, the established
technology that potentially could be disrupted also has two important
properties:
1 The performance of established product overshoots demand in established
market. Product may have too many bells and whistles that customers do
not need but are being forced to pay high prices for.
2 The cost of switching from the old product to the new one is low.
Rationale for Disruption
Why would a technology that exhibits the properties of disruptive technologies
outlined above offer an opportunity for new entrants to attack and replace
incumbents who have been exploiting an established technology? First, because
the technology creates a new market, incumbents who serve the old (main-
stream) market are likely to pay attention to meeting the needs of their existing
customers (in the old market) and therefore not give the new technology the
attention that it deserves. After all, these mainstream customers are the source
of the ?rm’s revenues and deserve attention. Moreover, because the perform-
ance of products from the new technology is initially inferior to that of existing
products and does not meet the needs of customers in the old market, incum-
bents are even less likely to pay attention to the new technology. When dimen-
sions of merit in the new market are different from those in the old market, it is
even more dif?cult to give the new technology the attention that it deserves.
Sometimes, the “new market” means the least demanding customers of the
existing market who are only too happy to use the low-cost product that meets
their needs but is perceived as inferior by the high-end segment. Second, because
products from the new technology cost less than established ones and are priced
accordingly, incumbents are less likely to pursue the new technology for fear of
taking the hit in reduced revenues. It is one thing to cannibalize one’s existing
products with new ones that bring in about the same revenues, but it is quite
another to cannibalize them with products that are priced a lot less. Financial
markets do not like drops in revenues.
Third, because the performance of the new products keeps improving, there
reaches a time when the new product has improved enough to start meeting the
needs of the mainstream customers that incumbents had been serving all along.
Some of these customers—especially those that are paying too much for bells
and whistles or over-performance that they do not need—switch to the new
lower-priced products made by the new entrants who have been serving the new
market. Many incumbents who now want to start making the new product ?nd
out that new entrants are further up the learning curve and perhaps enjoying
Disruptive Technologies as New Games 203
other ?rst-mover advantages associated with offering the disruptive technology
?rst. Moreover, incumbents’ dominant managerial logic in serving the old mar-
ket, together with the old structures and systems that had been put in place to
serve customers in the old market, can become a handicap. These factors
increase a new entrant’s chances of exploiting the disruptive technology better
than an incumbent.
To illustrate these points, consider the invasion of mainframe computers and
minicomputers by PCs in the 1980s and 1990s (Figure 8.2). Mainframes and
minicomputers were in the market long before PCs and satis?ed the needs of
many business customers as far as speed, software, and memory capacity were
concerned (Figure 8.2). When PCs started out, they were used largely by com-
puter enthusiasts and hobbyists, a new market compared to the business mar-
kets served by mainframes and minicomputers. PCs also cost much less than
mainframes and minicomputers. PCs’ performance was also initially inferior to
that of mainframes and minicomputers but often more than met the needs of
many computer enthusiasts and hobbyists. As the performance of PCs
improved, minicomputer makers kept listening to their customers and offering
them the types of minicomputer that they wanted, and not paying enough
attention to PCs. Eventually, PC performance improved to a point where it
started to meet the needs of some minicomputer customers, and at a much
lower price. Understandably, many minicomputer customers switched to PCs.
Some minicomputer makers who tried to enter the PC market were handi-
capped by their dominant managerial logic and the prospects of losing their
high-margin, high-revenue minicomputers. Moreover, some PC makers had
acquired PC brands and other ?rst-mover advantages and were in a better
position to pro?t from PCs than old minicomputer makers. The result was that
as PCs displaced minicomputers in most applications, new PC makers such as
Apple and Dell displaced many of the minicomputer and mainframe makers.
Effectively, in the Professor Christensen version of disruptive technology,
incumbents are so busy listening to their customers that they do not pay enough
Figure 8.2 PC versus Mainframes and Minicomputers.
204 Opportunities and Threats
attention to the disruptive technology, which starts out serving the less-
demanding needs of a new market. Moreover, since the new technology costs
less than the established technology, incumbents may be reluctant to suffer the
revenue drop that might come with switching to the lower-cost and lower-
priced product. Even if incumbents want to switch to the new technology, their
established processes, dominant managerial logic, relationships with old main-
stream customers and routines may make the transition dif?cult. Moreover,
the new entrants who adopted the technology ?rst may have established ?rst-
mover advantages. Table 8.2 provides a list of many technologies that ?t the
Christensen model of disruptive technologies.
Table 8.2 The Disrupted and Disruptors?
Disruptor Disrupted
Compact disc Cassettes and records
Desktop publishing Traditional publishing
Digital photography Chemical film-based photography
Distribution of software by Internet Distribution through distributors
e-mail Snail mail
High-speed CMOS video sensors Photographic film
Hydraulic excavators Cable-operated excavators
Internet Electronic data interchange (EDI)
Large-scale integration (LSI) Small-scale integration
Minicomputers Mainframes
Mini-mills for steel Integrated steel mills
Online auctions Offline auctions
PCs Minicomputers
PowerPoint-type software Drafting software
Small-scale integration Discrete components
Steam engine, electric motor, and internal-
combustion engine automobiles
Horse-driven cart
Steamships Sailing ships
Table-top copiers Large Xerox-type copiers
Telephone (originally worked for only 3 miles,
limited to local phone calls)
Telegraph (Western Union) long distance
Transistor radios Vacuum tube radio sets
Transistors Vacuum tubes
Wal-Mart’s discount stores in small rural
southwestern towns
Discount retailing in cities
Wireless phone service Fixed-wire phone service
Disruptive Technologies as New Games 205
Sustaining Technologies
A sustaining technology has the opposite effect on incumbents compared to a
disruptive technology in that, rather than displace established products, a sus-
taining technology is an incremental improvement in established products that
helps them get even more entrenched. Sustaining technologies are usually initi-
ated and pursued by incumbents who use them to reinforce their competitive
advantages.
Usefulness of Disruptive Technologies Framework for
Creating and Appropriating Value
The question is, of what use is the disruptive technologies model in creating and
appropriating value? As we pointed out earlier, the model provides answers to
three of the questions that we stated at the beginning of this chapter, namely: (1)
How can incumbents tell when to expect such innovations that stand to erode
their competitive advantages? (2) Why is it that incumbents often lose out dur-
ing these technological changes? (3) What can these incumbents do to better
pro?t from such changes? Answering these questions exposes the role of disrup-
tive technologies in creating and appropriating value.
How Can Incumbents Tell When to Expect Such Innovations that Stand
to Erode their Competitive Advantages?
The ?rst thing about taking advantage of the opportunities and threats of an
environment is to identify them. Because the disruptive technologies model lays
out the characteristics of the type of technology that is likely to be disruptive to
incumbents down the line, and which established technologies risk being dis-
placed by ?rms can use these characteristics to identify disruptive technologies,
ex ante; that is, ?rms can use these characteristics to identify disruptive tech-
nologies before disruption has taken place. In so doing, incumbents can care-
fully screen the different innovations that potentially represent a threat or
opportunity to their core businesses. New entrants can identify which technolo-
gies they can use to invade established or new markets. This can be done by
asking the simple questions shown in Table 8.3.
If the answer to all ?ve questions is YES, then the technology is potentially
disruptive to incumbents of the established market and these incumbents are
better off watching out for attackers. For attackers, it means that there is a good
chance for them to not only dominate the new market but to move into the old
market and erode the competitive advantages of incumbents there. To illustrate
these two points, consider the example of VOIP, which we will call Internet
telephony, versus ?xed line and wireless telephony. The technology was origin-
ally used by computer enthusiasts and college students who wanted to make
cheap or free phone calls and did not mind the poor quality of the call. By 2007,
the quality of Internet telephony calls had increased to a point where it was
dif?cult to tell the difference between an Internet phone call and a wireless or
?xed line call. As the quality of calls improved, the service moved to many other
markets, well beyond college students and enthusiasts. The cost of switching
from the traditional phone to VOIP service was very low for customers. Thus,
206 Opportunities and Threats
the answer to all ?ve questions in Table 8.3 is Yes. In the USA, new entrants
such as Vonage and Skype were going after both markets. Incumbent telephone
companies were at ?rst not very receptive to Internet telephony.
Why is it that Incumbents Often Lose out in the Face of these
Technological Changes?
Professor Christensen argued that two contributors to why incumbents often
lose out to new entrants, in the face of a disruptive technology, are old values
and processes. In exploiting an established technology, incumbents usually
build resources, processes and values. Processes are the “the patterns of inter-
actions, coordination, communication, decision making employees use to trans-
form resources into products and services of greater worth”
4
while values are
“the standards by which employees set priorities that enable them to judge
whether an order is attractive or unattractive, whether a customer is more
important or less important, whether an idea for a new product is attractive or
marginal and so on.”
5
Over time, especially if a ?rm has been successful, these
values and processes become embedded in the ?rm’s routines. Managers also
develop a dominant logic.
6
These values, processes and dominant logic are
strengths when it comes to exploiting established or sustaining technologies,
but in the face of some new games such as disruptive technologies, they can
become handicaps.
When a disruptive change or any other new game comes along and requires
different values or processes, the tendency is for the employees to stick with the
old routines that have worked before because routines, processes, and values
are dif?cult to change quickly. For example, if employees of an incumbent ?rm
have focused their attention on their existing customers so as better to provide
Table 8.3 To What Extent is Technological Change Disruptive to an Established Technology?
Question Answer Example: VOIP versus
old telephone service
Potentially disruptive technology
1. Does the innovation create a new market whose
performance requirements are not as demanding as those
of the old market?
Yes/No Yes
2. Does the innovation cost less than existing products? Yes/No Yes
3. Is the innovation inferior in performance but keeps
improving enough to be able to meet performance criteria
of the old market?
Yes/No Yes
Established technology
1. Does the established technology’s performance overshoot
demand, or are there too many bells and whistles for which
customers are being forced to pay?
Yes/No Yes
2. Are there little or no switching costs to switching from an
established technology to a disruptive one?
Yes/No Yes
Disruptive Technologies as New Games 207
these customers’ needs, their values and processes are likely to dictate that they
keep their attention on these customers, the sources of their revenues. In so
doing, they may miss out on the new market in which the disruptive technology
started out; and while the technology is gradually improving, employees in the
old market are still paying attention to their dominant customers. By the time
that these employees realize that the disruptive technology is now invading their
own market, it may be too late to quickly build the new values and processes
that are required to exploit the disruptive technology. Effectively, the old values
and processes have become handicaps for incumbents. Thus, new entrants,
without these old values, processes, and dominant managerial logic to handicap
them, have a better chance of exploiting the disruptive technology.
What Can these Incumbents do to Profit Better from Such Changes?
What should ?rms do in the face of disruptive innovations? It depends on
whether the ?rm is an incumbent or a new entrant. Professor Christensen sug-
gests several things that incumbents can do to improve their chances.
7
First, incumbents should convince upper-level management to see the disrup-
tive innovation as a threat to existing core businesses. In so doing, manage-
ment can commit the types of resources that are needed to tackle the innov-
ation. Since management’s instincts are to protect the core businesses that
bring in revenues, management is more likely to pay attention to the disruptive
innovation when it understands the enormity of the threat that the disrup-
tive innovation poses to an existing core business.
Second, when funds have been allocated to the innovation, and development
of products or services is ready to begin, the incumbent should turn over
responsibility to an autonomous unit within the ?rm that can frame the innov-
ation as an opportunity and pursue it as such. By using an autonomous unit, the
incumbent can (1) prevent the old processes and values from handicapping the
building of the new processes and values that are needed to exploit the innov-
ation, and (2) avoid the dominant managerial logic of the old business, if the
autonomous group is staffed with new employees who do not have the old
logic. It is also more dif?cult for political foes to disrupt the activities of the
autonomous unit.
Third, when a product is not yet good enough, the activities to develop the
product should be internal and proprietary. When a product becomes good
enough and commoditization starts, the incumbent should outsource it.
Fourth, ?rms should organize their business units as a function of the prob-
lems that customers want to solve (and associated solutions), rather than by
how easy it is to collect data for the company. Paying attention to customers’
problems, solutions, and contexts, rather than to the customers themselves,
enables a ?rm to see other customer’s needs better and to provide them.
The third and fourth items suggested for incumbents also apply to new
entrants. In addition, new entrants should ?rst go after markets that have been
ignored by incumbents, and then methodically work their way to incumbents’
existing markets.
208 Opportunities and Threats
Shortcomings of Disruptive Technologies Model
Like any framework, Christensen’s disruptive technologies model has its short-
comings. We explore three of them here: limited coverage, lack of strategy
focus, and not enough about pro?tability.
Limited Coverage
The characteristics of disruptive innovations are important because understand-
ing them enables ?rms to identify them and pay attention to the threats and
opportunities of potential disruptors. However, some innovations that do not
meet all the three characteristics of disruptive innovations still displace existing
products—that is, some innovations that are disruptive in outcome do not meet
all the characteristics of disruptive technologies spelled out above. Consider the
second property: innovation (new product) costs less than existing products.
Some innovations that start out costing more than existing products displace
the latter. New pharmaceutical drugs that displace existing ones are a case in
point—their initial costs are often higher than those of existing therapies. Next,
consider the third property: innovation starts out with inferior quality (com-
pared to existing products) but keeps improving enough eventually to meet the
needs of customers in the old market. Many innovations that start out with
superior performance, relative to existing products, still displace the existing
products. For example, many medications that initially outperform existing
ones, displace their predecessors. Electronic point of sale registers, which dis-
placed mechanical cash registers, were superior in performance to the latter
when they started out. Effectively, disruptive innovations, as de?ned by Chris-
tensen’s three characteristics, are but a subset of innovations that can be disrup-
tive. They are an even smaller subset of new games; but the Christensen de?n-
ition has the advantage that managers can use it to, ex ante, tell which innov-
ation will be disruptive and to try to do something about it.
Lack of Focus on Strategy: Prescriptions for Managers Are Only about
Implementation
The other shortcoming of the disruptive technologies model is that the prescrip-
tions for managers are largely about implementation issues and say very little
about the strategy that is being implemented. Recall that, according to Chris-
tensen, an incumbent that has a good chance of doing well in the face of a
disruptive technology is one that convinces upper-level management to see dis-
ruptive technology as a problem, creates an autonomous unit to pursue disrup-
tive technology, develops the product internally when it is still highly differenti-
ated but outsources it when it becomes a commodity, and organizes business
units as a function of the problems/solutions that customers want and not as a
function of how data is collected. These prescriptions are largely about the
organizational structure, systems, and people—the cornerstones of strategy
implementation. There is very little about the set of activities of the value chain,
value network, or value shop that needs to be performed to create and
appropriate value, and when and how these activities should be performed. The
prescriptions are also designed largely for incumbent ?rms, with very little
Disruptive Technologies as New Games 209
about what a new entrant could do to have a competitive advantage. After all,
not all attackers win.
Not Enough about Profitability
The primary emphasis of the disruptive technology model is on using the tech-
nology to develop products that customers ?nd valuable. Emphasis is on creat-
ing value and very little on appropriating the value; but as we saw in Chapter 4,
appropriating value often takes more than getting the technology right. Not
only are complementary assets often critical to pro?ting from a new technology,
a ?rm’s position vis-à-vis its coopetitors, its pricing strategy, the extent to which
the technology can be imitated, the number and quality of customers, and the
sources of revenue can also be critical. These shortcomings can be eliminated by
looking at disruptive technologies as the subset of the new games that they are.
Disruptive Technologies as New Games
What have disruptive technologies to do with new game strategies? Everything!
Disruptive technologies are often new games or the source of new games and
vice versa. On the one hand, for example, PC technology gave birth to all the
new game strategies that both new entrants and incumbents in the computer
industry pursued when they entered the PC submarket. The Internet is a disrup-
tive technology that has been the source of many new game strategies such as
those pursued by Google, eBay, Amazon, to name a few. On the other hand, for
example, the many ?rms whose R&D labs toil every day to invent radically
innovative products or processes often produce inventions that go on to become
disruptive technologies. For example, the microchip that would go on to replace
discrete transistor technology and make it possible to make everything from the
PC to the iPhone, was invented by Robert Noyce of Intel Corporation and Jack
Kilby of Texas Instruments.
Profiting from Disruptive Technologies: The New
Game Strategies Approach
A ?rm’s ability to pro?t from a disruptive technology starts with the ?rm’s
strengths and handicaps when it confronts the technology (Figure 8.3). These
strengths and handicaps in?uence how well the ?rm is able to take advantage of
the value chain and new game factors associated with the disruptive technology
to create and appropriate value (Figure 8.3).
Strengths and Handicaps in the Face of a Disruptive
Technology
As we saw in Chapter 5, every player in a new game brings some strengths from
its past resources/capabilities or product-market position (PMP) that can con-
tinue to be strengths or become handicaps in the new game. Since disruptive
technologies are new games, we can expect that both new entrants and incum-
bents bring some strengths from their pasts that can continue to be strengths or
become handicaps. Determining which former strengths can still be strengths
210 Opportunities and Threats
and which ones have become handicaps can be crucial in pro?ting from a
disruptive technology. Table 8.4 can be used to help make such a determination.
As we saw in Chapter 5, there are two primary determinants of which resource
becomes a handicap or strength: whether the resource is vital to exploiting the
disruptive technology, and whether the resource is separable. A resource is vital
Figure 8.3 Disruptive Technologies and Value Creation and Appropriation.
Table 8.4 Are Previous Strengths Still Strengths or Have they Become Handicaps in the Face
of a Disruptive Technology?
Resource Is the resource/capability vital
to the disruptive technology?
Is separability costless? In exploiting the disruptive
technology, the resource is a:
Resource 1 Y Y strength
Resource 2 Y N potential strength
Resource 3 N Y question mark
Resource 4 N N handicap
Disruptive Technologies as New Games 211
to a disruptive technology if it contributes substantially to value creation and
appropriability. It is separable if the ?rm has no problems taking the resource
away from a predisruptive technology application for use in a disruptive tech-
nology, or leaving the resource behind when it is more likely to hurt in the
disruptive technology than help. A ?rm may be prevented from using a resource
in a disruptive technology because of prior commitments, contracts, agree-
ments, understandings, emotional attachments, or simply because the resource/
asset cannot be moved from the predisruptive technology game to the location
of the disruptive technology.
A resource such as Resource 1 (Table 8.4) is a strength because it is important
in exploiting the disruptive technology and the ?rm can use it because there are
no prior commitments, agreements, understandings, or anything else that
prevents it from doing so. Many complementary assets such as brands and
distribution channels are usually strengths in the face of disruptive technologies.
IBM used its brand, relationships with businesses, and software developers to
dominate the PC market in the 1980s and early 1990s. (Recall that the PC was a
disruptive technology relative to minicomputers.)
A resource that was a strength in a predisruptive technology era becomes a
handicap if it is useless to the ?rm in exploiting the disruptive technology but
the ?rm cannot separate itself from the resource and move on. Separation may
not be possible because of prior commitments that the ?rm made in a predisrup-
tive technology period, or because of a lack of strategic ?t between the ?rm’s
corporate strategy and the disruptive technology. As we saw in Chapter 5,
Compaq’s relationships with distributors served it well for a while; but when it
decided to sell directly to end-customers, distributors prevented it from doing
so. Effectively, Compaq could not shake itself free of its prior commitments and
therefore could not pursue the proposed new business model. Often, a ?rm is
stuck with resources that it does not need even as it pursues the disruptive
technology. For example, since a disruptive technology usually starts out
addressing the needs of a new market with very low prices, incumbents may
have to adopt a low cost mentality to be competitive in the new market. Such a
mentality may be dif?cult to adopt successfully, especially if the ?rm’s products
in the old market are differentiated and it has a high cost-structure. It is dif?cult
to transform employees, with a high-cost culture born out of the high-cost
structure usually associated with a differentiation strategy, into a low-cost one.
Professor Christensen provided another good example. He argued that since
disruptive technologies usually ?rst address the needs of a new market, incum-
bents that were used to addressing the needs of the old market keep listening to
their customers—the primary source of their revenues—rather than customers
in the new market. Effectively, relationships with customers that were critical to
getting customers what they wanted prior to the disruptive change, now handi-
cap the ?rm’s efforts to listen to and address the needs of the new market. As
another example, take VOIP telephony. The old telephone company’s domin-
ant logic about how to make money carried over to the late 2000s for many old
telephone companies who could not understand how any ?rm would allow
people to make free intercontinental phone calls and still make money.
There are also cases where a resource is vital to a ?rm’s success in the face of a
disruptive technology but the ?rm cannot use the resource because of prior
agreements that prevent it from doing so (Resource 2, Table 8.4). As we saw in
212 Opportunities and Threats
Chapter 5, a noncompete clause in an important employee’s contract with a
previous employer can prevent the present employer from using the employee
effectively in exploiting a disruptive technology. Resource 3 is not important
in the new game and therefore of no signi?cance, since the ?rm can get away
from it.
From a PMP point of view, the question is whether strengths in a ?rm’s
previous PMP—the product and the ?rm’s position vis-à-vis its coopetitors—
that a ?rm brings to the disruptive technology remain strengths or become
handicaps. Because the product starts out addressing the needs of a smaller
market whose performance requirements are initially inferior to those of the
existing market, the old market is a handicap. Why? The prices and possibly
pro?t margins in the old market are higher than those in the new market. Not
many incumbents are likely to want to cannibalize their existing products, espe-
cially with new products whose prices are so low that they will suffer revenue
drops and possibly pro?t drops. It may also be dif?cult to change an organiza-
tion that has been built around a high-price high-cost structure and business
logic, to a low-price low-cost one.
Value Chain Activities in the Face of Disruptive Technologies
To offer products/services in the face of a disruptive technology, ?rms—incum-
bents and entrants alike—have to perform value chain activities. As we argued
in Chapter 4, to increase their chances of making the most contribution towards
value creation and appropriation, ?rms take advantage of so-called value chain
factors. They pursue the types of activities that:
1 Contribute to low cost, differentiation, number of customers and other
drivers of pro?tability.
2 Contribute to position the ?rm better vis-à-vis its coopetitors.
3 Take advantage of industry value drivers.
4 Build distinctive resources/capabilities and/or translate existing ones into
unique value.
5 Are comprehensive and parsimonious.
However, because disruptive technologies are new games, each ?rm can also
take advantage of new game factors—of the fact that disruptive technologies
generate new ways of creating and appropriating new value; offer opportunities
to build new resources/capabilities and/or translate existing ones in new ways
into value; create the potential to build and exploit ?rst-mover advantages;
attract reactions from new and existing competitors; and have their roots in the
opportunities and threats of an industry or macroenvironment. As we argued in
Chapter 4, value chain factors have a direct impact on value creation and
appropriation while new game factors have an indirect moderating effect. As
shown in Figure 8.3, the extent to which each value chain factor impacts value
creation and appropriation is moderated (pushed up or down in magnitude
and direction) by new game factors. Both factors rest on the strengths and
handicaps that the ?rm has when it faces the disruptive technology. We now
explore how.
Disruptive Technologies as New Games 213
Contribute to Low Cost, Differentiation, Number of Customers, and
Other Drivers of Profitability
Any ?rm that wants to make money from a disruptive technology has to offer
customers bene?ts that they perceive as more valuable to them than anything
that competitors can offer them; that is, irrespective of whether a ?rm is a new
entrant or an incumbent, it has to offer customers something unique if the ?rm
hopes to keep attracting customers. The ?rm also has to price the product well
and pursue the right sources of revenue. To offer distinctive customer bene?ts,
price them well, and pursue the right sources of revenue, a ?rm must perform
the appropriate value chain activities. Because a disruptive technology is a new
game, the ?rm can take advantage of new game factors. For example, since
disruptive technologies usually initially address a new market, they offer
opportunities to work with so-called lead users—customers who face needs that
other customers will encounter later but face them months or years before the
bulk of that marketplace does.
8
Because of their knowledge of what customers
want in the new product and their willingness to work with ?rms, lead users can
be very helpful in a ?rm’s efforts to offer distinctive value to its customers. The
new gameness of disruptive technologies also offers ?rms the opportunity to
move ?rst to build and exploit ?rst-mover advantages. For example, a ?rm can
build switching costs at customers, increasing the uniqueness of its PMP.
However, offering customers something that they value implies that a ?rm
has gotten the technology or aspects of it right. One way to do this is, as
suggested by Christensen, to convince upper-level management to see disruptive
technology as a problem, create an autonomous unit to pursue disruptive tech-
nology, develop a product internally when it is still highly differentiated but
outsource it when commoditized, and organize business units as a function of
the problems/solutions that customers want. Getting the technology right is not
always a guarantee to make money, since coopetitors with power can extract
most of the value. Moreover, the technology can be imitated by a ?rm that has
dif?cult-to-imitate but important complementary assets. Such an imitator will
make the money even though the ?rm being imitated got the technology right—
hence, the need to look at other value chain factors apart from getting the
disruptive technology right and offering customers the right product features.
Improve the Position of a Firm vis-à-vis Coopetitors
Disruptive technologies also have an impact on industry factors and therefore
an impact on a ?rm’s position vis-à-vis its coopetitors. Rivalry increases since
both new entrant attackers and incumbents are competing to exploit the new
technology, often in both the new and old markets. Growth lessens the intensity
of rivalry somewhat. The number of ?rms increases, thereby increasing the
bargaining power of buyers. New entry is high as entrepreneurs enter to exploit
the new technology. Suppliers have more ?rms to sell to than before the disrup-
tive technology. Effectively, the industry is not as attractive as it was before the
disruptive change, and appropriating value created depends on how ?rms take
advantage of these forces that are reducing the attractiveness of the markets in
performing their activities.
A ?rm can take advantage of new game factors by improving its position vis-
214 Opportunities and Threats
à-vis coopetitors and in the process, dampen some of these repressive forces.
First, if a ?rm bypasses powerful distributors and sells directly to more frag-
mented end-customers, the ?rm is effectively increasing its bargaining power
vis-à-vis buyers, and increasing its chances of working more closely with lead
users to get the technology right. Second, by integrating vertically backwards,
early in the life of a disruptive technology, a ?rm may be able to improve its
position vis-à-vis suppliers. It can use this improved position to, for example,
convince sole suppliers of important components to ?nd second sources for
these components, further improving its position vis-à-vis the suppliers. Finally,
working cooperatively with coopetitors, rather than seeing them as antagonists
over whom one has to have power, often dampens competitive forces.
Take Advantage of Industry Value Drivers
Recall that industry value drivers are those industry factors that stand to have a
substantial impact on the bene?ts (low cost or differentiation) that customers
want, the quality and number of such customers, or any other driver of pro?t-
ability. Disruptive technologies often change industry value drivers. For
example, in of?ine auctions, the location of the auction was a critical industry
value driver since it determined who would attend the auction and the more
people at the auction, the better for sellers. In online auctions, the location is no
longer a value driver. Now it is the number of registered members that belong to
a particular community or website. Consequently, emphasis in the face of the
Internet is not on having the best location but on having the largest number of
registered users. eBay seems to have understood this well. Another example is
Nintendo’s introduction of the Wii. One reason why Nintendo was able to
make money on each console sold while Sony and Microsoft lost money on
their consoles (PS3 and Xbox 360, respectively) was because the video game
console industry was an industry in which the prices of the microchips used in
consoles dropped rapidly as older chips quickly became obsolete. Since Nin-
tendo was pursuing a reverse positioning strategy, it used these old chips that
cost a lot less than the cutting-edge chips used by its competitors. Effectively,
Nintendo was able to take advantage of the rapidly falling prices of chips and
keep its costs very low.
Build Distinctive Resources/Capabilities and/or Translate Existing
Ones into Unique Value
The resources that a ?rm needs in the face of a disruptive technology can be
grouped into two: technology resources and complementary assets. Technology
resources are the resources that a ?rm needs to get the technology right. Com-
plementary assets here are all the other resources, beyond those that underpin
the disruptive technology, that a ?rm needs to offer customers value and pos-
ition itself to appropriate the value. They include distribution channels, brand
name reputation, installed base, shelf space, and so on, and are often critical to
pro?ting from a disruptive technology. Although new technology resources are
often needed in the face of a disruptive technology, scarce important comple-
mentary assets that were important in pro?ting from the established technology
usually remain useful and important. Firms with such complementary assets
Disruptive Technologies as New Games 215
often stand to do well. Because disruptive technologies initially address new
markets, ?rms may have to build the complementary assets required to focus on
these new markets from scratch and new entrants may have an advantage build-
ing the complementary assets for these new markets. Incumbents usually have
the complementary asset for the older market and these complementary assets
can help them fend off attacks by new entrants. Often, new entrants with the
technology resources team up with incumbents that have the complementary
assets.
Because a disruptive technology costs less than the older one and is initially
inferior in performance, incumbents and new entrants alike often need new
technological resources to get the new technology right. By convincing upper-
level management to see the disruptive technology as a problem, creating an
autonomous unit to pursue the disruptive technology, and so on, an incumbent
can mitigate some of the problems of dominant managerial logic to build the
types of resource that will enable it to get the new technology right. By moving
?rst, the ?rm can also build and exploit ?rst-mover advantages.
Conform to Parsimony and Comprehensiveness
In performing the activities that will enable it to create and capture value in the
face of a disruptive technology, a ?rm has to be careful not to perform unneces-
sary activities or leave out important activities. An AVAC analysis can help a
?rm sort out which activities contribute to value creation and capture, and
which do not.
Implementation of New Game Strategies
As we saw in Chapter 7, the strategy that a ?rm pursues also has to be imple-
mented well if its full potential is to be realized. A structure, systems/processes,
and people that ?t the strategy has to be pursued if a ?rm is going to realize the
full potential of its new game strategy. Having the right values and processes
are part of the implementation. The four measures advocated by Professor
Christensen—convincing upper-level management to see the disruptive
technology as a problem, creating an autonomous unit to pursue disruptive
technology, developing product internally when it is still highly differentiated
but outsource it when commoditized, organizing business units as a function of
the problems/solutions that customers want—are a subset of implementing a
new game strategy.
Revisiting the Questions
One way to summarize what we have explored in this chapter is to revisit the
questions that we raised at the beginning of the chapter.
How Can Incumbents Tell When to Expect Innovations that
Stand to Erode their Competitive Advantages?
As part of monitoring the opportunities and threats of its political, economic,
social, technological, and natural (PESTN) environments via, for example, a
216 Opportunities and Threats
PESTN analysis, a ?rm should perform the ?ve-part test of Table 8.3 to deter-
mine the extent to which the new technology stands to become disruptive to an
established technology. A new technology is potentially disruptive to an estab-
lished technology if the answers to the questions of Table 8.3 are largely Yes.
Moreover, by anticipating the likely actions and reactions of coopetitors, a ?rm
may be able to respond better to disruptive technologies since it is monitoring
not only the technology but also the actions of ?rms. A ?rm is better prepared to
cooperate and compete in the face of a disruptive technology if it knows not
only about the technology but also about the coopetitors trying to exploit the
technology.
Why Is it that Incumbents (Some of them very Successful)
Often Lose Out in the Face of Disruptive Technologies?
Recall that proponents of the disruptive technologies model argue that incum-
bents fail because, in trying to get the new technology right, the processes and
values that they developed in exploiting the established technology handicap
their efforts. The primary goal of actors, according to the model, is in getting
the technology right—in developing the type of product that customers, in the
new and old markets, want. The new game strategies model maintains that
there is more to making money from a new technology than getting the technol-
ogy right. Thus, incumbents can also fail to pro?t from a disruptive technology
if they do not have the right complementary assets, position themselves well vis-
à-vis coopetitors, have the wrong pricing strategy, or do not pursue the right
sources of revenue in creating and appropriating value. Additionally, a ?rm
may be handicapped by resources/capabilities and PMPs that were strengths in
the predisruptive technology era but that have become handicaps. For example,
predisruptive technology era strengths such as resources, prior commitments,
dominant logic, corporate strategy, existing products, and position vis-à-vis
coopetitors can become handicaps.
What Can Incumbents Do to Profit Better from Disruptive
Technologies?
The disruptive technologies model argues that an incumbent can improve its
performance in exploiting a disruptive technology if it convinces upper-level
management to see the technology as a problem, creates an autonomous unit to
pursue disruptive technology, develops the product internally when it is still
highly differentiated but outsources it when it becomes a commodity, and
organizes business units as a function of the problems/solutions that customers
want and not as a function of how data is collected. These prescriptions are
meant largely to overcome the problems that incumbents face, in trying to get
the technology right; but since there is a lot more to pro?ting from a new
technology than getting it right, an incumbent not only has to reduce the effects
of its handicaps on its ability to get the technology right but also obtain com-
plementary assets, position itself advantageously vis-à-vis its coopetitors, and
perform any other activity that will enable it to create and appropriate value. It
has to take advantage of both value chain and new game factors. Note also that
incumbents often have at least one advantage over new entrants in the face of a
Disruptive Technologies as New Games 217
disruptive technology—they usually have complementary assets such as distri-
bution channels, and brands that can be used in exploiting the disruptive tech-
nology, especially in the established market. These complementary assets can be
used to, among other things, convince a new entrant that has the technology but
no complementary assets to team up with the incumbent.
What Should New Entrants Do?
The disruptive technology model suggests that new entrants should start out by
attacking the new market ?rst, reserving entry into the old market for later.
Given their strengths and handicaps, new entrants should take advantage of
both value chain and new game factors to create and appropriate value. Add-
itionally, they can also exploit the fact that incumbents have handicaps that
they do not.
Disruptiveness of New Games
In the disruptive technologies framework that we have explored, there are two
types of technology: disruptive and sustaining. One implicit assumption is that
within each of these groups, there is homogeneity—that is, all disruptive tech-
nologies have the same level of disruptiveness while all sustainable technologies
have the same level of sustainability. However, since not all technologies have
the same characteristics, we can expect disruptive technologies to differ in their
level of disruptiveness. Thus, an interesting question is, how disruptive is a
disruptive technology? Since disruptive technologies are a subset of new games,
we can understand the extent to which some disruptive technologies are more
disruptive than others by exploring the new gameness (disruptiveness) of new
games. In Chapter 1, we started exploring the new gameness of new games
using the framework that has been summarized in Figure 8.4. In the framework,
the vertical axis captures the impact of a new game on the competitiveness of
existing products—that is, it captures the extent to which a new game renders
existing products noncompetitive. The horizontal axis captures the impact of
the new game on existing resources/capabilities (technological and market-
ing)—that is, it captures the extent to which the technological and marketing
resources/capabilities that are required to pursue the new game build on exist-
ing resources/capabilities or render them obsolete.
9
In the framework, there are
four types of new games: regular, position-building, resource-building, and
revolutionary.
10
New gameness and disruptiveness increase as one moves from
the origin of the matrix to the top right corner, with the regular new game
being the least disruptive while the revolutionary new game is the most
disruptive.
By de?nition, disruptive technologies drastically reduce the competitiveness
of existing products. Thus, we can expect disruptive technologies to be located
in the upper half of the matrix of Figure 8.5. Take PCs, for example. The
technology and other resources needed to make PCs built on the existing
resources needed to build minicomputers and PCs eventually rendered mini-
computers noncompetitive. Thus, in the matrix of Figure 8.5, PCs would be
located in the upper-left quadrant. Other examples that fall into this quadrant
include mini-mills and different generations of disk drives. However, digital
218 Opportunities and Threats
Figure 8.4 Disruptiveness of Disruptive Technologies.
Figure 8.5 Examples of Degrees of Disruptiveness.
Disruptive Technologies as New Games 219
photography falls in the upper-right quadrant because the technology is radic-
ally different from chemical ?lm-based photography technology. And the qual-
ity of digital technology has improved to a point where chemical ?lm-based
technology is being phased out. Like PCs, it is a disruptive technology but a
revolutionary new game rather than a position-building new game.
Key Takeaways
•
Over the years, many new technologies have replaced older ones and in the
process, incumbent ?rms have been replaced. This has raised four
questions:
1 How can incumbents tell when to expect such innovations that stand to
erode their competitive advantages?
2 Why is it that incumbents (some of them very successful) often lose out
during these technological changes?
3 What can these incumbents do to pro?t better from such changes?
4 What should new entrants do to be successful? After all, not all new
entrants do well.
•
Foster’s S-curve was one of the ?rst models to explore the ?rst question. He
argued that a ?rm can tell that a new technology is about to displace an
existing one when the physical limits of the existing technology have been
reached—when the returns on efforts become very small.
•
According to Professor Clayton Christensen, disruptive technologies
exhibit the following three characteristics:
1 They create new markets by introducing a new kind of product or
service.
2 The new product or service costs less than existing products or services,
and therefore is priced less.
3 Initially, the new product performs worse than existing products when
judged by the performance metrics that mainstream existing customers
value. Eventually, however, the performance catches up and addresses
the needs of mainstream customers.
•
Contrast this with a sustaining technology which is an incremental
improvement in established products and is often used by incumbents to
reinforce their competitive advantages.
•
Meanwhile, those established technologies that are prime candidates for
disruption usually have products:
1 Whose performance overshoots demand, with too many bells and
whistles for which customers are being forced to pay.
2 With little or no switching costs for customers.
•
The disruptive technologies model was developed by Professor Christensen
and provides some answers to three of the four questions raised:
1 How can incumbents tell when to expect innovations that stand to
erode their competitive advantages? Using the following checklist, a
?rm can determine, ex ante, which technology potentially is likely to
disruptive its business models:
220 Opportunities and Threats

Does the new technology create a new market whose performance
requirements are not as demanding as those of the old market?

Does the new technology cost less than existing products?

Is the new technology inferior in performance (compared to that of
established technology) but keeps improving enough to be able to
meet performance criteria of the old market?

Does the performance of the established technology overshoot
demand?

Are the costs of switching from the established technology to the
new one low?
2 Why is it that incumbents (some of them very successful) often lose out
in the face of a disruptive technology? Incumbents fail to exploit disrup-
tive technologies because they are handicapped by:

Processes developed in exploiting established technology.

Values developed in exploiting established technology.
3 What can incumbents do to profit better from disruptive technologies?
Incumbents can overcome these handicaps by:

Convincing upper-level management to see disruptive technology as
a problem.

Creating an autonomous unit to pursue disruptive technology.

Developing a product internally when it is still highly differentiated
but outsourcing it when it is commoditized.

Organizing business units as a function of the problems/solutions
that customers want.
•
The new game strategies framework encompasses the disruptive technolo-
gies model, since disruptive technologies are new games. It answers all four
questions:
1 How can incumbents tell when to expect innovations that stand to
erode their competitive advantages?

When a PEST analysis suggests that the political, economic, social,
or technological components of the environment are a threat or an
opportunity. This includes the ?ve-question test of disruptive
technologies.

When, by monitoring the likely reaction of coopetitors, incumbents
?nd that coopetitors are likely to adopt the new technology.
2 Why is it that incumbents (some of them very successful) often lose out
in the face of disruptive technologies? In creating and appropriating
value, incumbents are handicapped by:

Strengths from predisruptive technology era that have become
handicaps: resources, prior commitments, dominant managerial
logic, corporate strategy, existing products, position vis-à-vis
coopetitors, values, systems, and processes.

Not enough strengths or ability to build them, to exploit value chain
and new game factors.
Disruptive Technologies as New Games 221
3 What can incumbents do to profit better from disruptive technologies?

Not only reduce the effects of handicaps, but also take advantage of
strengths (e.g. complementary assets), in creating and appropriating
value. This includes not only getting the technology right, but also
doing other things to create value and better position the ?rm to
appropriate the value. It entails taking advantage of both value
chain and new game factors. Given its strengths and handicaps, the
?rm should perform activities that:

Contribute to low cost, differentiation, or other drivers of
pro?tability.

Contribute to position the ?rm better vis-à-vis its coopetitors.

Take advantage of industry value drivers.

Build and translate distinctive resources/capabilities.

Are parsimonious and comprehensive.

While:

Taking advantage of the new ways of creating and capturing the
new value generated by the new game.

Taking advantage of opportunities generated by the new game
to build new resources or translating existing ones into unique
value.

Taking advantage of ?rst-mover advantages and disadvantages.

Anticipating and responding to coopetitors’ reactions to its
actions.

Identifying and taking advantage of opportunities and threats
from the macroenvironment.

The strategy must then be properly implemented by:

Convincing upper-level management to see disruptive tech-
nology as a problem.

Creating autonomous unit to pursue disruptive technology.

Developing product internally when it is still highly differ-
entiated but outsourcing it when commoditized.

Organizing business units as a function of the problems/
solutions that customers want.
4 What should new entrants do to be successful?

The same things that incumbents do but without the handicaps and
strengths of incumbents.
•
Some disruptive technologies are more disruptive than others. Revolution-
ary disruptive technologies are the most disruptive.
Key Terms
Disruptive technology
Foster’s S-curve
S-curve
Sustaining technology
222 Opportunities and Threats
Globalization and New Games
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
De?ne globalization, and the different strategies that ?rms can pursue in
going international.
•
Analyze who appropriates how much value from products that are
developed and sold globally.
•
Be introduced to the strategies that ?rms pursue when going global.
•
Understand the drivers of globalization and why ?rms go international.
•
Begin to understand the critical role that governments can play in value
appropriation.
Introduction
Oil is arguably the most global of all global products. It is explored and
extracted from countries in all six continents, by people and equipment from all
over the world. It is re?ned, transported, sold, and used in all corners of the
earth. All countries need it and depend on each other for it, and for the tech-
nologies that go into ?nding, transporting, and processing it. The list of prod-
ucts that are produced using oil is endless. Towards the middle of 2008, the
price of a liter of gasoline at the pump reached record highs in many countries
even as the price of oil futures ?irted with the $150 per barrel record price. Oil
companies recorded very high pro?ts and some analysts wondered what the
high prices would do to the world economy.
1
Some consumers wondered if the
oil companies deserved the high pro?ts. Using our terminology, people won-
dered if the oil companies created all the value that they were appropriating. If
that were not the case, who was creating the value that the oil companies were
capturing? If they deserved the high pro?ts, who was capturing most of the
value perceived by customers? How about the oil-exporting or importing coun-
tries? How much of what consumers paid for oil from each of these countries
actually went to the countries? We will explore these questions in this chapter.
We start the chapter with an example on how to calculate the value that is
appropriated by different players along an international oil value chain. We
then brie?y discuss globalization and its drivers. This is followed by a discus-
sion of new game strategies that ?rms use when they go global.
Chapter 9
Introductory Example: Appropriating Value in
Globalization
Suppose a ?rm pursues the right global new game strategy (given its strengths
and handicaps) to create value; how much of the value can it appropriate? It
depends on how much of the value created the other players in the international
value system, especially governments, appropriate. Governments have in?nite
power and can use it to appropriate most of the value created in a value chain,
leaving the creators of such value with very little to show for their efforts. To
illustrate what can happen in a value chain, let us explore a very short minicase.
We use the oil industry because it is one of the most global industries in the
world. Directly or indirectly, oil touches almost every life on earth. Firms and
governments bene?t from oil.
Example 9.1. Minicase: Who Creates and Who Appropriates Value in the
Oil Industry?
In the 2000s, Nigeria was Africa’s largest exporter of oil and exported some of
its oil to many countries including the USA, India, France, Italy, Spain, Canada,
and the Netherlands.
2
Finding costs for Africa had jumped from $7.55 per
barrel in 2002–3 to $15.25 in 2003–5.
3
In 2003, lifting costs and production
taxes were $3.57 and $1.00 per barrel respectively. Table 9.1 shows the June
2007 gasoline prices, taxes, cost per barrel of oil, and currency exchange rates
for the Organization for Economic Cooperation and Development (OECD)
countries as reported by the International Energy Agency (Agence Internation-
ale de L’energie), an OECD agency.
4
There are 158.98 liters to the barrel. The
joint ventures that produced oil in Nigeria are shown in Table 9.2.
5
The price
that consumers paid for gasoline re?ected the cost of crude oil to re?ners,
re?nery processing costs, marketing and distribution costs, the retail station
costs, and taxes. Crude oil costs, in turn, included the cost of exploring and
?nding oil, drilling for it, pumping it out, transporting it to re?ners, and export
taxes paid to the exporting country.
Question 1: How much of the value in a liter of gasoline using crude from
Nigeria was captured (1) by each OECD country, (2) by the oil com-
panies, and (3) by Nigeria? How much of the value was created by
governments?
Question 2: Can you explain the difference between the amount appropriated
by Nigeria and that appropriated by each OECD country?
Answer
We perform the calculations for France ?rst, and simply state the results for the
other countries. All calculations are in US dollars and liters.
Of the $1.771 paid by customers in France for a liter of gasoline (Table 9.1),
France captured $1.101 (62.17%). Therefore, the amount left to be shared by
other players in the value chain is $0.670 ($1.771 ? 1.101); that is, $0.670 of
the $1.771 has to be shared by (a) the oil companies that explore for crude oil,
drill, pump, and transport it to re?neries; (b) the re?ners (often oil companies)
224 Opportunities and Threats
who re?ne, market, and transport to gas stations for sale to customers, and the
gas station’s take; and (c) the exporting country, Nigeria in our case.
We are told that the average crude price in France in April 2007 was $65.72/
barrel = ($65.72/158.98) per liter = $0.4134/liter. Therefore distribution and
marketing, and re?ning and pro?ts account for $0.2566 ($0.670 ? $0.4134) or
Table 9.1 June 2007 OECD Gasoline Prices and Taxes
Country Price (in
country’s
currency)
Tax (in
country’s
currency)
Exchange
rate for a
dollar
Price
(US$)
Tax
(US$)
April crude oil
prices (US$/
barrel)
France () 1.316 0.818 0.743 1.771 1.101 65.72
Germany () 1.393 0.877 0.743 1.875 1.180 65.67
Italy () 1.348 0.789 0.743 1.815 1.063 64.51
Spain () 1.079 0.545 0.743 1.452 0.733 63.73
UK (£) 0.966 0.628 0.504 1.917 1.246 67.73
Japan (Yen) 139.000 60.400 121.610 1.143 0.497 62.38
Canada (C$) 1.066 0.312 1.061 1.005 0.294 65.96
USA (US$) 0.808 0.105 1.000 0.808 0.105 59.64
Source: International Energy Agency (Agence Internationale de l’Energie), OECD/IEA (2007). End-user petroleum
product prices and average crude oil import costs. Retrieved August 9, 2007, from http://www.iea.org/Textbase/stats/
surveys/mps.pdf.
Table 9.2 Oil Joint Ventures in Nigeria
Joint venture operated by: Estimated production
in 2003 (barrels per
day)
% of Nigerian
production in 2003
Partners in joint
venture (share in
partnership)
Shell Petroleum Development
Company of Nigeria Limited (SPDC)
operated by Royal Dutch Shell, a
British/Dutch company
950,000 42.51 NNPC (55%)
Shell (30%)
TotalFinaElf (10%)
Agip (5%)
Chevron/Texaco Nigeria Limited
(CNL), operated by Chevron/Texaco
of USA
485,000 21.70 NNPC (60%)
Chevron (40%)
Mobil Producing Nigeria Unlimited
(MPNU), operated by Exxon-Mobil
of USA
500,000 22.37 NNPC (60%)
Exxon-Mobil (40%)
Nigerian Agip Oil Company Limited
(NAOC), operated by Agip of Italy
150,000 6.71 NNPC (60%)
Agip (20%)
ConocoPhillips
(20%)
Total Petroleum Nigeria Limited
(TPNL), operated by Total of France
150,000 6.71 NNPC (60%)
Elf (now Total)
(40%)
Source: Energy Information Administration of the US Department of Energy (2003), Nigeria. Retrieved July 30, 2007,
from http://www.eia.doe.gov/emeu/cabs/ngia_jv.html.
Globalization and New Games 225
14.49% of the $1.771. The crude price of $0.4134/liter includes ?nding costs,
lifting costs, production taxes, and “pro?ts” for exporting country and oil
company partners.
The question now is, what fraction of the $0.4134/liter goes to Nigeria. To
estimate Nigeria’s share, we ?rst estimate the ?nding and lifting costs, and
production taxes as follows:
the cost of oil extraction is $19.83 ($15.25 ?nding costs + $3.57 lifting costs
+ $1.00 production taxes) per barrel = ($19.83/158.97) per liter = $0.1247
per liter.
Thus, ?nding costs, lifting costs, and production taxes account for $0.1247
or 7.04% of the $1.771 price per liter. Therefore Nigeria and its venture part-
ners (Shell, Chevron/Texaco, Agip, Total, Mobil) are left with $0.2887
($0.4134 ? 0.1247) to share. To estimate Nigeria’s share of the oil ventures, we
?rst estimate what share of the oil shipped belongs to it. The weighted average
of Nigeria’s share is 57.87% (from Table 9.2, the sum of Nigeria’s percent
ownership in each venture multiplied by the number of barrels produced per
day by the venture, all divided by the total number of barrels per day from all
ventures). Therefore, of the $0.2887 amount, Nigeria appropriates $0.1671
(0.5787 × 0.2887) or 9.43% of the $1.771 that the customer pays per liter while
its partners appropriate the remaining $0.1216 ($0.2887 ? 0.1671) or 6.87%
of the $1.771. The results are summarized in Table 9.3.
This calculation can be repeated for each OECD country. The results from
these calculations are summarized in Table 9.4, and displayed in Figure 9.1.
France appropriates more than six times the value that Nigeria appropriates
from Nigerian oil and more than eight times the value that Nigeria’s oil com-
pany partners appropriate. By oil companies, we mean the companies that
explore for and ?nd oil, drill for it, lift it (pump it into tankers), transport it to
re?neries, re?ne it, distribute it, and sell it—the companies that create most of
the value that customers pay for. Germany appropriates a little more than
France while Italy and Spain appropriate slightly less than France but still a lot
Table 9.3 What Each Player Gets
Player(s) Amount
appropriated
per liter ($)
Percentage
appropriated
Comment
The French Government 1.1010 62.17
Distribution and marketing, and Refining and
profits
0.2566 14.49
Crude oil
Finding costs, lifting costs and production taxes 0.1247 7.04
Nigeria 0.1671 9.43 $0.4134 (23.34%)
Venture partners (Shell, Chevron/Texaco, etc)
combined
0.1216 6.87
Total (per liter French price) 1.7710 100.00
226 Opportunities and Threats
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more than Nigeria, the oil exporting country. It should be noted that only US
federal taxes are included. Including US State taxes could alter the numbers for
the USA.
Implications of Government’s Insertion into a Value Chain
By imposing a tax on an import or a subsidy on an export, a government is
inserting itself into the product’s international value chain and in?uencing the
way value is created and appropriated by each player. This can have huge
consequences on globalization. We consider the effects of taxes and subsidies
separately.
Effect of Import Duties and Taxes
By appropriating 62% of the value in a liter of gasoline, the French government
is extracting some consumer surplus from customers as well as some supplier
surplus from the oil companies and exporting countries such as Nigeria. (Con-
sumer surplus is the bene?t perceived by customers minus the price paid by
customers.) How much of the value extracted is supplier surplus and how much
is consumer surplus depends on the price elasticity of demand for oil. The price
elasticity of demand of a product is the change in quantity demanded that
Figure 9.1 Who Appropriates How Much from Nigerian Oil?
228 Opportunities and Threats
results from a change in the product’s price. The more elastic the demand, the
more that oil suppliers and exporters suffer, since the large taxes reduce the
quantity that customers buy. The more inelastic the demand, the more cus-
tomers suffer, since they still buy a lot of the product, despite higher prices from
the high taxes. To illustrate the effect of taxes and value appropriation along an
international value chain, let us use the simple but informative illustration of
Figure 9.2.
6
If there were no taxes, suppliers would supply the equilibrium
quantity Q
E
at the equilibrium price P
E
. With a tax T, not only does the quantity
that is demanded fall from Q
E
to Q
T
, the price that these suppliers obtain also
drops from P
E
to P
S
. This double whammy of a drop in quantity and price
results in a drop in revenues from OP
E
RQ
E
to OP
S
MQ
T
. The more elastic the
price elasticity of demand, the larger would be the drop in revenues. The drop
also means that ?rms that would have been pro?table at prices between P
E
and
P
S
are no longer pro?table and likely to go out of business. On their part, the
customers who can still afford the high prices get to pay P
C
rather than P
E
,
foregoing P
E
P
C
NR in consumer surplus that they could have pocketed. Whether
the overall effect of taxes on consumers is good or not, depends on what the
government does with the money. The effect on suppliers and the supplying
country is not good. They lose a supplier surplus of P
E
P
S
MR.
The demand for the product in Figure 9.2 is elastic, since, for example, the
ratio Q
T
Q
E
/P
C
P
E
is greater than one, assuming that OP
E
=OQ
E
. If the demand
were inelastic, the drop in suppliers’ revenues and resulting negative effect on
the exporting country would still be there but not as high while the overall effect
on consumers would be worse. Returning to the petroleum example, there is
some evidence that demand for oil is inelastic in the short run but elastic in the
long run. In other words, if the price of gasoline went up today, most people
would not, for example, go out and buy a new fuel-ef?cient car right away,
unless they had been planning to buy a car. Rather, they are more likely to keep
driving their existing cars but when it is time to buy the next car, they may buy
one that is more fuel-ef?cient. It is also true that some people would forgo that
family vacation because of the cost of gas.
Figure 9.2 Effect of Taxes on Value Appropriation.
Globalization and New Games 229
Effect of Export Subsidies
A government can also in?uence globalization activities in an industry by sub-
sidizing exports. An export subsidy is an amount that each supplier (exporter)
is paid for a certain quantity that it exports. The subsidy can be in the form of a
cash payment, a tax break, or the free use of government assets such as land.
Subsidies are usually good for the exporters but not for the competitors that the
subsidized ?rms face in the global market. To understand what the impact of
export subsidies can be on competitors and the importing country, consider
Figure 9.3.
7
Without subsidies, all exporters can sell a quantity Q
E
at a price P
E
.
Suppose a government decides to subsidize its exporters with a subsidy d. With
the subsidy, suppliers who would have exported their products at a loss because
of their high cost structures can remain in the market because they are now,
given the subsidies, getting an effective price of P
S
instead of P
E
. Because of the
subsidy, the price that subsidized exporters charge customers is actually P
C
. The
overall effect is that more of the product is sold at lower prices than before the
subsidy. Customers get lower prices, thanks to the subsidies. However, for sup-
pliers that do not have the subsidies and whose costs are higher than the new
subsidized price, subsidies can spell disaster. An example that has been used to
illustrate the bad effects of subsidies is that of cotton farmers in Niger and
Mali.
8
Many farmers in these countries, most of whom lived on less than a
dollar a day, took loans from the World Bank to grow cotton. Because US
cotton farmers were subsidized by the US government, they were able to sell
cotton in the world market at prices that were well below those of the unsubsid-
ized farmers in Niger and Mali, for example. The result was that farmers from
Niger and Mali sold their cotton at a loss and many of them went out of
business.
Figure 9.3 Effect of Subsidies on Value Appropriation.
230 Opportunities and Threats
Classifying Value Creators and Appropriators
We can classify members of a value chain as a function of whether they capture
more value than they create or create more value than they capture. This clas-
si?cation is shown in Figure 9.4. The vertical axis of the ?gure captures the
extent to which a ?rm’s contribution to value creation is high or low, while the
horizontal axis captures the extent to which a ?rm’s value appropriation is low
or high. We use animals and insects to represent the different types of player.
Bees
In every value chain, there are usually some ?rms or individuals who create lots
of value but do not get to appropriate a lot of it. Like bees, these ?rms or
individuals work very hard all the time to create value but other players capture
more it than they deserve, leaving these bees with less than they created (other
players take away their honey). From our example above, the companies that
?nd, drill, and pump oil would fall into this category. They capture value, all
right; but not as much as they create compared to the exporting and importing
governments. As we saw in Chapter 4, there are several reasons why a ?rm may
not be able to capture all the value that it creates. One of these reasons is that
the player with more power may capture more value than it creates. In the oil
industry case, governments have more power than the oil companies and can
therefore appropriate more value than the creators of the value. In countries
where governments regulate drug prices, it is possible that pharmaceutical
companies appropriate less value than they create when they sell drugs at lower
prices than patients or insurance companies and governments may be willing to
pay. Where drug prices are not regulated, it is also possible that ?rms extract
Figure 9.4 Who Appropriates More Value than It Creates?
Globalization and New Games 231
more from desperate patients than the drugs are worth. It is possible that coffee
growers capture very little of the value that coffee drinkers perceive in a cup of
coffee. It is also possible that cocoa growers capture only a very small fraction
of the value that chocolate lovers perceive in a bar of chocolate.
Beavers (Ants)
In some value chains, the ?rms that work hard to create value get to appropriate
all of it. We liken such ?rms to beavers who work very hard to create value and
often derive lots of bene?ts from their hard work.
Foxes (Piranha, Vulture, Crocodile)
As we saw in the oil industry example, some ?rms or governments appropriate
a lot more value than they create. In some cases, they do not even create value
but get to appropriate a lot of it. They reap a lot more than they sowed. Such
players are more like foxes since they do very little but capture a lot of value.
They have been called piranhas, and vultures.
Bears
In their value chains, some ?rms play niche roles in which they do not care
much about having a competitive advantage. They do enough just to get by.
They are the opposite of beavers who work all the time. They are more like
bears. They create very little value and do not appropriate much of it either.
Globalization
Globalization is the interdependence and integration of people, ?rms, and gov-
ernments to produce and exchange products and services.
9
It creates opportun-
ities for new jobs, learning, new and improved products/services, increased
trade, ?nancial ?ows, and enhanced standards of living. However, globalization
also poses a threat to some businesses, jobs, and ways of living. That is particu-
larly true when globalization is not pursued correctly. If pursued well, global-
ization can result in improvements in the standard of living of participants—it
can be a positive-sum game, that is, if globalization is pursued well, everyone
should be better off. If not pursued well, it becomes a zero-sum or even a
negative-sum game. That may be one reason why to some people, globalization
means the dominance of the rest of the world by a few countries and powerful
?rms at the expense of local jobs and cultures. And to others, it means exploit-
ation of the poor in developing countries, the destruction of the environment,
and the violation of human rights. To advocates of globalization, however, it is
a powerful tool for reducing poverty as the world’s economies and societies get
more and more integrated. Each player has a better chance of creating or adding
value to something that someone somewhere in the world values. Each player
also has a better chance of ?nding something that he or she likes.
For a ?rm, globalization is about asking and answering questions such as:
what is the right product space and system of activities—what set of activities
meets the need for local responsiveness and exploits the bene?ts of global inte-
232 Opportunities and Threats
gration? How does a ?rm build the right resources/capabilities from the right
countries? How does a ?rm deal with each country’s macroenvironment, espe-
cially with the different governments? For an oil ?rm, for example, deciding
which country to explore for oil, working with government of?cials of the
country, investing in the oil ?elds, locating the right people and equipment,
?nding the oil, pumping it out, transporting it, dealing with governments of
importing countries, and re?ning and distributing the oil are all globalization
issues with which it has to deal.
The Multinational Corporation
A major player in globalization is the multinational corporation. A multi-
national corporation (MNC) is a ?rm that has market positions and/or
resources/capabilities in at least two countries. (From now on, we will use the
word “resources” when we really mean “resources/capabilities.” We will also
use “products” when we really mean “products and services.”) MNCs increas-
ingly depend on sales and resources from outside of their home countries. They
can be grouped as a function of where they choose to sell their products, and of
the resources that they need. This classi?cation is shown in Figure 9.5. In the
?gure, the vertical axis captures the effect of a ?rm’s market-position. In par-
ticular, it captures whether a ?rm’s products and services are sold domestically
only or in other countries as well. The horizontal axis captures the extent to
which the valuable resources/capabilities that a ?rm needs to make (conceive,
design, develop, and manufacture) the product are domestic only or are also
Figure 9.5 Types of Multinational.
Globalization and New Games 233
foreign. If the resources that a ?rm needs to make its products are all from its
home country and the ?rm sells all its products within its home country, we call
it a domestic corporation (Figure 9.5). Many small businesses fall into this
category. If a ?rm designs, develops, and produces its products at home, but
sells them in two or more countries, we say the ?rm is a position multinational
since it has product-market positions in countries other than its home country.
Japanese car companies in the 1960s and 1970s were largely position multi-
nationals. All their cars were designed, developed, and manufactured in Japan
and shipped to the US and other countries for sale. When a ?rm’s design,
development, and production of a product is done in many countries but the
product is sold in only one country, the ?rm is said to be a resource multi-
national since it depends on more than the home country for its capabilities.
Early in the life of US tire companies, they established rubber plantations in
different developing countries and shipped the rubber to the USA to be used to
make tires that were sold only to domestic car companies. If a ?rm sells its
products in two or more countries and the resources that it needs come from
two or more countries, the ?rm is classi?ed as a global multinational. Most of
today’s major companies fall into this category. Intel’s microprocessors are
sold all over the world and the company has design centers and microchip
fabrication and assembly plants in many countries.
Drivers of Globalization
What makes globalization more likely to take place than not? What drives
more cross-border utilization of labor and know-how, exchange of
knowledge, movement of capital, trade, human migration, and integration of
?nancial markets and other activities? Four factors in?uence the process of
globalization:
1 Technological innovation
2 Consumer tastes
3 Government policies
4 Firm strategies.
Technological Innovation
One of the largest drivers of globalization has been technological innovation.
First, technological innovation has made it possible to develop products that
more and more people all over the world like, thereby facilitating trade in these
products and the integration of the activities that underpin the products. For
example, the cell phone—a technological innovation that is itself a product of
many technological innovations—is a product that most people in the world
want. The microchips, LCD screen, battery and many components that go into
a cell phone are complex systems that require different skills and know-how
that many different countries possess. Designing, developing, marketing, sell-
ing, and delivering this global product requires the integration of ideas, skills,
products, and people from different countries. The same can be said of jet
engines, the Internet, jet planes, computers, drugs such as Viagra, Prozac, and
Lipitor, and so on.
234 Opportunities and Threats
Second, technological innovation has facilitated communications, capital
?ows, exchange of know-how, interaction between people and ?rms, and
reduced transportation time and costs. Because of the Internet, designers for a
major company in Japan can work on a design, hand it over to fellow designers
in Europe before leaving for the day. Before the engineers in Europe go home
for the day, they can also hand over the design to engineers in California, who
hand over to their Japanese counterparts before going home for the day. The
engineers in each of these countries can be of different nationalities who just
happen to want to live in the countries. Financial institutions use the Internet
and other communications and computer systems to route funds all over the
world. These funds can ?nance international projects from major chip fabrica-
tion plants in Silicon Valley or Asia to micro-projects in southern Africa. Avail-
ability of the Internet also means that people can compare prices of products
and labor from all over the world, often instantaneously. Worldwide telecom-
munications systems also mean that ?rms can advertise better and try to har-
monize consumer tastes. Lower communications and transportation costs
mean that consumers are more exposed to lower-cost products that they
may like.
Some of the ?rst innovations to have a huge impact on globalization were in
transportation. Motorized ships that ran across the Atlantic Ocean played a
major role in the transatlantic migration and trade that were critical to building
the American economy. Later, the jet airplane would change world travel not
only by transporting people worldwide but also by transporting important
business documents in much shorter times. More importantly, ocean trans-
portation has become so cost-effective that steel, as heavy as it is, can be made
in Korea and still be cost-competitive in California. Effectively, technological
progress moves the vertical line AB in Figure 9.5 leftwards, increasing the zone
in which global and resource multinational activities can take place. It also
moves the line CD downwards, thereby increasing the zone in which position
and global multinational activities can take place.
Consumer Tastes and Needs
Consumer tastes and needs have always been a major driver of globalization.
Europeans’ taste for spices, for example, was an important reason for their
trading with India and why Columbia ended up in the Americas. Diseases in
many countries can be cured by medications developed in others. Some of these
tastes or needs are dormant until awakened by ?rms through advertising or the
introduction of a new product. Very few people in the world knew that they
needed the Internet or cell phones until the products were introduced. Lower
communications and transportation costs often mean more availability of low-
cost products that can in?uence consumers’ taste. Consumers’ tastes can also be
in?uenced by the experiences that they had as a result of innovations in com-
munications and transportation that made it possible for them to travel to other
lands, or ?nd out about them via, for example, the Internet.
Globalization and New Games 235
Government Policies
Government policies play one of the most signi?cant roles of all the drivers of
globalization. Governments can use quotas, tariffs, taxes, subsidies, and import
duties to sti?e or greatly facilitate imports or production. In addition to having
an in?uence on what gets imported, governments can have great in?uence over
what is produced and exported. In some sectors such as healthcare, some gov-
ernments control prices, and what can or cannot be sold. Governments also
in?uence the other drivers of globalization such as technological innovations in
transportation and communications. A country can decide to enforce or not
enforce intellectual property protection laws. Governments control the ?ow of
currency and therefore investment capital. A country’s ability to protect foreign
investments from vandalism or nationalistic activities also plays a role in who
invests in the country.
Multinationals’ Strategies
Globalization is also driven by the extent to which ?rms want to take advantage
of the other drivers of globalization to create and appropriate value. For
example, if a ?rm’s strategy rests on extending its existing core competences to
many markets, using worldwide labor, taking advantage of economies of scale,
or learning from abroad, the ?rm may decide to push for globalization. As part
of its strategy, a ?rm may advertise to in?uence consumer tastes in different
countries, or work with policy makers in different countries to obtain legisla-
tion that favors globalization. Many multinational corporations have larger
budgets than most poor countries and can be very in?uential when it comes to
globalization legislation. They can also innovate to offer the kinds of product
that will help consumers discover their latent needs. They can not only in?uence
the ?ow of capital to their worldwide investment sites but also help bring down
trade barriers by in?uencing policy makers.
Why Firms Go International (Global)
The question is, why would any ?rm want to enter global markets or expand its
existing global activities rather than focus on its home market? Why would any
domestic company want to become a multinational? There are several reasons
for going global, or expanding globally:
•
Search for growth
•
Opportunity to stabilize earnings
•
High cost of production at home
•
Following a buyer
•
Offensive move
•
Opportunity to take advantage of scale economies
•
Easier regulations overseas
•
Larger market abroad
•
Chance to learn from abroad.
236 Opportunities and Threats
In Search of Growth
If a ?rm’s domestic market is stagnant, declining, too competitive, mature, or
not growing fast enough, the ?rm may see foreign markets as places where it
could ?nd the growth that it does not have at home. This is particularly true if
the ?rm’s market valuation has factored in growth, and capital markets expect
the ?rm to continue to grow at a rate that the home market cannot support.
One of many alternatives is for the ?rm to diversify into other markets within its
home country, unless there are other compelling reasons to go global.
Opportunity to Stabilize Earnings
Since a ?rm’s pro?ts often depend on domestic economic factors, its pro?ts are
likely to rise and fall with domestic economic cycles. By going international, a
?rm may be able to reduce this cyclicality if it can successfully enter a country
with the right cyclicality.
High Cost of Production at Home
One of the most common reasons for ?rms to go international is the high
domestic cost of factors of production. For example, the cost of labor for low-
tech manufacturing in many western countries and Japan has become so high
that many ?rms in the West move some of their manufacturing activities to
China, Taiwan, Korea or India.
Firm May Be Following Buyer
Very often, a ?rm goes international because its key buyer is going inter-
national. Some Japanese auto suppliers moved with the automobile makers
when the latter decided to start assembling cars in the USA. When McDonald’s
entered the Russian market, the J.R. Simplot Company went along to produce
potatoes for McDonald’s french fries.
Offensive Move
A ?rm can also start operating in a foreign country to preempt competitors that
it believes are likely to enter the foreign country. This is particularly true if there
are ?rst-mover advantages to be had in the foreign country.
Economies of Scale and Extension of Capabilities
When a ?rm offers a product with very high ?xed (upfront) costs and very little
or no variable costs, every unit sold after the breakeven volume is pro?t. Going
global increases a ?rm’s chances of selling even more units and making even
more money. This is particularly true for products such as software that do not
need major modi?cations to suit local tastes and therefore can be sold anywhere
in the world at little extra cost. This is also particularly true if the home market
is very small relative to the minimum ef?cient scale of the ?rm’s technology.
One reason why many Swiss ?rms such as Nestlé went international very early
Globalization and New Games 237
was because their home market was too small for the kinds of volume that they
needed in order to compete with foreign ?rms that had larger home markets.
Regulations Overseas May be Easier than at Home
It is not unusual for developing economies to have little or no regulations on
safety and environmental pollution, and no anticompetition laws. Some ?rms
may move to these countries to take advantage of these laws.
Larger Market and Free Market Principles
Some markets are simply larger and more free market than others. Thus, ?rms
may enter such markets to take advantage of the large size and free-market
atmosphere. The USA is one such country.
Learn from Abroad (Market Idea, Acquire New Skills, etc.)
Although it has traditionally been thought that knowledge ?ow is one way—
from the home country to the host country into which the ?rm is moving—there
is growing recognition that ?rms can also learn from their host countries and
take the knowledge home or to other markets.
Globalization for a Competitive Advantage
Suppose a ?rm wants to sell its products to a foreign country or take advantage
of the resources in the foreign country to produce new products. Is there any-
thing that it can do to increase its chances of having a competitive advantage as
a result of the move? A framework for exploring this question is shown in
Figure 9.6. As we saw in Chapter 1, a ?rm’s pro?tability in a market is a
function of its PMP and the resources that underpin the position. Recall that a
?rm’s product-market position consists of the bene?ts (low-cost or differenti-
ated products) that the ?rm offers and its position vis-à-vis coopetitors. To
occupy such a position and perform the relevant activities, a ?rm needs
resources. Thus, we can explore the pro?tability of a ?rm’s entry into a foreign
country as a function of its PMP in the new country and the resources that it
uses to create and/or appropriate value in the country (Figure 9.6).
Unique Product-Market Position (PMP)
The vertical axis captures the PMP that the ?rm occupies—whether the position
is unique (white space, sweet spot) or a battle?eld. Occupying a unique PMP
means that a ?rm (1) offers a product with bene?ts that no one else in the
market segment or country does, and/or (2) performs a distinctive system of
activities that underpins the bene?ts. The bene?ts can be product features, loca-
tion, lower cost, or better bang for the buck. The PMP can be unique because of
the perceived uniqueness of product features. It can also be unique because of
the location or region of the country that the ?rm serves. The unique position
can be in one country or in many countries. Since the bene?ts that the ?rm
offers its customers are unique, the effect of rivalry on the ?rm is low, the threat
238 Opportunities and Threats
of substitutes is low, and the ?rm has more power over buyers than it would
have if it were in a battle?eld. The fact that a ?rm moves into a unique position
does not tell us much about barriers to entry or its position vis-à-vis suppliers
but there are things that the ?rm can do to raise barriers to entry into its unique
space and increase its power over coopetitors. For example, it can pursue ?rst-
mover advantages such as building switching costs at customers. Building a
brand that is associated with the unique space can also raise barriers to entry.
A battle?eld is a product-market space that already has players. Such players
have usually been in the market long enough to have developed rivalries, under-
standings, cooperative relationships and other capabilities to create and
appropriate value in the market. Why would anyone enter a battle?eld?
Although battle?elds can be rife with competition, they have some advantages.
Technological and marketing uncertainties are usually reduced and a new
entrant with important complementary assets may be able to do well. A ?rm
may also enter because it has distinctive resources that it uses to give it an
advantage in the foreign country. Many ?rms do enter battle?elds. Some do so
because they believe that there is something distinctive about them that will
allow them to win when they come in. Others do so because of other strategic
reasons. In any case, a ?rm is usually better off pursuing a unique PMP.
Valuable Global Resources/Capabilities
The horizontal axis of Figure 9.6 captures the type of major global resources/
capabilities that a ?rm utilizes to conceive of, design, manufacture, market the
product, and position itself to make money—whether the resources are scarce
Figure 9.6 Different Global Strategies.
Globalization and New Games 239
and important, or easily available or unimportant. Resources are scarce and
important if they are dif?cult to imitate or substitute, and make a signi?cant
contribution towards value creation or appropriation. These resources can be in
a ?rm’s home country, in the foreign country that the ?rm is entering, or
worldwide. Examples of scarce and important resources include exclusive
rights to explore oil in oil-producing countries, relationships with government
of?cials in foreign countries, patents in pharmaceuticals, shelf space in of?ine
stores, some major brands, a large network in an industry that exhibits network
externalities, etc. Such resources therefore stand to give a ?rm a competitive
advantage. If the resources are important but easy to imitate, their owners
quickly lose any advantage that they may have had as competitors swoop in,
making it dif?cult to appropriate any value that a ?rm may have created using
the important resources. An example of resources that are important but easy to
imitate is low-tech manufacturing capabilities. They are important but because
they are usually easy to imitate and therefore easily available, we classify them
as “easily available or unimportant” in Figure 9.6.
Global Strategy Types
Depending on whether a ?rm decides to pursue a unique PMP or enter a battle-
?eld, has scarce dif?cult-to-imitate resources or can build them, a ?rm’s strategy
falls into one of the following four categories: global adventurer, global star,
global heavyweight, and global generic (Figure 9.6).
Global Adventurer
In a global adventurer strategy, a ?rm enters a country or countries by occupy-
ing a unique PMP, but the major resources/capabilities that it uses to create and
appropriate value are easily available or unimportant. The product that
embodies the unique value can target one country or many countries. The
product can be made in the foreign country or in the home country and
exported to the foreign country. Many exports that target an unmet need in a
country fall into this category. Japanese automobile makers were utilizing a
global adventurer strategy when they exported fuel-ef?cient dependable cars to
the USA during the 1970s when US automakers GM, Ford, American Motors,
and Chrysler focused on making larger and less fuel-ef?cient cars. All the major
resources for the cars were Japanese and although it may not feel that way
today, selling small Japanese cars in the USA in the late 1960s through the
1970s was an adventure.
A retailer that builds the ?rst retail store in a region of a foreign country is
pursuing an adventurer strategy. Whether the global adventurer strategy works
for a ?rm is a function of the drivers of globalization—a function of techno-
logical developments, consumer tastes, government policies, ?rm’s corporate
strategy, and the type of product in question. Take the example of Japanese cars
in the USA in the 1970s. Shipping technology had improved to a point where
cars could be shipped cost-ef?ciently from Japan to California, 5,500 miles
away. Because of the oil crises in the USA in the 1970s, some consumers were
interested in looking at fuel-ef?cient dependable cars. US government policies
were less protective at the time, compared to those of the governments of other
240 Opportunities and Threats
rich countries; that is, until the US government imposed a quota on Japanese
cars. There had also been attempts by Japan’s powerful Ministry of Inter-
national Trade and Industry (MITI) to prevent Honda from entering the car
production business at home. An important part of Honda’s strategy was to
expand abroad and the large US market, where it had been selling motorcycles,
presented some good opportunities. Its chances of growing pro?tably were bet-
ter in the USA than in Japan.
A unique PMP gives a global adventurer some opportunities to take advan-
tage of the new gameness of the position, including ?rst-mover advantages.
Honda went on to build a brand that associated the company with zippy
engines and dependable reliable low-cost cars. It then, together with Toyota and
Nissan, introduced luxury cars to compete with BMW, Mercedes, and other
luxury imports to the USA. Honda introduced the Acura, Nissan the In?niti,
and Toyota the Lexus.
The primary advantage to the global adventurer strategy is the fact that it
identi?es and focuses on a unique PMP with its associated bene?ts and short-
comings. There is one major drawback to the strategy. Since the resources that a
global adventurer uses are easily available or unimportant, the unique PMP can
be easily imitated unless the ?rm takes steps to build ?rst-mover advantages
that raise barriers to entry.
Global Star
In a global star strategy, a ?rm enters a country or countries by occupying a
unique product-market space, and the global resources/capabilities that it uses
to create and appropriate value are scarce and important. Thus, pursuing a star
strategy gives a ?rm both the advantages of having a unique PMP and scarce
important resources. Ikea’s strategy for entering the US market in the 2000s is
an example. It occupied a unique position, relative to its competitors (fun shop-
ping experience, low-cost but fashionable furniture, no delivery, little in-store
service, and furniture that was not guaranteed to last forever), and had a scarce
and important worldwide network of experienced designers, and an ability to
coordinate and integrate the activities of its suppliers of materials and manu-
facturers worldwide.
10
Strategies for both the Airbus A380 and the Boeing 787
also fall into this category. Each occupies a unique spot on the PMP maps for
airplanes and the resources needed to offer the plans are scarce and important.
Often, one of the important capabilities of a global star is its ability to coordin-
ate and integrate resources and know-how from different countries and differ-
ing cultures. Making both the A380 and Boeing 787 required coordination of
many different resources and capabilities from different countries. This
coordination and integration is facilitated by technological innovation.
Global Heavyweight
In a global heavyweight strategy, a ?rm enters a country or countries by con-
fronting existing competitors, but has scarce and important resources/capabil-
ities that it uses to create and appropriate value. The resources can be from one
country or many countries. Such a ?rm is effectively in a battle?eld where it
confronts existing industry ?rms in creating and appropriating value, using its
Globalization and New Games 241
scarce resources. When an oil company goes into a country where other com-
panies are already exploiting for oil and obtains exploration rights to ?nd and
sell oil to the world, it is employing a global heavyweight strategy. Airbus
pursued a global heavyweight strategy when it introduced its A320 airplanes.
The plane was designed to compete directly with the Boeing 737 and the
McDonnell Douglas DC 9 and MD-80. While some of the technological know-
how to build the plane may have been easily available, the A320 ?y-by-wire
technology was the ?rst in the category of planes. Moreover, coordinating
the activities of the makers of major airplane components from French,
German, and British companies was no easy task. Many of the ideas utilized in
McDonald’s restaurants in each European country came not only from the
country and the USA, but also from other European countries.
11
Global Generic
In a global generic strategy, a ?rm enters a country or countries by confronting
existing competitors, and the major resources/capabilities that it uses are easily
available or unimportant. Firms that produce commodity products in low-cost
labor nations and export them to other countries to compete with other com-
modity products from other countries are pursuing this strategy. Many produ-
cers of generic drugs for export usually have generic strategies; so do makers of
textiles. Many products are usually introduced to a foreign country through
exports that were designed, developed, and produced at the home country and
exported to the foreign country. As the product gains acceptance, local
resources are built to respond better to local differences.
Using New Games to Gain a Competitive Advantage
If a ?rm’s chances of having a sustainable competitive advantage are best when
it pursues a global star strategy rather than the other three strategies, why can’t
all ?rms pursue the same global star strategy? One reason is that not every ?rm
has the two drivers of success in pursuing each of these strategies: (1) the ?rm’s
strengths and handicaps in the face of the new game, (2) its ability to take
advantage of the characteristics of new games to create and appropriate value.
Strengths and Handicaps
Recall from Chapter 5 that when a ?rm faces a new game, it usually has prenew
game strengths that can continue to be strengths in the face of the new game or
become handicaps. For a domestic company that is going multinational by
offering the same products that it offered at home to other countries, two
obvious strengths are the ?rm’s domestic PMP and resources. If a ?rm offers a
low-cost product domestically, it can usually take the resources that enabled it
to produce the low-cost products to the foreign country or sell a version of the
low cost product in the foreign country. Effectively, if a ?rm’s domestic
resources are scarce and important in the foreign market, they can become the
bases for the ?rm to pursue a global star or heavyweight strategy. If the
domestic PMP is the basis for occupying a unique market segment or position in
the foreign country, the ?rm can pursue a global adventurer or star strategy.
242 Opportunities and Threats
When Toyota and Honda decided to enter the US automobile market, they used
both their domestic resources and products to enter. When McDonald’s entered
foreign countries, many potential customers in the foreign countries had
already visited the ?rm’s stores in the USA or were Americans visiting the
foreign country or moving there to work. Intel’s domestic capabilities in micro-
processors and worldwide acceptance of its PC enabled it to establish chip
design centers, fabrication and assembly in countries outside the USA to make
and sell its products to anyone anywhere in the world. Effectively, if a domestic
company has distinctive domestic products and resources, it can build on them
to become a multinational.
A ?rm’s strengths at home can also turn out to be handicaps in foreign
countries. McDonald’s all-American image, which is a strength in the USA, did
not play well at ?rst in France.
12
Ability to Take Advantage of New Game Characteristics
The extent to which a ?rm can gain a competitive advantage in going inter-
national is also a function of the extent to which it takes advantage of the new
game characteristics of going international. Recall that new games present a
?rm with an opportunity to:
•
Take advantage of the new ways of creating and capturing new value gener-
ated by the new game.
•
Take advantage of opportunities generated by the new game to build new
resources or translate existing ones in new ways.
•
Take advantage of ?rst-mover’s advantages and disadvantages, and com-
petitors’ handicaps that result from the new game.
•
Anticipate and respond to coopetitors’ reactions to its actions.
•
Identify and take advantage of opportunities and threats from the
macroenvironment.
Take Advantage of the New Ways of Creating and Capturing New
Value
When a ?rm decides to go international, it has to locate customers, offer them
bene?ts, and position itself to appropriate the value so created. In doing so, it
has the option to occupy a unique product-market space or challenge existing
competitors in the country. As we saw above, a unique PMP has the advantage
that it is, on average, more attractive than a battle?eld—the competitive forces
in a unique position are more friendly compared to those in a battle?eld with
seasoned competitors. However, a ?rm with distinctive domestic resources that
can be transferred to the foreign country to address the needs of customers in
the battle?eld may be able to enter the battle?eld and do well. For example, up
to the late 1980s, the US luxury car market had been dominated by BMW,
Mercedes, Audi, and Cadillac. Toyota, Nissan, and Honda challenged these
incumbents using capabilities that they had built serving the low-end market.
Toyota introduced its Lexus line of products in 1989 and using its design,
lean manufacturing know-how, relationships with suppliers, and marketing,
it won many awards. A ?rm may also choose to enter a battle?eld by using
Globalization and New Games 243
technological innovations that render existing products in the market noncom-
petitive, or render existing resources obsolete. For example, cell phone technol-
ogy allowed many ?rms all over the world to compete successfully head-on with
incumbent ?xed-line telephone companies and win.
Take Advantage of Opportunities to Build New Resources or Translate
Existing Ones in New Ways
Different countries are endowed with different resources or levels of resources.
Some countries have oil, others have gold, some have low-cost labor, others
high-tech know-how, and so on. The level of the resource varies from one
country to the other. For example, the level of high-tech know-how varies even
within the group of so-called high-tech countries. Thus, when a ?rm goes inter-
national, it has an opportunity to acquire new resources in the foreign country
or bring in resources from its home country. Sometimes, these new resources
are distinctive, and a ?rm can use them to produce and market its products in
many countries. For example, oil companies can acquire the rights to explore
for oil in different oil?elds in different countries. If they are successful, these oil
companies own the wells (often in partnership with local governments) and can
re?ne, distribute, and sell the oil from the wells in any country. In going inter-
national, a ?rm can also build strong relationships with government of?cials to
in?uence legislation and public opinion about its products or presence in the
country.
When a ?rm goes international, it can also use some of its domestic resources
to create and appropriate value in the foreign country. Such a ?rm is effectively
translating its resources in new ways.
Take Advantage of First-mover’s Advantages and Disadvantages, and
Competitors’ Handicaps that Result from New Game
If a ?rm is the ?rst to offer a particular product in a country, it has the
opportunity to build and take advantage of ?rst-mover advantages. Such ?rst-
mover advantages are particularly important when a ?nite resource is involved.
For example, if a ?rm is the ?rst to go to a foreign country and discover oil or
any other precious material, it has the opportunity preemptively to secure rights
to the oil well and exploration rights to nearby properties. Such ?elds are usu-
ally limited and once they have been taken, there may be few or none left. The
?rm also has an opportunity to form partnerships with government-owned
companies such as the “national oil companies” of oil-exporting countries.
Moreover, a ?rm that discovers minerals in a country ?rst and forms partner-
ships with the government is ahead of the learning curve for exploration in the
particular geology and in working with local of?cials. The ?rm also has an
opportunity to shape regulation, and even the educational system as far as the
particular industry is concerned.
In industries where network effects are important, a ?rst mover into a coun-
try has an opportunity to build a large network with the right properties, and
use the network to its advantage. In online auctions, for example, the more
people that belong to an online auction community such as eBay’s, the more
valuable it is to each member and the more that new potential members are
244 Opportunities and Threats
likely to gravitate towards the community. In the countries where eBay was the
?rst to establish an online auction community, it did very well. In the one
country where it was not the ?rst—Japan—it did not do as well. Yahoo was the
?rst to move to Japan in the auctions category and did very well.
In retail, for example, when a ?rm is the ?rst to enter a country or region,
it has an opportunity preemptively to take up the good retail locations. If the
?rst mover builds the right number of stores and provides the right service,
rational potential second movers would think twice before trying to build in
these locations, if to do so would result in price wars and unhealthy rivalry. In
some cases, the opposite may happen. Burger King usually locates near
McDonalds.
Finally, if a ?rm moves into a country ?rst, it has an opportunity to hire the
best employees ?rst and work with them to build the type of culture that will
keep them at the ?rm, depriving followers of one of the cornerstones of the
success of any company.
Anticipate and Respond to Coopetitors’ Reactions to its Actions
In going international, it is also important for a ?rm to anticipate the likely
reaction of competitors. If the ?rm chooses to enter a unique PMP, it is import-
ant to think of what competitors are likely to do when they ?nd out that the
?rm is making money in the unique space. If competing oil companies ?nd out
that an oil company has found oil somewhere, they are likely to want to come
in. Anticipation of such reactions by competitors is one reason why a ?rm may
want to intensify its efforts to build and take advantage of ?rst-mover advan-
tages since they increase barriers to entry. McDonalds should know that Burger
King will be coming and should prepare accordingly.
If a ?rm chooses to enter a battle?eld, incumbents in the ?eld will either ?ght
the entry, forget about it, or cooperate. If the ?rm believes that incumbents will
?ght its entry, it can pursue one of several options. First, it can enter and ?ght if
it has the scarce resources that will give it an advantage over incumbents. It can
also enter and ?ght if it is using a disruptive technology or any other innovation
that stands to render incumbents’ existing products noncompetitive or their
resources obsolete. Second, the ?rm can decide to move into a unique space
rather than take on the ?ght. If the ?rm believes that incumbents will leave it
alone when it enters, it may want to enter but only after assuring itself that the
market will be large enough to support its entry and that incumbents might not
change their minds and become hostile. If incumbents want to cooperate, the
?rm may want to enter. The question is, why would incumbents want to
cooperate? They may be forced by government regulations to allow entry. In
that case, the ?rm can enter but understand that the competitive forces from
rivalry, potential new entry, etc. may still be higher than being in a unique
product space. Firms in a market may also welcome entry if they are forced by a
powerful buyer to have second sources.
Globalization and New Games 245
Identify and Take Advantage of Opportunities and Threats of
MacroEnvironment
When going international, a ?rm is moving from one country’s political, eco-
nomic, social, and technological system to another. Differences between home
country macroenvironment and foreign macroenvironments can be consider-
able. In some countries, governments can shut down businesses or nationalize
them for no good reason and the businesses have no legal recourse, while in
other countries government actions against businesses have to have a legal basis
and the ?rms have the right to challenge the government in a fair court system.
In some countries, copyrights, patents, trademarks, and other intellectual
property are respected and their protection monitored and enforced by the
government. In other countries there is very little or no intellectual property
protection. In some countries, governments have extra entry and exit barriers
beyond those dictated by the type of industry. In many countries, governments
play some role in the merger and acquisition of ?rms but in others, some gov-
ernments may take a more nationalistic than economic approach.
13
Some
governments pay attention to the natural environment and corporate social
responsibility while others do not. The list of differences goes on and on. In any
case, a ?rm that is going international may want to pay attention to the polit-
ical, economic, social, and technological environment of the foreign country
into which it is moving for any opportunities and threats of which it may want
to take advantage. For example, if a ?rm depends on its intellectual property
protection to give it a sustainable competitive advantage at home where viola-
tion of such protections are prosecuted, the ?rm may have to ?nd another
cornerstone for its competitive advantage or lobby the foreign government for
changes in its laws. The other side of the coin is that a ?rm that always wanted
to enter an industry but could not because of intellectual property protection at
home can move to a country where such protections are less restrictive.
Some generic manufacturers of pharmaceuticals locate where patent protection
for some drugs is, for national security and other reasons, not as strong as in
the USA.
Privatization and deregulation in foreign countries, and technological change
in general often pose opportunities and threats for a ?rm that is going inter-
national. In privatization, businesses that were owned by a government are sold
to the private sector (individuals or businesses). Privatization presents an
opportunity for a ?rm to enter a country and take over existing assets and
products. Because government-owned businesses are often state monopolies,
buying them gives a ?rm a chance to operate as a near monopoly or as part of a
duopoly. The disadvantage is that the culture at government-owned ?rms may
not be conducive to competing for pro?ts, and changing such a culture can be
very dif?cult. In deregulation, governments simplify, reduce, or eliminate
restrictions on the way ?rms conduct business to increase ef?ciency and to
lower prices for consumers. The easing or elimination of restrictions can create
an opportunity for a ?rm to move into the deregulating country in a pro?table
way. For example, as we saw in Chapter 2, Ryanair took advantage of Euro-
pean Union deregulation of the airline industry in the Union to build a
pro?table business. Technological innovation also presents opportunities for
?rms that are going international. The case of cell phones in countries where
246 Opportunities and Threats
?xed-line telephones, run by government monopolies, had failed illustrates how
the combination of privatization, deregulation, and technological innovation
can make a big difference in a foreign country. For example, in Nigeria, Gabon,
Kenya, and Cameroon where governments deregulated and privatized tele-
coms, foreign companies entered with cell phone businesses in each country and
did very well.
Key Takeaways
•
At the international level, governments can capture a lot of the value that
?rms create.
•
Actors (?rms and governments) can be classi?ed as a function of whether
they create the value that they capture: bees create lots of value but others
capture most of what they create. Beavers create lots of value and capture
most of it. Foxes create little or no value but capture a lot of the value
created by others. Bears create little value and capture little too.
•
Government-imposed taxes and subsidies can result in value destruction.
•
Globalization is the interdependence and integration of people, ?rms, and
governments to produce and exchange products and services.
•
A key character in globalization is the MNC. This is a ?rm that has estab-
lished PMPs and/or resources/capabilities in at least two countries. A ?rm is
a position multinational if it designs, develops, and produces its products at
home, but sells them in two or more countries. If a ?rm’s design, develop-
ment, and production of a product is done in many countries but the prod-
uct is sold in only one country, the ?rm is said to be a resource multi-
national. If a ?rm has market positions in two or more companies and the
resources that it needs come from two or more countries, the ?rm is
classi?ed as a global multinational.
•
The extent to which globalization takes place in an industry is a function of:

Technological innovation

Consumer tastes and needs

Government policies

Multinationals’ strategies.
•
Some reasons for ?rms going global or expanding globally include:

The search for growth

Opportunity to stabilize earnings

High cost of production at home

Following a buyer

Offensive move

Opportunity to take advantage of scale economies

Easier regulations overseas

Larger market abroad

Chance to learn from abroad.
•
In using new games to go international, a ?rm can locate in a unique
product-market space where it offers unique value to customers and has few
competitors, or can enter a battle?eld where there are already competitors.
The resources that a ?rm uses to create and appropriate value in a unique
Globalization and New Games 247
product space or battle?eld can be either scarce and important resources, or
easily available or unimportant. In going international, four strategies are
possible:

In a global adventurer strategy, a ?rm enters a country or countries by
occupying a unique product-market space, but the major resources/cap-
abilities that it uses to create and appropriate value are easily available
or unimportant.

In a global star strategy, a ?rm enters a country or countries by occupy-
ing a unique product-market space, and the global resources/capabil-
ities that it uses to create and appropriate value are scarce and
important.

In a global heavyweight strategy, a ?rm enters a country or countries by
confronting existing competitors, but has scarce and important
resources/ capabilities that it uses to create and appropriate value.

In a global generic strategy, a ?rm enters a country or countries by
confronting existing competitors, and the major resources/capabilities
that it uses are easily available or unimportant.
•
If a ?rm’s chances of having a sustainable competitive advantage are best
when it pursues a global star strategy rather than the other three strategies,
why can’t all ?rms pursue the same global star strategy? One reason is that
not every ?rm has the two drivers of success in pursuing these new game
strategies:
1 A ?rm may not have the right strengths and handicaps—from its exist-
ing PMP and resources/capabilities—in the face of the new game.
2 A ?rm may not have the ability to take advantage of the characteristics
of new games to create and appropriate value. It may not be able to:

Take advantage of the new ways of creating and capturing new
value generated by the new game.

Take advantage of opportunities generated by the new game to
build new resources or translate existing ones in new ways.

Take advantage of ?rst-mover’s advantages and disadvantages, and
competitors’ handicaps that result from the new game.

Anticipate and respond to coopetitors’ reactions to its actions.

Identify and take advantage of opportunities and threats from the
macroenvironment.
Key Terms
Bears
Beavers
Bees
Drivers of globalization
Foxes
Global adventurer
Global generic
Global heavyweight
Global multinational
248 Opportunities and Threats
Global star
Multinational
Position multinational
Resource multinational
Appendix: Value Appropriation of Oil by the UK
Suppose you did not have the OECD data and wanted to calculate how much
the UK appropriated from each liter of gasoline bought there. The UK had a
value added tax (VAT) of 17.5% on all imported oil. It also had a tax (duty) of
47.1 pence (US$0.942) per liter of gasoline (petrol) that went in force in Octo-
ber 2003 and was expected to go up.
14
In June 2007, the price of a liter of
gasoline in the UK averaged 96.38 pence (US$1.9276).
15
A 2006 US Depart-
ment of Energy report had shown that distribution and marketing accounted
for 9% of the $2.27/gallon gasoline in the USA in 2005, state and federal taxes
for 19%, crude oil for 53%, while re?ning costs and pro?ts accounted for
19%.
16
(Additional data: in June 2007, the British pound was worth $2 and there are
0.2642 US gallons to the liter. There are 158.97 liters to the barrel or 42 US
gallons to the barrel.)
Question
How much of the value in a liter of petrol (gasoline) sold in the UK was cap-
tured (1) by the UK Government, (2) by the oil companies.
Solution
An oil value chain consists of four major stages: exploration (and associated
?nding costs), extraction and shipping (and associated lifting costs, production
taxes, and transportation costs), re?ning (re?ning costs), and marketing and
distribution (marketing and distribution costs, taxes).
For simplicity, we perform all the calculations in US dollars.
In 2007 customers in the UK paid $1.9276 for a liter of gasoline. The UK
government’s share of the $1.9276 per liter was:
1 US$0.942 duty tax (from UK tax of 47.1 pence per liter ($0.942 per liter,
since £1 = $2)).
2 $0.287089 VAT (from 1.9276 ? (1.9276/1.175)). This re?ects the fact that
the $1.9276 price of a gallon is 117.5%, not 100%, since VAT is 17.5%.
3 Therefore, for each US$1.9276 liter of gasoline sold in the UK in 2007, the
UK government appropriated 0.942 + 0.287089 = $1.229089.
4 Percentage of value appropriated by UK government = (1.229089/1.9276)
= 63.76%.
The remaining $0.698511 per liter ($1.9276 ? $1.229089) or 36% has to be
shared by (a) the oil companies that explore for crude oil, drill, pump and
transport it to re?neries (b) the re?ners (often oil companies) where it is re?ned,
marketed, and transported to gas stations for sale to customers, and the gas
Globalization and New Games 249
station’s take, and (c) the exporting country. Since there is no UK data on what
fraction of the remaining 36% (after UK Taxes) goes for crude, re?ning, export-
ing country taxes, etc., we will use the US fractions. From the 2006 US data
provided, distribution and marketing accounted for 9% of the cost of gasoline,
state and federal taxes for 19%, crude oil for 53%, while re?ning costs and
pro?ts accounted for 19%. What we need here to help us with our estimates for
the UK, are the ratios of distribution and marketing crude oil, and re?ning costs
and pro?ts without US state and federal taxes. Without taxes, these three are
81% of the cost of gasoline. There:
1 Distribution and marketing represent 11.11% (0.09/0.81).
2 Crude oil represents 65.43% (0.53/0.81).
3 Re?ning costs and pro?ts represents 23.46% (0.19/0.81).
Recall that $0.698511 per liter ($1.9276 ? $1.229089) or 36% represents dis-
tribution and marketing (including gas station costs and pro?ts), crude oil costs,
and re?ning and pro?ts. Of the $0.698511 per liter,
a Distribution and marketing = $0.0776 ($0.698511 × 0.1111) which is
4.03% of the $1.9276 per liter cost (0.0776/1.9276).
b Crude oil = $0.4571 ($0.698511 × 0.6543) which is 23.71% of the $1.9276
per liter cost (0.4571/1.9276).
c Re?ning costs and pro?ts = $0.1638 ($0.698511 × 0.2346) which is 8.50%
of the $1.9276 per liter cost (0.1638/1.9276).
In other words, of the $1.9276 that customers in the UK paid for a liter of
gasoline in 2007, the government appropriated $1.229089 (63.76%), distribu-
tion and marketing captured $0.0776 (4.03%), crude oil took $0.4571
(23.71%), and re?ning and pro?ts were $0.1638 (8.50%).
Now that we know what fraction of the $1.9276 per liter goes to crude
production and transportation, we can determine the exporting country’s
share.
Per barrel calculations:
Cost of oil extraction = $19.83 ($15.25 ?nding costs + $3.57 lifting costs +
$1.00 production taxes) per barrel = ($19.83/158.97) per liter = $0.1247
per liter.
The amount left for oil companies for their pro?ts, other costs, and royalties for
the UK government is $0.4571 ? $0.1247 = $0.3323 per liter. These numbers
are summarized in Table 9.5.
250 Opportunities and Threats
Table 9.5 What Each Player Appropriates
Player(s) Amount
appropriated per
liter ($)
Percentage
appropriated
Comment
The UK Government (Duty and VAT) 1.229089 63.76
Distribution and marketing 0.077600 4.03
Refining and profits 0.163800 8.50
Crude oil
Finding costs, lifting costs, and production taxes 0.124700 6.47
Oil company profits, UK royalties, other costs 0.332400 17.24 $0.4571
(23.71%)
Total (per liter UK price) 1.927600 100.00
Globalization and New Games 251
New Game Environments and the
Role of Governments
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Understand how macroenvironments can be the source of opportunities
and threats for new games.
•
Understand what makes some environments more conducive to innovation
and wealth creation than others.
•
Understand why governments have a role to play in business and what that
role is.
•
Appreciate the role that governments must play in creating new-game
friendly environments.
Introduction
Firms and the industries in which they create and appropriate value do not
function in a vacuum. They are in?uenced by their macroenvironments—the
technological, political-legal, demographic, sociocultural, economic, and nat-
ural environments (PESTN) in which ?rms and industries operate (Figure 10.1).
Macroenvironments are often the source of opportunities and threats to ?rms
and their industries. For example, regulation and deregulation both increase or
decrease barriers to entry and therefore in?uence industry dynamics and
opportunities to make money. Witness deregulation of the airline industry in
the European Union which gave rise to many low-cost startup airlines. Also
witness the deregulation and privatization of phone services in developing
countries such as Cameroon and Kenya that have allowed wireless phone ser-
vice businesses to thrive in these countries. National and international eco-
nomic factors such as interest rates, exchange rates, employment, income, and
productivity also impact industry competitiveness and therefore the types of
new game activities that can be performed. For example, income growth may
increase some customers’ willingness to pay for certain products, making these
customers more precious to ?rms that are able to offer them the type of value
that they want. As globalization increases, the opportunities to pursue new
game strategies and the threat to existing business models increase. In this chap-
ter, we explore the role of macroenvironments as sources of opportunity and
threats for new games, and examine the role that governments can play to help
?rms create and appropriate value. We start the chapter with a description of
macroenvironments and their role as a source of opportunities and threats to
Chapter 10
new games. We then explore those characteristics of some environments that
make them more conducive to innovation than others. Next, we explore the
rationale for why governments have a role to play, and examine what that role
is in the face of new games.
Macroenvironments as Sources of Opportunity and
Threat
The macroenvironment—made up of the technological, political-legal, socio-
demographic, economic, and natural environments—is a source of opportun-
ities and threats that ?rms can exploit using new game activities.
Technological Environment
Some of the best opportunities to perform new game activities have been
driven by technological change. The change from mainframe computers to per-
sonal computers gave many ?rms the opportunity to overturn the way value
had been created and appropriated in the computer industry. For example,
startup software developers such as Microsoft pursued new business models in
which they focused on software alone rather than software and hardware, as
had been the practice in the computer industry. Hardware and software makers
also sold their products rather than lease them as had been practiced by many
?rms. The discovery of DNA laid the foundation for the creation of many
biotech ?rms and is fundamentally changing many activities, from the way
pharmaceutical ?rms pursue cures for different ailments to how crimes are
Figure 10.1 The Macroenvironment.
New Game Environments and the Role of Governments 253
solved. The invention of the Internet spurred the creation of many ?rms,
changed the way many so-called of?ine ?rms perform their activities, and had a
big in?uence on the lifestyles of many consumers.
The invention of railways, steamships, airplanes, steel, cement, transistors,
microchips, alternating current, and numerous other inventions also presented
opportunities for new ?rms to be created and for new ways of creating and
appropriating value. At the same time, however, these opportunities were
threats to existing technologies and the incumbent ?rms whose competitive
advantages were rooted in the older technologies. Railroads were a threat to the
horse-driven carts, the transistor was a threat to the vacuum tube and associ-
ated businesses, the Internet is a threat to some bricks-and-mortar businesses,
and so on. In many cases, the technological change was at the periphery of value
creation but played a role in positioning a ?rm. For example, one reason for the
success of Dell’s build-to-order business model was the Internet.
Political-legal Environment
The political-legal environment includes antitrust regulation, tax laws, foreign
trade regulation, and employee protection laws. The political-legal environ-
ment can have tremendous in?uence on the way new value is created. Consider
the case of the Bayh–Dole Act in the USA. Before 1980, the intellectual property
rights to any discoveries or inventions that universities and other nonpro?t
organizations made while performing federally-sponsored research belonged to
the US Federal government. The government effectively appropriated most of
the value created. On December 12, 1980, the Bayh–Dole Act or Patent and
Trademark Law Amendments Act, sponsored by Senators Birch Bayh of Indi-
ana and Robert Dole of Kansas was passed.
1
Among other things, the Bayh–
Dole act, which was amended in 1984 and 1986, gave US small businesses,
universities, and nonpro?t organizations intellectual property rights to any
discoveries and inventions made using federal funds. The idea was to give aca-
demic researchers an incentive to commercialize and pro?t from their inven-
tions and discoveries. The Act effectively transferred ownership of discoveries
and inventions from the government that sponsored them to the ?rms that
performed the R&D. It also insured that individual researchers who did the
work bene?ted. Prior to Bayh–Dole, only about 5% of the patents accumulated
to the government were commercialized. In December 2005, over 4,500 ?rms,
with roots at universities and other nonpro?t organizations, had been founded
based on patents generated as a result of Bayh–Dole.
2
In 2004 alone, American
universities and institutes received $1.39 billion in licensing-fee revenues. They
also applied for over 10,000 new patents. Other developed countries, including
Germany and Japan, adopted similar acts. This apparent success has had some
costs to universities and the spread of knowledge. Many academics now hesi-
tate to reveal all the results of their research while others have been accused of
paying too much attention to commercial ends rather than the knowledge for
knowledge’s own sake that universities are supposed to be all about. Given how
much money some universities now make from their research, there now are
some questions as to whether such universities should still hold onto their non-
commercial research tax exemption status.
254 Opportunities and Threats
Economic Environment
Economic variables such as aggregate demand and supply for key commodities
such as oil, currency movements, stock market performance, disposable
incomes, interest rates, money supply, in?ation, and unemployment can also
represent opportunities and threats for ?rms. For example, when housing
values in a country appreciate, as was the case in the early 2000s in the USA and
Europe, house owners feel richer and spend more. An appreciation in the value
of shareholders’ stocks also makes them feel richer and increases their willing-
ness to pay.
3
One estimate is that an increase in housing values of $100 can
increase spending by as much as $9 while an increase of $100 in stock market
values increases spending by $4.
4
Increased stock market or housing wealth can
also mean more money for ?nancing new ventures. Of course, a burst in a
bubble spells trouble; that is, decreases in housing values are also likely to
decrease spending.
The petroleum crisis of the 1970s resulted in more demand for vehicles with
higher gas mileage than US automakers could build. This opened up an
opportunity for Japanese carmakers with more fuel-ef?cient cars than their
American competitors to gain market share. Sometimes, the opportunity is cre-
ated by an innovation that takes advantage of existing macroeconomic condi-
tions. For example, Professor C.K. Prahalad of the University of Michigan has
argued that although billions of people in the world earn very little money, they
constitute a large market that can be tapped through innovation of new prod-
ucts that can meet the needs of this group of innovations in how to get the
products to them.
Sociocultural and Demographic Environments
Demographic variables include shifts in populations, age distributions, ethnic
mixes, educational levels, lifestyle changes, consumer activism, birthrates, life
expectancies, and household patterns in cities, regions, and countries. A change
in any of these variables can be an opportunity or threat to performing new
game activities. For example, as many people who started using the Internet as
children grow older, ?rms will have to deal with many consumers who do not
think much about shopping online or telecommuting.
Sociocultural variables include the beliefs, norms, and values of consumers,
countries, communities, or employees. Because beliefs, norms, and values are
dif?cult to detect, opportunities and threats that come from changes in socio-
cultural variables are usually some of the most dif?cult to detect.
Natural Environment
The natural environment consists of the air that we breathe, the water that
sustains all life, climate, landscapes, grasslands, forests, wildlife, animals,
oceans, mineral resources, and any other living or nonliving things that occur
naturally on earth and its surroundings. When ?rms perform business activities,
the activities often have an impact on the natural environment. For example,
some activities result in the pollution of air, water, or soil. Such pollution can
have major effects on climate, other resources, and ultimately the quality of life
New Game Environments and the Role of Governments 255
or survival of living things. Other activities use up nonrenewable or scarce
resources. Consequently, businesses often face pressure from environmentalist
groups or laws from governments to limit the adverse effects that business
activities have on the environment. Moreover, the natural environment should
have an effect on how ?rms conduct business. While some ?rms might view, for
example, pressure to reduce pollution as a threat, others might see it as an
opportunity to use new game activities to offer products whose development,
production, and use pollute less than existing ones.
Conducive Environments to Value Creation and
Appropriation
In playing its role to improve the ability of its ?rms to create and appropriate
value, it would be nice if governments knew what makes some environments
more conducive to creating wealth from new games than others. That way,
these governments could tailor their activities towards building such environ-
ments. In the 1990s and 2000s, many countries poured billions of dollars into
so-called high technology clusters, trying to replicate the success of the USA’s
Silicon Valley. In 2005, for example, the French government planned to pour
500 million per year, from 2006 to 2008, into its sixteen clusters, from aero-
space to biotechnology, collectively called the poles de compétitivité.
5
Most of
the 500 million was spent on industry R&D. By the late 2000s, however,
many countries were ?nding out that although they invested a lot in these
clusters and produced lots of patents and academic papers, they were not creat-
ing as much wealth as the Silicon Valley.
6
They had no Intels, Apples, Genen-
techs, Ciscos, Yahoos, Googles, eBays, etc. etc. to show for their efforts. As we
argued in Chapters 4 and 5, when a cluster invents or discovers something, the
invention or discovery is only the ?rst step in creating and appropriating value.
The invention or discovery still has to be converted into something that cus-
tomers perceive as valuable to them, and the inventor or followers (from the
cluster) must also be positioned to appropriate the value. Clusters also need
complementary assets and good business models to create wealth for cluster
members; otherwise, their inventions would be appropriated by ?rms from
other countries that have the right complementary assets and business models.
In general, environments that are conducive not only to invention but also to
the right business models, and have the right complementary assets possess the
following attributes (Figure 10.2):
1 High ?nancial rewards for successful new games.
2 Financial support for entrepreneurial activities.
3 A culture that tolerates failure.
4 The right coopetitors.
5 A procreative destruction environment.
High Financial Rewards For Successful New Games
New game activities are risky and therefore the payoff for investing in them has
to be high for ?rms to invest. For most ?rms, this payoff is ?nancial. Yes, there
are some individuals and organizations that pursue new game activities for
256 Opportunities and Threats
socially responsible non?nancial reasons; but most players prefer to make
money, even if in the end, they give the money that they earned to charities.
Thus, an environment with good ?nancial payoffs for new games is more likely
to attract investors than one without. In the USA, the rewards for successful
new game activities can be astronomical. A look at the Forbes list of 500 bil-
lionaires shows that by far the largest number of self-made billionaires is in the
USA. In fact, there are more such billionaires in the USA than in all the other
countries of the world combined. These payoffs come in different forms. First,
there is the initial public offering (IPO) in which ?rms offer some of their shares
to the public for the ?rst time. The founders of Google, for example, were
billionaires a few days after the company went public. A ?rm can also push up
its net worth by spinning out an entrepreneurial unit and issuing an IPO for the
unit. Expectation of such rewards can be a very good incentive for the kind of
effort and dedication that it takes to pursue many innovations. Dr James H.
Clark, founder of Silicon Graphics Inc (SGI) and Netscape, put it best, “With-
out IPOs, you would not have any startups. IPOs supply the fuel that makes
these dreams go. Without it, you die.”
7
Second, the rewards can also come when
a venture is bought, usually by a more established ?rm with complementary
assets. Such an acquisition can give the investors cash, shares in the established
?rm, or high-level positions in the established ?rm. In fact, many venture capit-
alists invest in startups largely because they expect to cash out at the IPO or
when a more established company buys the venture.
Financial Support for Entrepreneurial Activities
Availability of venture capital is critical to engaging in new game activities,
especially entrepreneurial ones. By making money available for projects that
would normally be considered too risky by incumbent ?rms, venture capitalists
enable entrepreneurs to be more daring in their pursuit of new games. Some
entrepreneurs use personal or family savings, or loans from friends to ?nance
Figure 10.2 Determinants of Environments that are Conducive to Profitable New Games.
New Game Environments and the Role of Governments 257
their ventures, in anticipation of the potential high ?nancial rewards. Anticipa-
tion of such rewards, coupled with readily available venture capital, allows
more people to search for more ideas in more places with more combined
determination. Many of those whose ventures are successful usually reinvest
their earnings in new ventures. Clark reinvested some of the money that he had
made at SGI in Netscape. Kleiner and Perkins reinvested some of what they
made in Genentech and Tadem Computers into later ventures such as AOL,
Amazon.com, Netscape, and Google.
As we saw earlier, there may be times when a government is better off spon-
soring R&D activities. For example, if a project is too complex and entails too
much uncertainty, and the output is knowledge with public properties, ?rms are
likely to shy away from investing in the project and government is better off
investing in it. Thus, countries in which governments invest in R&D for gener-
ating new game ideas, without too many strings attached to the results, may be
more likely to be more conducive to new games than those that do not.
Culture that Tolerates Failure
Many ventures never make it to the payoff at the IPO, acquisition, or successful
product. They simply fail. In some environments, such failures are fatal. In
some countries, someone who is associated with a failed company may be
doomed. The fear of such repercussions prevents many investors in such
environments from investing in ventures. In other environments, such failures
stop neither the entrepreneurs nor their ?nancial backers. Why? First, players in
such environments understand that most new games require experimentation,
trial, error, and correction. Failure is therefore part of the learning that goes on.
Thus, those who fail learn in the process and this can improve their chances of
doing well the next time around. Second, many of the complementary players,
especially venture capital ?rms, have seen many failures before and still come
out ahead. Moreover, some of the players are serial entrepreneurs who have
experienced both success and failure several times before. The culture in such
environments tolerates failure. Whereas bankruptcy laws are harsh in Europe
and entrepreneurs who fail are stigmatized, in the Silicon Valley, “bankruptcy is
seen almost as a sign of prowess—a dueling scar if you will.”
8
Presence of Coopetitors and Factor Conditions
Recall that in performing new game activities, a ?rm usually needs to interact
with coopetitors to obtain some of the information and other resources that it
needs to create and appropriate value. Since some of the knowledge needed is
tacit, having these coopetitors in close enough proximity to allow for in-person
interactions can facilitate the process of knowledge identi?cation, exchange,
recombination, and transformation. Take the presence of suppliers. Being close
to suppliers gives a ?rm the opportunity to interact with component developers
and work more closely with them as both supplier and ?rm go through their
experimentation, trial, error, and correction process. They are able to provide
each other with the type of quick feedback that, in some industries, can be
the difference between success and failure. Such close interaction can enable a
?rm to be more effective in creating and appropriating value. Having very
258 Opportunities and Threats
demanding customers can also force ?rms into pursuing new games more dili-
gently so as to meet the needs of these demanding customers.
9
The presence of
the right inputs can also contribute to the conduciveness of an environment to
new games. For example, without the availability of electrical engineering and
computer science graduates in the USA, the Internet revolution may never have
taken off in the USA when it did. Finally, the presence of venture capital ?rms
can also be crucial.
A Procreative Destruction Environment
A system that encourages competition—especially between incumbents and
new entrants—can be critical to creating value. Major innovations usually
result in so-called creative destruction in which new ?rms replace some incum-
bents. A system that unduly protects incumbents can impede progress. For
example, those developing African countries that continued to protect their
?xed-line phone companies missed out on one of the biggest business success
stories in Africa—the cell phone communications business. If a country’s cluster
invents something but cannot commercialize it because the home country is
overprotective of its incumbent ?rms and old jobs, an entrepreneur in another
country is likely to pick up the invention and commercialize it. If the idea is a
success abroad, incumbents everywhere will eventually be displaced. Effect-
ively, the home country can have one of its own startups displace its incumbents
or someone else from the outside will do it. Moreover, if incumbents are over-
protected, entrepreneurs and venture capitalists can take their ideas and
investment to another country where they can commercialize the ideas and
pro?t from them. Government policies that make life dif?cult for startups can
curb entrepreneurial activity in their countries. In some countries, revenues are
taxed regardless of whether or not a ?rm makes money. This can be dif?cult for
startups that usually need cash early in their life cycles. In some countries, it
can take as many as 23 days to start a business while in others, it takes only
three days.
What Should Governments Do?
A lot of what governments can do to create environments that are conducive to
new games follows directly from our discussion of what makes for conducive
environments.
Foster a Culture that Encourages Financial Rewards for Successful
New Games
Laws in some countries prevent a ?rm from issuing an IPO until it has shown
several years of pro?ts. Such laws are meant to protect investors from
unscrupulous ?rms and their investment bankers; but they also keep out inves-
tors who can better decide the level of risk that they can handle and when they
should invest in a ?rm. Individuals know better than their governments which
companies are good investment issues. Again, investors can take their money to
those countries which do not unduly restrict when a ?rm can go public.
In some countries, billionaires are frowned at while in others they are
New Game Environments and the Role of Governments 259
admired for the hard work that enabled them to earn the money, unless it was
inherited. Yes, disparities in wealth can be a problem; but for every billionaire
that is created during an IPO, there are thousands of employees and other
stakeholders that become millionaires. If you aspire to work hard and become a
billionaire (and use the money to help refugees, etc.), would you stay where
billionaires are frowned upon or go where you are admired?
Encourage Financial Support for New Games
Some governments tax the revenues that startups receive, leaving cash-strapped
startups even more cash-strapped. This is in contrast to other countries in which
?rms pay taxes only on income and get to deduct losses in their tax returns. If
you were a venture capitalist, would you rather invest in a country with high tax
rates on revenues and where billionaires are frowned upon, or in one where
income, not revenues, is taxed at low rates and billionaires are admired as
wealth creators? If you wanted to work for a startup, would you want to work
for the former or the latter? Taxing revenues may be equivalent to a farmer
eating most of his/her young sheep and being left with little to maintain his/her
?ock. Successful startups create more jobs and wealth for their employees,
increasing the tax revenues for countries. With increasing globalization, venture
capitalists can move their capital to the country that they believe is more hos-
pitable to startups. Entrepreneurial employees can also move to those countries
where they believe they can pursue their dreams better. It is interesting that
venture capital was invented by a Frenchman while teaching in the USA, and
France has little or no wealth creation by venture capitalists.
Encourage Competition and Get out of the Way
Laws that protect incumbents in the face of revolutionary new games can back-
?re. That is because creative destruction eventually takes hold. Thus, protecting
incumbents from disruptive technologies by slowing down attackers only
delays the inevitable. Moreover, if a government slows down attackers in its
country, other countries may not. The more restrictive country may therefore
?nd itself falling behind as far as the disruptive technology is concerned, and
when its incumbents fall, they may be falling into the hands of foreign attackers.
Thus, a country may be better off encouraging competition between incum-
bents and new entrants, and getting out of the way.
Build a Culture that Tolerates Failure
While it is not very clear what a government can do to build a culture that
tolerates failure, a relaxation of bankruptcy laws can help. In some countries,
bankruptcy laws are so strict that some failed entrepreneurs can be banned
from running another company for many years. Such laws may be contributing
to stigmatizing failed ?rms. In the USA, Chapter 11 bankruptcy proceedings
allow the bankrupt ?rm’s employees to move on to another ?rm, and the assets
to be redeployed.
10
Relaxing these other countries’ bankruptcy laws may help.
260 Opportunities and Threats
Keep Investing in Public Knowledge and Public Complementary Assets
Of course, governments need to continue to invest in R&D projects that
generate knowledge with public properties, since ?rms are not likely to invest
in such projects; but they should attach few strings to the results of the
R&D, encouraging competition whenever possible. Governments are terrible
at making products and therefore should not try to get too far into product-
making. The job of governments is to make it easier for ?rms to make safe
and good products. If a government stands in the way of an innovation,
another government will ?nd a way to get its ?rms to pro?t from the
innovation.
Rationale for the Role of Government
11
In describing what governments should do to create environments that are
conducive to innovation, we did not explain why a government needs to play a
role. In this section, we explore the rationale for why governments have a role
to play in the face of new games. Because of the nature of people and the
knowledge that they must turn into customer value during new games, there
may be times when governments must intervene to facilitate more optimal value
creation and appropriation. Whether government intervention is needed is a
function of the:
1 Complementary assets needed.
2 Characteristics of the knowledge that must be transformed.
3 Amount of uncertainty and complexity involved.
4 Characteristics of the people that take the decisions and transform the
knowledge.
5 Type of industry in which the ?rm operates.
6 Extent to which there are negative or positive externalities involved.
Public Goods as Complementary Assets
Some of the complementary assets that a ?rm needs to create and appropriate
value are so-called public goods. A public good is a good that is nonrivalrous
and nonexcludable. A good is nonrivalrous if consumption of the good by an
individual does not reduce the amount of the good that is available for con-
sumption by others. A good is nonexcludable if it is dif?cult to prevent some
people from using it. An example of a public good is air. When one person
breathes air, he or she does not reduce the amount of air that is available for
others to breathe. Moreover, it is dif?cult to exclude some people from breath-
ing air. Consequently, it is dif?cult for an individual to clean only the air that he
or she wants to breathe. Another example of a public good is national defense.
Because of their nonrivalrous and nonexcludable properties, public goods may
be better provided by governments. It is dif?cult for each individual to defend
himself or herself from a foreign bomb. A safe country, good roads, steady
supply of energy, transportation systems, and a clean sustainable natural
environment are public complementary assets that can be critical to the type
of economy in which ?rms create and appropriate value. Because of the
New Game Environments and the Role of Governments 261
public nature of these assets, governments may need to play a major role in
providing them.
Paradoxical, Public, and Leaky Nature of Knowledge
The knowledge that underpins new game ideas has certain characteristics that
can make it dif?cult for a ?rm to appropriate the value from knowledge that it
generates.
12
First, suppose a ?rm wants to sell a new game idea. A potential
buyer cannot determine the value of the idea until it knows what the idea is all
about; but once it knows the idea, the potential buyer may no longer have an
incentive to pay for it, especially if the buyer is opportunistic. It already has the
idea and can shirk. Such a situation may discourage potential suppliers of
knowledge for new game ideas from investing in its generation. This situation is
sometimes referred to as the knowledge paradox.
13
Second, another character-
istic of knowledge is that of nonrivalry. If A sells some knowledge to B, doing so
does not reduce the amount of knowledge that A has. What is more is that B,
the buyer, will always have the knowledge and can keep reselling it. Unlike
products or services that are used up, and the producer can sell more of them,
knowledge remains in circulation no matter how many people consume it. This
may also discourage potential suppliers from investing in knowledge gener-
ation, since they may end up selling only one or a few copies.
Third, if a seller of a new game idea found a buyer, the idea may leak during
the process of transfer. Or, once the buyer starts to make money from it, it can
be quickly copied. In either case, appropriability of the knowledge is reduced.
This leakage is a function of the explicitness or tacitness of the knowledge. If it
is tacit and therefore requires learning by doing, experiencing, and interacting
over time with the generator of the knowledge, the risk of leakage may be
reduced. In any case, this leakiness property may also reduce the incentive to
invest in the production of new ideas for new games. It is important to point out
that leakage of knowledge, also called spillovers, may not always be bad, from a
societal point of view. It allows ?rms not to duplicate each other’s past research
efforts and waste money that could be used to extend the technology and offer
society better value.
There are several things that could be done to alleviate these knowledge
problems. The ?rst is for the government to grant and protect intellectual prop-
erty rights to producers of knowledge. That is what the governments of many
developed countries have already done by enacting and enforcing laws that
grant patents, copyrights, trade marks, trade secrets, and so on. If a ?rm is
awarded a patent on something, it can freely discuss it with potential buyers
without fear of an opportunistic buyer running away with the idea. Second, the
government can engage directly in idea generation itself and give the output
freely to its ?rms and entrepreneurs—that is, governments can generate know-
ledge and encourage spillover of the knowledge. By “engage” in idea gener-
ation, we mean that the government can have its own laboratories that engage
in the research, or award grants to universities and other institutions to perform
the research. Third, a government can provide subsidies for ?rms and indi-
viduals alike to encourage private production of knowledge. We will have more
to say about these three remedies later in this chapter.
262 Opportunities and Threats
Uncertainty and Complexity of Value Creation and
Appropriation
The uncertainty associated with the generation and application of some break-
through ideas is so large that very few ?rms are likely to invest in the generation
of such ideas. No ?rm could have foreseen the potential applications of the
structure of the DNA before its discovery. Nobody could have forseen how far-
reaching its applications would be. Thus, many pro?t-seeking ?rms are not
likely to have invested in the activities that led to the discovery of the structure
of the DNA. Complex projects that involve very many ?rms, individuals, and
governments are also dif?cult for individual pro?t-seeking ?rms to pursue
alone. Take the Internet, for example. What type of ?rm could have planned,
discovered, and implemented the Internet?
Effectively, if the uncertainties inherent in ideas for new games are very large,
?rms may not be willing to take the risk of investing in their generation. One
solution is to shift the risk of failure to insurers; but shifting risk to an insurer
has some problems. The insured has more information about the new game
than the insurer. An opportunistic insured may decide not to give the insurer all
the information that is needed to write a good policy. Even if the insured were
not opportunistic and honestly wanted to give the insurer all the needed infor-
mation, it may not be able to articulate all of the information, given the
uncertainty and complexity of the project and the fact that the insured is cogni-
tively limited. Moreover, even if the insured could articulate all the information,
the insurer may not be able to absorb and process all of the information either.
This information asymmetry between the insured and insurer leads to the two
potential classic problems of adverse selection and moral hazard. A large
majority of ?rms that seek insurance for idea generation may be ?rms that have
something to hide. Since the insurer does not have all the information that it
needs to differentiate between those that are opportunistic and those that are
not, it may end up getting only the opportunistic ones. This is the adverse
selection problem. It is also possible that the insurer succeeds in selecting the
right insureds. Once the contract has been signed, the insureds may become
complacent and not work as hard as they would if they were not insured. Given
the complexity and uncertainty associated with the innovation, it is dif?cult to
tell when the innovator is shirking or being a bum. The problem that arises from
?rms behaving opportunistically once they have signed a contract is the moral
hazard problem.
Effectively, if the uncertainty and complexity of idea generation is too high,
?rms may not want to invest in it; and because of the adverse selection and
moral hazard problems associated with complex and uncertain projects, insur-
ance companies may not be willing to insure the idea generation. A government
can do several things to insure such idea generation. First, a government can
undertake some of the risky idea generation itself. Second, a government can
allow ?rms to cooperate in the idea generation while making sure that the ?rms
are not colluding. Third, a government can subsidize R&D spending. Fourth, a
government can extend the protection life of the intellectual property that
comes from the projects. Again, we will discuss these measures below.
New Game Environments and the Role of Governments 263
Heterogeneity, Self-interest, and Cognitive Limitation of
People
Firms and the individuals that work for them are usually not the rational pro?t-
maximizing players that neoclassical economics often assumes. Rather, the
people who work for ?rms do the best they can to make sure that their ?rms are
pro?table and that their own interests are met. The satisfaction or utility that
people derive from performing a particular activity varies from individual to
individual and from context to context. While the Nelson Mandelas of the
world derive a lot of satisfaction from working hard to give other people a
chance to work hard and improve their own lives, other people work hard
because they want to keep their immediate families happy. Yet others work
hard to make a lot of money and then give it away to charity. Others work hard
to generate ideas so that they can be recognized as the best at what they do by
their professional colleagues or the Nobel committee. Thus, a government’s role
ought to take into consideration the fact that people are very diverse as far as
their incentives to generate new game ideas are concerned.
People are also cognitively limited. Their information collection, processing,
and expression abilities are limited and therefore, there is only so much that
most people can learn or process at any one time. Firms are also cognitively
limited. Thus, some projects may be too knowledge-intensive for such ?rms.
Governments can facilitate cooperation between ?rms that want to develop
such projects.
Minimum Efficient Scale Requirements of Industry
Whether or not a government should play a role in value creation and
appropriation is also a function of the minimum ef?cient scale involved. Min-
imum ef?cient scale (MES) is the smallest output that minimizes unit costs.
14
In
some industries or markets, the MES is equal to or larger than the market. Such
an industry is said to be a natural monopoly because one ?rm can produce at
lower cost than two or more ?rms. The natural monopoly concept was used to
justify monopolies in telecommunications, railways, electricity, water services,
and mail delivery. Since changes in technology usually result in reductions in
MES, it may be dif?cult to justify the presence of natural monopolies in some of
these industries today. For example, because of the nature of cell-phone tech-
nology (compared to ?xed-line telephony) the introduction of competition in
the telecommunications industries of many developing countries has resulted in
much better customer service and pro?ts for the providers.
Negative and Positive Network Externalities of Some
Activities
In Chapter 5, we said that a product or technology exhibits network external-
ities if the more people that use the product or technology, the more valuable
that it becomes to each user. There is another type of network externality that is
de?ned as the cost or bene?t imposed by the actions of two transacting parties
on a third party.
15
It is called a negative externality if a cost is imposed on the
third party, and a positive externality if a bene?t is imposed on a third party. A
264 Opportunities and Threats
classic example of a negative network externality is that of a power plant that
burns coal to produce electricity but, in doing so, also produces sulfur dioxide
that rises into the air and eventually falls as acid rain. The acid rain is a negative
externality since, in calculating the cost of the electricity that it sells, the electric
company does not factor in the cost of the acid to the people on whose property
or bodies the acid rain falls. By regulating the amount of sulfur dioxide that a
power plant can emit into the air, a government can reduce the amount of this
negative externality. Pollution from cars is also a negative externality. A classic
example of positive externality is that of a bee that, in searching for food,
pollinates the plants that it visits. If a farmer breeds bees, it cannot tell them
which crops to pollinate and which ones not to. Therefore, a government
department of agriculture may be better off breeding the bees and letting them
pollinate crops for everyone.
The Role of Government During New Games
In exploring the rationale for a government role in the face of new games, we
hinted at some of the things that governments could do to help ?rms create and
appropriate value better. In this section, we go into more detail of what gov-
ernments could do. In particular, we explore seven government roles that can
help ?rms in the face of new games. A government can serve as:
16
•
R&D ?nancier
•
Leader user
•
Provider of public complementary assets
•
Regulator/deregulator
•
Facilitator of macroeconomic fundamentals
•
Educator, information center, and provider of political stability.
R&D Financier
Recall that the “public good” nature of knowledge can make it dif?cult for
?rms to appropriate their inventions, thereby discouraging ?rms from investing
in some knowledge-generation activities. Also recall that the complexity and
uncertainty associated with certain knowledge-generation activities can dis-
courage ?rms from investing in R&D. One solution to these two problems is to
have the government perform the research and make the results available to the
public. Governments spend on two kinds of R&D: basic research, and applied
research. Basic research is about the search for knowledge for knowledge’s own
sake, with little attention given to if, whether, or how research ?ndings could be
converted into products. Applied research is research that is targeted towards a
particular application. Government research is conducted largely in govern-
ment laboratories, universities, within some ?rms, or at joint endeavors made
up of some combination of the three. In 2007 alone, the US Government
planned to spend over $130 billion on R&D.
Government-sponsored R&D has played a major role in the creation of new
industries, or has been a key driver for many innovations within existing indus-
tries. Two examples are the Internet and the structure of the DNA. The Internet
grew out of the US Defense Department’s Advance Research Projects Agency
New Game Environments and the Role of Governments 265
(DARPA) in which research on computer networks was sponsored by DARPA.
Firms eventually joined in to help build the Internet to the phenomenon that it
has become. Without the US Government’s R&D funding, there would be no
Internet today! The double-helix structure of genes or DNA also has its roots in
government-sponsored research conducted at Cambridge University to thank
for its discovery. Both these discoveries went on to become the sources of
numerous new games.
Financing R&D has other bene?ts beyond solving the problems of the “pub-
lic” properties of knowledge and of the complexity and uncertainty associated
with some projects. First, in ?nancing R&D, the government is also educating
its workforce with the knowledge and skills that ?rms need to create and
appropriate value. Once the Web took off, for example, it was easier to ?nd
employees with computer science and other information technology skills,
partly because of the many students trained with DARPA and National Science
Foundation (NSF) funds in the computer Science and Electrical Engineering
departments of many universities. Second, government R&D spending also
spurs private ?rms to invest in related invention or commercialization activities.
Third, by focusing attention on speci?c areas, government R&D projects can
enjoy the economies of scale that come with large R&D projects.
Although government intentions may be good, the results of their actions are
not always positive. Stories of failed projects also abound and questions about
just how much R&D the government should undertake haunt policy makers.
Government as Lead User
In the face of a new game or an innovation, interaction with customers can be
critical to understanding the bene?ts that they want and to being better able to
provide the bene?ts. Professor Eric von Hippel of the Massachusetts Institute of
Technology (MIT) has argued that lead users can be critical to the process of
innovation.
17
Lead users are customers whose needs are similar to those of other
customers except that they have these needs months or years before the bulk of
the marketplace does, and stand to bene?t signi?cantly by ful?lling these needs
earlier than the rest of the customers. The US government was an important
lead user in some critical products. For example, the US defense department
saw many bene?ts in the transistor replacing the bulky vacuum tube when it
pursued it well before most would-be users of the transistor. Since transistors
were much smaller and consumed less power than vacuum tubes, electronic
systems built from it would not only be lighter and provide more functionality,
they would require smaller power supplies, further reducing the weight of the
whole system. This made the transistor and subsequent integrated circuits par-
ticularly attractive to the Defense Department and the US National Aeronautics
and Space Administration (NASA). The US government’s willingness to award
contracts to both incumbents and new entrants, and to work closely with them
may have helped US semiconductor ?rms into the early industry leadership
position that they occupied for a long time.
18
The US role as lead user was
not isolated to semiconductors. Jet engines, airplanes, and computers have all
bene?ted from this shepherding by governments. This role is not limited to the
USA. Rothwell and Zegveld found that purchases by European and Japanese
governments played a signi?cant role in innovation.
19
266 Opportunities and Threats
Provider of Public Complementary Assets
A country’s infrastructure is critical to any new game activities that ?rms within
the country decide to pursue. For example, without a transportation system
that enables goods to be delivered to customers reliably and at reasonable costs,
online ?rms such as eBay and Amazon would not be as successful as they have
been. An information superhighway facilitates communications not only
between different business units of a ?rm; it also facilitates interaction between
coopetitors. Chip design can now take place 24 hours a day with people in
Israel, Japan, and the Silicon Valley taking turns to work on the same project.
Thus, by providing the infrastructure that its ?rms need, a country is helping its
?rms create and appropriate value better than countries that do not.
Government as Regulator/Deregulator
Another way to deal with the “public” nature of knowledge that can prevent
?rms from investing in knowledge generation is to grant inventors some mon-
opoly privileges over their inventions. In the USA, for example, the need for
such a privilege is written in Article 1, Section 8 of the constitution: Congress
shall have power “To promote the progress of science and useful arts, by secur-
ing for limited times to authors and inventors the exclusive right to their
respective writings and discoveries.” Firms can take advantage of this privilege
by seeking intellectual property protection via patents, copyrights, trademarks,
and trade secrets. If a ?rm has patented its invention, it can reveal it to a
potential buyer without being afraid of it being stolen since the patent is proof
of ownership. The market power that intellectual property protection can
bestow on a ?rm can be an incentive for ?rms to invest in inventions or dis-
coveries. Patenting is not limited to technologies; business models can be
patented too. For example, Net?ix was awarded a patent for its Internet-based
approach for renting videos to customers.
Ironically, a government is also responsible for preventing monopolies, since
they can result in under-innovation. For example, antitrust legislation in the
USA seeks to prevent any mergers that can unduly increase the market power of
one organization, since such market power can result in the emerging organiza-
tion keeping prices arti?cially high, or a lack of incentive to innovate. Other
activities, such as collusion and predatory pricing, that can result in arti?cially
high prices, are also illegal in some countries. In the USA, for example, the
Sherman Act makes illegal any agreements among competitors that enable them
to keep their prices arti?cially at some level by ?xing the prices or coordinating
their outputs. Tacit collusion is also illegal. In tacit collusion, rather than use
explicit formal agreements, ?rms can, for example, send signals as to what their
actions are going to be, inviting competitors to follow suit. In predatory pricing,
a ?rm lowers its prices (below its cost) so as to drive out competitors and then
raises them when the prey is out of the market. This is dif?cult to prove, espe-
cially early in the life of an innovation, because innovators can claim that they
are lowering their prices to attain the kinds of volume that can take them down
the learning curve (up the S-curve) rapidly, resulting in such lower cost, on
average, that they can afford to sell at a loss at the beginning.
Other public goods, such as the air that we breathe and the natural environ-
New Game Environments and the Role of Governments 267
ment, also have to be protected by governments. For a passenger that drives
10,000 miles a year, a 10 mpg improvement in a car’s gas mileage reduces
emissions to the atmosphere by 2.4 million pounds of CO
2
(for a person who
drives 10,000 miles per year, every 1 mpg improvement saves 24 pounds of CO
2
each year). Governments can also deregulate. Such deregulations can radically
change the nature of competition in an industry. Deregulation and privatization
of the telecommunications sectors of many developing countries have resulted
in competition and some pro?table business with happy customers.
Facilitator of Macroeconomic Fundamentals
New games are also economic activities and therefore their health depends as
much on how ?rms play the game as it does on the macroeconomic funda-
mentals of the countries in which they operate. Economic policies that spawn
expectations of low in?ation, low interest rates, growth, and pro?ts encourage
?rms to invest more in R&D and associated complementary assets. Expect-
ations of such pro?ts can encourage more entrepreneurs to engage in new game
activities. Expected low interest rates make it easier for projects to make ?rm
hurdle rates. New game activities may be the engine of economic progress; but it
is also true that economic processes can feed that engine.
Educator, Information Center, and Provider of Political
Stability
In most countries, governments are responsible for most of the general educa-
tion of its young. In the face of new games such as the Internet and biotechnol-
ogy, having the trained personnel can be the difference between ?rms in one
country performing better than those in other countries. As we stated earlier,
the introduction of computer science departments in many universities in the
USA and grants from the NSF may have been instrumental to the success of US
?rms’ ability to exploit the computer revolution. The country’s ability to attract
smart people from all over the world may have helped not only the country’s
computer industry but also other industries such as biotechnology.
Alternate Explanations: Porter’s Diamond
In his diamond model, Professor Michael Porter of the Harvard Business School
offered an alternate explanation for why some regions or countries are more
innovative than others. He argued that a ?rm’s ability to gain a competitive
advantage is a function of four factors:
20
1 Factor conditions
2 Demand conditions
3 Related and supporting industries
4 Firm strategy, structure, and rivalry.
268 Opportunities and Threats
Factor Conditions
Factor conditions are inputs such as labor, capital, land, natural resources, and
infrastructure that ?rms need to create and appropriate value. These factors of
production can be divided into two: key or specialized factors, and non-key or
generic factors. Specialized factors are inputs such as skilled labor, capital, and
infrastructure that are usually created, not inherited. These specialized factors
are likely to give a ?rm a sustainable competitive advantage, since they are more
dif?cult to replicate. Non-key factors are inputs such as unskilled labor and raw
materials that are easy to replicate or acquire. Non-key factors are unlikely to
give a ?rm a sustainable competitive advantage, since they are easy to replicate
or acquire. Professor Porter argued that scarcity of factors of production in a
country often helps, rather than hurts, the country because scarcity generates an
innovative mentality while abundance often results in waste. For example, land
prices in Japan were very high and therefore factory space was very expensive.
Thus, to cope better with the scarcity of space, the Japanese invented just-in-
time inventory and other techniques that reduced inventory in factories.
Demand Conditions
Demand conditions in a region or country can also have an impact on the ability
of local ?rms to have a competitive advantage. If local customers have sophisti-
cated demands, local ?rms are more likely to ?nd new ways to meet these
sophisticated needs. If ?rms can meet the very sophisticated demands of local
customers, they will ?nd it easier to meet the relatively less sophisticated
demands of other markets. If the sophisticated demand becomes global, the
local ?rms are better positioned to exploit the demand since their competitors
(from abroad) have not yet developed the skills to meet such sophisticated
demand. For example, demanding French wine consumers pushed French wine
suppliers to develop skills and other resources for producing some of the best
wines in the world.
Related and Supporting Industries
Having suppliers, complementors, buyers, and competitors located in the same
region can also help local ?rms to innovate better. A ?rm that is developing a
product can have an advantage if its suppliers and buyers are located nearby,
since they can all exchange critical information more easily during the
experimentation, trial, and error that takes place during innovation. Suppliers
can more easily ?nd out what ?rms want and supply it. Firms can more easily
work with buyers to ?nd out what they want.
Firm Strategy, Structure, and Rivalry
The competitive advantage of ?rms in a country also depends on their domestic
strategies and structure. For example, competition in domestic markets can be
?erce, since ?rms know a lot about what their local rivals are doing. What is
interesting is that such ?erce rivalry can be good in the long run because com-
petition can force ?rms to be more ef?cient or to innovate to survive. They also
New Game Environments and the Role of Governments 269
develop tactical skills for dealing with competitors. With the more ef?cient and
innovative ways honed at home, such ?rms can have a competitive advantage
when they face global markets with competitors without such capabilities.
PESTN Analysis
Recall that a ?rm’s macroenvironment is a major source of opportunities and
threats. One way to identify these threats and opportunities from a macro-
environment is to use a PESTN (pronounced as PEST N) analysis. PESTN
stands for Political, Economic, Social, Technological, and Natural environment.
Most readers may be familiar with the PEST part of the analysis. In this book,
however, we add the N. The factors that make up each component of the
PESTN analysis are shown in Figure 10.3. Each of these components was
described in detail at the beginning of this chapter. The extent to which any of
these factors constitutes a threat or opportunity for a ?rm is a function of the
industry in which the ?rm operates and the ?rm’s strategy. For example, while
in pharmaceuticals, “intellectual property protection” is important, it is usually
not the case in retail. Thus, what a government does about intellectual property
protection may not be of too much interest to many retail ?rms—unless, of
course, they want to pursue some sort of new game in this area. Effectively, the
number of factors that matter for any particular PESTN analysis will always be
only a subset of those shown in Figure 10.3.
21
As can be expected, some of the
factors are interrelated. For example, “physical and monetary policy” are part
of the Political component as well as of the Economic component. It is not
unusual for a PEST analysis of an industry to provide a laundry list of the
threats and opportunities that can impact an industry. However, since we are
interested in how these opportunities and threats can be exploited by a ?rm
to create and appropriate value, we focus on how each of the factors
impacts industry competitive forces, industry value drivers, and the system of
activities (and associated resources) that a ?rm performs. Given the vast num-
ber of factors that drive each component, we will explore only one factor per
component.
Political
In a PESTN analysis, one determines the extent to which the factors listed in
Figure 10.3 are opportunities or threats, given the objectives of the ?rm in
question. Take the ?rst political factor—consumer protection laws—shown in
Figure 10.3. Strict consumer protection laws are a threat to ?rms that do not
have the capabilities to offer customers the right products. They can also be an
opportunity for a ?rm with the right capabilities. Strict consumer protection
laws can be good for local ?rms that want to compete globally. That is because,
once a ?rm satis?es these strict local consumer protection laws, it can use the
capabilities developed to satisfy the laws of any other country whose laws are
equally strict or less. For example, once a ?rm meets the strict US Food and
Drug Administration (FDA) requirements for approving a new drug, the ?rm
can very easily meet the requirements for any other country. The FDA laws are
meant to protect patients.
270 Opportunities and Threats
Economic
Availability of a trained and low-cost workforce is an opportunity for a ?rm
that wants to produce locally. The only caution for managers is that such
opportunities do not last too long because many other ?rms are likely to locate
there and before long, the workforce will become high-cost.
Social
If differences between classes in a country are strong, it can be dif?cult to get
them to work together. That would make it dif?cult for an innovative ?rm that
thrives on diverse inputs. Firms are also less likely to enjoy the kinds of econ-
omy of scale that can be enjoyed in environments where the lines between
classes are not as strong. Customers are also less likely to enjoy fully the size
bene?ts of network externalities. However, strong divisions between classes
make it easier to segment markets into niches and to price discriminate better.
Figure 10.3 A PESTN Analysis.
New Game Environments and the Role of Governments 271
Technological
New potentially disruptive technologies can be a threat to incumbents but an
opportunity for new entrants who use the new technology to attack incum-
bents. They can also be an opportunity for incumbents that act preemptively to
adopt the technology before attackers move in.
Natural
If environmental consciousness is high, governments, ?rms, and consumers will
see its importance better, and what it takes to act in a way that is more environ-
mentally sustainable. Thus a high environmental consciousness is an opportun-
ity for businesses that want to offer more environmentally sustainable products
and a threat to incumbent businesses that do not want to change.
Advantages and Disadvantage of a PEST Analysis
A PESTN analysis offers one way to have a big picture of the opportunities and
threats from a ?rm’s political, economic, social, technological, and natural
environments. Exploring these components together provides an opportunity to
see some of the relationships among the components. It can be used to identify
sources of potential new games. The PEST has several disadvantages. The list of
drivers of each component can be very long. For example, the “political” com-
ponent in Figure 10.3 has 14 factors, and many more could be added. More-
over, there is no way of determining which of these factors is more important
than the other. The analysis says very little about the link between each of the
factors and a ?rm’s pro?tability.
Key Takeaways
•
Firms and the industries in which they operate do not exist in a vacuum;
they are surrounded by their macroenvironments of political, economic,
social-demographic technological, and natural. These environments are
primary sources of the threats and opportunities that ?rms often face.

The political environment includes antitrust regulation, tax laws,
foreign trade regulation, and employee protection laws.

The economic environment includes stock performance, disposal
incomes, interest rates, currency movements, economic growth,
exchange rates, and in?ation rate.

Sociocultural variables include the beliefs, norms, and values of
consumers, countries, communities, and employees. Demographic
variables include shifts in populations, age distributions, ethnic mixes,
educational levels, lifestyle changes, consumer activism, birthrates,
life expectancies, and household patterns in cities, regions, and
countries.

The technological environments have to do with the changes in the
technologies that go into products, their distribution, marketing,
service, and usage.
272 Opportunities and Threats

The natural environment consists of the air that we breathe, the water
that sustains all life, climate, landscapes, grasslands, forests, wildlife,
animals, oceans, mineral resources, and any other living or nonliving
things that occur naturally on earth and its surroundings.
•
Environments that are conducive to pro?table new games (innovation) pos-
sess the following characteristics:

High ?nancial rewards for successful new games.

Financial support for entrepreneurial activities.

A culture that tolerates failure.

The right coopetitors.

A procreative destruction environment.
•
What should governments do to foster environments that are conducive to
innovation? Governments can:

Foster a culture that encourages ?nancial rewards for successful new
games.

Encourage ?nancial support for new games and other entrepreneurial
activities.

Encourage competition and get out of the way.

Build a culture that tolerates failure.

Keep investing in public knowledge and public complementary assets.
•
For the following six reasons, governments may have to intervene in opti-
mal value creation and appropriation:

The nonrivalrous and nonexcludable properties of public comple-
mentary assets make it less likely that for-pro?t ?rms will invest in such
assets without help from their governments.

The paradoxical, public, and leaky nature of knowledge make it less
likely that for-pro?t ?rms will invest in generating such knowledge
without help from their governments.

The uncertainty and complexity of some projects make it less likely that
for-pro?t ?rms will invest in them without help.

The heterogeneity, self-interest, and cognitive limitation of people sug-
gests that employees may need different types of motivation; some of
which can only come from the government.

If an industry’s MES is so large that it is inef?cient to have more than
one ?rm in the industry.

If industry’s activities, products, or technology exhibit negative or posi-
tive externalities.
•
A government can serve as:

R&D ?nancier

Leader user

Provider of public complementary assets

Regulator/deregulator

Facilitator of macroeconomic fundamentals

Educator, information center, and provider of political stability.
New Game Environments and the Role of Governments 273
•
Porter’s Diamond model suggests that the ability of ?rms in a region or
country to gain a competitive advantage depends on the region’s or
country’s:

Factor conditions.

Demand conditions.

Related and supporting industries.

Firm strategy, structure, and rivalry.
•
A PESTN (political, economic, social, technological, and natural environ-
ments) analysis can be used to explore the opportunities and threats of a
macroenvironment.
Key Terms
Adverse selection
Minimum ef?cient scale
Moral hazard
Natural monopoly
Negative externality
Nonrivalrous good
PESTN
Positive externality
Public good
274 Opportunities and Threats
Coopetition and Game Theory
Reading this chapter should provide you with the conceptual and analytical
tools to:
•
Further appreciate the signi?cance of always taking the likely reaction of
your coopetitors into consideration when deciding on whether or not to
pursue a new game activity.
•
Understand the differences between cooperative and noncooperative game
theory that can be applied to the concepts and tools of this book.
•
Appreciate the usefulness and limitations of game theory as a tool or theory
for strategic management.
•
Understand why one needs both cooperative and noncoperative game
theory if one decides to use game theory to explore new game strategic
action.
Introduction
When a ?rm performs a new game activity or any other activity, its competitors
are likely to react to the activity. For example, if a ?rm introduces a new prod-
uct, lowers or raises its prices, launches a new ad campaign, increases R&D or
marketing spending, enters a new business, boosts manufacturing capacity,
builds a new brand, or performs any other activity, its rivals are likely to
respond sooner or later. Thus, how successful the ?rm is with the new activity is
a function not only of how the ?rm performs the activity but also of competi-
tors’ reaction. Thus, before taking a decision, a ?rm may want to consider its
competitors’ likely actions and reactions. In particular, the ?rm may be better
off asking itself questions such as: How are my rivals acting? How will they
react to my actions? How best should I react to my rival’s reaction to my
actions? If the rival moves ?rst, what should I do? A useful tool for exploring
some of these questions is game theory. Game theory enables ?rms not only to
ask what their competitors are planning to do but also to ask what is in the best
interests of these competitors. In this chapter, we explore how game theory can
be used to explore some of these questions. Because this book assumes no prior
knowledge of game theory, most of this chapter is dedicated to reviewing some
of the key concepts of both cooperative and noncooperative game theory that
are important to understanding value creation and appropriation.
Chapter 11
The Role of Game Theory in Strategic Innovation
Recall that to create and appropriate value, a ?rm often has to cooperate and
compete with different members of its value system. For example, a ?rm can
cooperate with its suppliers, complementors, or customers to create value, and
compete to appropriate the value. It can also cooperate with some rivals to
compete better against others, as is the case when ?rms enter co-marketing
agreements or form strategic alliances to develop new products. Of course,
?rms compete against each other when they offer similar products, hire from
the same pool of employees, bid for contracts, advertise, price their products,
seek partners to cooperate with, or purchase components. Effectively, the for-
tunes of a ?rm and those of its coopetitors—the rivals, suppliers, customers,
and complementors with which it cooperates and competes—are often inter-
dependent. Therefore, in deciding what to do, each ?rm is better off taking into
consideration the actions and reactions of it coopetitors. This is where game
theory comes in. Game theory is a tool for formally analyzing competition and
cooperation between ?rms as they create value and position themselves to
appropriate the value.
1
Rather than be content with asking what one’s coopeti-
tor plans to do, game theory suggests that managers ask what is in one’s coo-
petitor’s best interest and how one is likely to act or react in that best interest
and one’s own interest.
Cooperative and Noncooperative Games
There are two major approaches to game theory: cooperative and noncoopera-
tive. Noncooperative game theory has been more commonly utilized to explore
strategy questions than cooperative game theory. Both address different ques-
tions in strategy.
2
Noncooperative game theory is about how to better compete
against rivals by taking their likely reactions into consideration when one per-
forms activities. It has been used to analyze strategic moves whose outcomes
depend on one’s rivals’ likely actions and reactions, such as whether to intro-
duce a new product, increase R&D or advertising spending, retaliate against
new entrants, preannounce a new product introduction, increase manufactur-
ing capacity, raise or lower prices, or emphasize a particular brand. Non-
cooperative game theory is about individual rivals competing against each
other. It says little about the fact that during value creation and appropriation,
?rms must bargain or cooperate with suppliers, compete for buyers, interact
with complementors, and sometimes explicitly cooperate with rivals. It says
nothing about the bargaining power of suppliers, complementors, and buyers,
and the threat from substitutes and potential new entrants that can be critical to
value creation and appropriation. Nor does it say much about how an alliance
such as Wintel would compete against another coalition such as Apple. This is
where cooperative game theory comes in. Cooperative game theory is useful in
exploring how much value can be created by cooperating with coopetitors, how
much power each coopetitor has, and how much of the value created each actor
can be expected to appropriate.
3
A cooperative game details the outcomes that occur when players (coopeti-
tors) jointly plan their strategies and play as combinations of players, and not
individual players.
4
The unit of analysis is a group or coalition of individual
276 Opportunities and Threats
actors. The players can negotiate binding contracts that allow them to pursue
these joint strategies.
5
When there is competition, it is between groups of play-
ers rather than individual players. In strategic management, these coalitions are
subsets of coopetitors—suppliers, buyers, rivals, coopetitors, and complemen-
tors. In noncooperative games, the unit of analysis is the individual actor and
there are no binding contracts between players (usually rivals) that can be
enforced through outside parties. Competition is between individual competi-
tors. If ?rms pursue activities that appear to be “cooperative,” such as tacit
collusion, it is because the self-interest of individuals (not that of a coalition)
dictates that “cooperative behavior” be pursued. Note also that the terms
cooperative and noncooperative may be unfortunate because cooperative
games often entail not only cooperation but competition between coalitions
(e.g. Wintel versus Apple).
Noncooperative Games
Consider a market in which there are two major players, each of which can
impact the market by lowering or raising its prices. Coke and Pepsi in carbon-
ated soft drinks, Boeing and Airbus in commercial aircraft, or P?zer and Lilly in
erectile dysfunction are good examples. Suppose the two major players are
Boeing and Airbus and you are the manager at Airbus responsible for setting
prices. Both ?rms are considering some price changes. The bene?ts to each ?rm
of either lowering or raising prices are contingent on what its competitor does
to its prices—that is, the bene?ts depend on whether the other ?rm also lowers
or raises its prices. Effectively, there are several alternatives to the outcome of a
?rm raising its prices in such an industry with two major players. Two of these
alternatives are summarized in the payoff matrix of Figure 11.1 in which each
cell represents a different outcome and the payoffs for the particular outcome
are written in the cell. In the game, Boeing and Airbus are the players. Lower
price and Raise price are the two strategies (moves) that are available to each
player. The rows represent Airbus’ available strategies (lower price or raise
price) while the columns are Boeing’s strategies. Within each cell are two pay-
offs that either ?rm stands to make as a consequence of its move and that of its
competitor. In each cell, the number to the left represents Airbus’ payoff while
that to the right represents Boeing’s payoff. Thus, in Figure 11.1, if both Airbus
Figure 11.1 A Payoff Matrix.
Coopetition and Game Theory 277
and Boeing lower their prices, they each make $15 million more. However, if
Airbus lowers its prices but Boeing raises its prices, Airbus’ payoff is 40 while
Boeing’s loses sales to Airbus and ends up with a negative payoff (–45). If both
?rms raise their prices, each has a payoff of 45. If Boeing lowers its prices but
Airbus raises its prices, Boeing’s payoff is 40 while Airbus’s is –45. Effectively,
in noncooperative game theory, a game is made up of a set of players, a set of
strategies (moves) that each player can pursue, a speci?cation of the payoffs for
each combination of strategies, and the timing of the moves. (We will return to
the timing element later.) Thus, the outcome of the game depends on the payoffs
that each player expects to receive. It also depends critically on what each
player believes that the other will do. If Airbus believes that Boeing will raise its
prices, it will raise its own prices and obtain the payoff of 45 instead of the 40
that it would receive if it lowered its prices. If it believes that Boeing will lower
its prices, it will also lower its prices.
Simultaneous Games
In the game of Figure 11.1, each player takes its decision about whether to
lower or raise its price without knowing which decision the other player has
taken. That is, each player selects its strategy without knowing which strategy
the other player has selected. Such games are called simultaneous games, since
each player moves without knowing the other player’s move. Even if the players
take their decisions at different points in time, the game is still a simultaneous
game so long as each player chooses its strategy without knowing the strategy
that the other player has selected. The timing issue is not so much that both
players took their decisions at the same time but that each one took its decision
without knowing the decision that the other had taken. Each ?rm has its beliefs
about what the other player will do but does not know what it has done before
moving.
Dominant Strategy
Consider another example, where two major ?rms in a market can either adver-
tise or choose not to advertise (Figure 11.2). If both ?rms choose not to adver-
tise, they save on advertising costs and their market shares stay about the same,
giving each the same payoff of 40. If they both advertise, their payoff is 20 each.
However, if one ?rm advertises and its competitor does not, it takes market
share from the competitor and ends up with a much higher payoff of 50 while
Figure 11.2 Dominant Strategy.
278 Opportunities and Threats
the competitor receives 10. More importantly, note that if Firm X advertises, its
payoff is 20 when Firm Y advertises and 50 when Firm Y does not advertise; but
if Firm X does not advertise, its payoff is 10 when Firm Y advertises and 40
when Firm Y does not advertise. Thus, Firm X is better off advertising no
matter whether Firm Y advertises. Effectively, no matter what Firm Y does,
Firm X is better off advertising. We say that to Advertise is a dominant strategy
for Firm X since, when it advertises, it is doing the best that it can, no matter the
strategy that Firm Y pursues. Another examination of Figure 11.2 shows that to
Advertise is also a dominant strategy for Firm Y since, no matter what Firm X
does, Firm Y is better off advertising. Thus, the two ?rms end up in the upper-
left cell with a payoff of (20, 20). This cell is the only noncooperative equi-
librium in the game and is called the dominant strategy equilibrium, since it
results from the fact that each player has a dominant strategy. In this cell, each
?rm is maximizing its payoff, given what it believes the other to be doing.
Nash Equilibrium
Two major commercial aircraft manufacturers want to introduce the next-
generation commercial airplane. There is a market for a very large airplane, the
so-called SuperJumbo, an aircraft that can carry up to 800 passengers com-
pared to an existing maximum of about 500. Given the huge R&D, manu-
facturing and marketing investment needed, the market might not be large
enough for each ?rm pro?tably to offer a SuperJumbo. There is also a market
for a so-called SuperLiner, a smaller aircraft that has a longer ?ying range than
the SuperJumbo and carries about 300 passengers, but this market might also
not be large enough to support both ?rms. As Figure 11.3 shows, if both manu-
facturers (Firm A and Firm B) offer the SuperJumbo, they stand to each lose $2
billion. If they both offer the DreamLiner, they also stand to lose $2 billion each.
However, if Firm A offers the SuperJumbo while Firm B offers the DreamLiner,
Firm A’s payoff is $5 billion while Firm B’s $4 billion. If Firm A offers the
SuperJumbo while Firm B offers the DreamLiner, both ?rms have Payoffs of $4
billion and $5 billion respectively. So long as each ?rm does not offer the same
product that the other is offering, they will do just ?ne. These ?rms do not get
together in meetings and decide who will offer what type of airplane, since to do
so might be considered anticompetitive and therefore illegal in some countries.
However, they can make their intentions known by the announcements that
they make about future products. Suppose, for example, that Firm A announces
its plans to offer the SuperJumbo. Firm B, on reading this announcement in the
Figure 11.3 Nash Equilibrium.
Coopetition and Game Theory 279
press, announces that it will shelve any plans that it might have had to offer a
SuperJumbo and concentrate on offering a DreamLiner. Given what Firm B
believes that Firm A will do (offer a SuperJumbo and not offer the DreamLiner),
it has no incentive to deviate from its proposed action of offering the Dream-
Liner. Similarly, given what Firm A believes Firm B will do (offer a DreamLiner
and not offer the SuperJumbo), it has no incentive to deviate from its proposed
action of offering the SuperJumbo (Figure 11.3).
6
Effectively, neither ?rm has an incentive to deviate from its proposed action,
given what it believes the other ?rm will do. If either ?rm takes the proposed
action, its payoff is $5 billion. If it deviates and its opponent’s proposed action
remains unchanged, its payoff will be –$2 billion. Thus, the strategy set of the
top-right cell of Figure 11.3 is a Nash equilibrium. In a Nash equilibrium, each
?rm is doing the best that it can, given what the other is doing. No single player
can do better by unilaterally changing its move. In the strategy set of the top-
right cell, Firm A is doing the best that it can (with a payoff of 5), given what
Firm B is doing, and Firm B is doing the best that it can, given what Firm A is
doing. Note that the strategy set given by the bottom-left cell is also a Nash
equilibrium. A dominant strategy equilibrium is also a Nash equilibrium; but
not all Nash equilibria are dominant equilibria. For example, the dominant
strategy equilibrium of Figure 11.2 (top-left cell) is a Nash equilibrium; but the
Nash equilibrium of Figure 11.3 (top-right cell) is not a dominant strategy
equilibrium.
Prisoners’ Dilemma
The example of Figure 11.2 belongs to a class of games known in game theory
as prisoner’s dilemma. In these games, the payoffs are such that each player has
an incentive to pursue a strategy that will result in a worse outcome than if both
players had simultaneously chosen the other strategy. In Figure 11.2, the strat-
egy that will give both ?rms the highest payoff is Don’t advertise; but because
each has an incentive to advertise, they both miss out on the larger payoff. In
fact, even if both players had a chance to come to some type of cooperative
agreement, the incentive to deviate from the agreement may still be too strong
to resist. The name prisoners’ dilemma comes from a game in which two
prisoners who are alleged to have jointly committed a crime are separated and
told the following: if either one confesses to both of them having committed the
crime, both prisoners will be convicted but the confessor will receive a light
sentence while the other prisoner will receive a much heavier sentence. We have
shown the light sentence in Figure 11.4 as –1 (one year in prison) and the much
heavier sentence as –10 (ten years in prison). If neither prisoner confesses, both
prisoners will be convicted of a lesser crime and serve about two years (–2). If
both confess, they each receive a three-year sentence. As it can be seen in Figure
11.4, the incentive is to confess. The dominant strategy for both prisoners is to
confess. Thus both players will end up with the top left payoff, which is lower
than the payoff in the bottom right cell. Incentives could encourage players to
choose the preferred outcome of the lower right cell. For example, according to
the movies, the Ma?a gave its members a very good incentive to not confess.
280 Opportunities and Threats
Repeated Simultaneous Games
In many competitive arenas, ?rms face each other repeatedly. For example,
Coke and Pepsi have repeatedly introduced new products, set product prices,
and launched new product promotions in the same markets. Intel and AMD
have had to negotiate prices of microprocessors with PC makers several times
over each product’s life cycle and each time each new product is introduced.
However, the games we have explored so far have assumed that the players have
no history of performing the particular activity; the games are one-shot repre-
sentations with no repetition. To model interactions such as repeated new
product introductions, we use repeated games in which the same game is played
on many different occasions. In repeated games, a ?rm has a chance to establish
a reputation about its behavior and learn about the behavior of its competitors.
The question is, how would the outcome of a repeated game be any different
from that of the standard one-shot game? It depends on whether the end of the
last stage of the repeated game is speci?ed and known or not.
By speci?ed and known, we mean that the players, their strategies, and
corresponding payoffs for each set of strategies are given, such as in the
examples above. If the last stage of the game is not speci?ed and known, and
players know that they have to face each other again in the future, the fear
of future retaliation may make each player behave in a more cooperative
way. Effectively, if players are going to encounter each other repeatedly, one
player can always punish the other player for something that he/she did in
the past. Each player may cooperate with the other because he or she knows
that if he or she is cheated by the other player today, he or she can punish
the cheat tomorrow. Thus, the prospect of future vengeful retaliation may
force players to do the right thing. Consider the prisoner’s dilemma case of
Figure 11.1. If the ?rms that price the products have to face each other
repeatedly in the same market, they will ?nd a way to “cooperate” and raise
their prices. Tacit collusion, which we will explore later, is a good vehicle for
such cooperation.
If the last stage is speci?ed and known, then the repeated game can be
Figure 11.4 Prisoner’s Dilemma.
Coopetition and Game Theory 281
analyzed by starting from the last stage and working one’s way backwards to
the ?rst stage. Suppose, for example, that there is no incentive to cooperate in
the last stage. Then, since it is the last stage, there is no prospect of future
vengeful retaliation and therefore nothing to force players to behave more
cooperatively in that ?nal stage. If there is nothing to force players to behave
more cooperatively in that last stage, there is probably no reason why they
should cooperate in the last-but-one stage, last-but-two stage, and so on.
Firms can also learn from their actions. If two ?rms make the mistake of
introducing very similar products in the same white space today when there is
extra white space that they could each occupy, they will be wiser tomorrow.
If ?rms lose a lot of money by lowering their prices when they should
not (Figure 11.1), they will learn and think twice when they have to play the
same game.
Sequential Games
All the games we have discussed so far are simultaneous games, since each
player selects its strategy without knowing which strategy the other player has
selected. These games apply in those cases where ?rms take their decisions
without each ?rm knowing the decision that the other ?rm has taken. In many
other circumstances, however, ?rms move sequentially, not simultaneously. In
fact, in most new game strategies, ?rms move in turns: ?rst movers, then fol-
lowers. In sequential games, one player moves before the other. Figure 11.5 is a
sequential game representation of the simultaneous game of Figure 11.3 in
which Firm A moves ?rst. The decision tree of Figure 11.5 is called the extensive
form of the game (compared to the form of Figure 11.3 which is called the
normal form). It captures the possibilities and sequence of events. Firm A has
the ?rst move. It must decide whether to offer the SuperJumbo or DreamLiner
?rst. To take this decision, it must anticipate what Firm B is likely to do. Effect-
ively, deciding what Firm A should do consists of starting from what it believes
that Firm B will do and working backwards. If Firm A were to offer the Super-
Jumbo, Firm B will offer the DreamLiner for the payoff of (5, 4) rather than the
(?2,?2) that goes with offering the SuperJumbo; but if Firm A offers the
DreamLiner, Firm B will offer the SuperJumbo for the (4,5) payoff. In this
second option, Firm A’s payoff is 4 rather than 5 from the ?rst option. Thus, a
Figure 11.5 A Sequential Game.
282 Opportunities and Threats
rational Firm A will go for the ?rst option and offer the SuperJumbo ?rst,
believing that Firm B will offer the DreamLiner. By moving ?rst, Firm A has a
chance to earn some ?rst-mover advantages.
If a ?rm moves ?rst in a sequential game, it can either try to deter entry by
competitors or encourage it. If it tries to deter entry but competitors still enter, it
can ?ght the entry, accommodate it, or change the rules of the game. We exam-
ine these cases next.
Deterrence and Sequential Games
If a player who moves ?rst can deter entry, it is virtually a monopoly in its
product-market space and stands to enjoy some monopoly bene?ts, including
increased pro?tability. There are several steps that a ?rm can take to deter entry
and therefore maintain its pro?tability chances.
Evoke Barriers to Entry
If an incumbent has built ?rst-mover advantages, it can use them to deter entry.
For example, an incumbent can threaten to sue any new entrants that, in enter-
ing, violate its protected intellectual property. Whether such a threat works is a
function of whether the ?rm has a reputation for suing any ?rms that have
violated its intellectual property protection. If an incumbent has accumulated a
lot of cash, it can use it to accelerate the rate at which it preemptively acquires
scarce resources to demonstrate to potential new entrants that critical resources
will be more scarce and costly if they were to enter. If an incumbent has a large
market share and its products enjoy economies of scale (e.g. in R&D, advertis-
ing, and manufacturing), it can use its low-cost position to threaten the new
entrants with a price war if they were to enter. It can also sign agreements with
suppliers, distributors, complementors, and buyers to lock up critical inputs
and complements.
Limit Pricing
An incumbent can also use limit pricing to deter entry. In limit pricing, a ?rm
keeps its prices low, hoping that the low prices will discourage pro?t-motivated
rational new entrants who want large pro?ts from entering. The assumption is
that the prices will remain low or even drop if the potential new entrant were to
enter. Limit pricing will work only if there is something about the incumbent
that allows it to keep its cost lower and can therefore pass on some of its costs
savings to customers in the form of low prices. That would be possible, for
example, if the ?rst mover has established a system of activities that allows it to
have a low-cost structure, enjoys economies of scale, has gone up the learning
curve, or enjoys any other ?rst-mover advantage that allows it to keep its costs
low relative to those of potential new entrants. One important thing about limit
pricing is that, like any other deterrent measure, there should be something
about the ?rm that makes its “threat” of limit pricing credible. For example, if a
?rm can demonstrate that it has a low-cost structure that is dif?cult to replicate,
potential new entrants are more likely to take it seriously when it threatens limit
pricing or starts practicing it. As we will see below, irreversible investments in
Coopetition and Game Theory 283
assets or activities that underpin the type of ?rst-mover advantages that can
allow a ?rm to keep its costs low can also lend credibility to a ?rm’s decision to
practice limit pricing.
Commitment and First-mover Advantages
In sequential games, the player that moves ?rst has the potential to earn ?rst-
mover advantages. One way to demonstrate to potential followers that one has
these ?rst-mover advantages or is in the process of earning them, is to make the
right commitments. The right commitments can deter or slow down entry by
followers. For example, heavy investments in R&D and intellectual property
protection capabilities (including lawyers) by a ?rst mover tells potential fol-
lowers that it is committed to acquiring and protecting its intellectual property.
For a commitment to be effective in deterring or slowing down competitors,
it must be credible, visible to competitors, and understandable.
7
A commitment
is credible if there is something about it that makes competitors believe in it and
the options that it creates or limits. The primary driver of credibility is irreversi-
bility of the commitment. A commitment is irreversible if it is costly or dif?cult
to walk away from or undo. That would be the case, for example, if the assets
that underpin the commitment cannot be pro?tably redeployed elsewhere. The
idea here is that if a player’s commitment is irreversible, the player is more likely
to stay and ?ght followers rather than accommodate them or exit. Rational
followers, knowing that the player is not likely to welcome entry, are likely to
refrain from entering. Wal-Mart’s saturation of neighboring small towns in the
Southwestern USA with retail stores and matching distribution centers and
logistics are another example of commitment. Since, for example, it would be
dif?cult or costly to use Wal-Mart’s thousands of stores and distribution centers
in contiguous small towns for something other than retail, rational potential
new entrants are less likely to try to enter these towns. Credibility of commit-
ments also depends on the options that are eliminated when a ?rm makes the
commitments. If, for example, in making the commitments, a player eliminates
all its options, it is more likely to stick with the commitment and ?ght. In
choosing to operate only out of secondary airports, for example, Ryanair is
giving up the option to operate out of the larger more congested primary air-
ports. Thus, anyone that wants to ?ght Ryanair in one of the secondary airports
that it occupies should expect the airline to ?ght harder than it would ?ght if it
could just pick up and move to a larger primary airport.
Of course, for a commitment to have the right effect on competitors, they
must understand the commitment and its implications. In the ?uid phase of a
technological change, for example, there is so much market and technological
uncertainty that it is dif?cult to tell what commitments and their likely out-
comes are all about. A ?rm can make parts of its plants available for tours to
demonstrate that it has investment in the right equipment and personnel. Many
other commitments, such as investments in intangible assets or a commitment
to keep prices high, are more dif?cult to see and understand. This is where
signaling comes in.
284 Opportunities and Threats
Signaling and Reputation
If a player conveys meaningful information about itself to other players, it is
said to be signaling.
8
Signals from a ?rm are usually designed to in?uence the
perceptions of coopetitors’ and their actions or reactions. Whether the signal is
successful in conveying the right message is a function of the coopetitor’s per-
ception of the signal. Thus, the reputation of the ?rm that sends signals plays a
major role in the effectiveness of the signal. An extended warrantee, for
example, can be a signal of good quality and reliability. If the warrantee comes
from a ?rm with a reputation for reliability, coopetitors are more likely to
believe that the products are reliable. Brand names, packaging, advertising, and
even prices can be signals of quality. A ?rm might publish the number of patents
that it receives in a particular area every year to signal to competitors that it has
the capabilities to maintain its ?rst-mover advantage in intellectual property.
Effectively, ?rms can use signals to in?uence the actions and reactions of coo-
petitors. The signals can sometimes be designed to confuse or fool competitors.
Encourage Entry
Sometimes, rather than try to deter ?rms from entering, a ?rst mover is better
off encouraging entry. That would be the case, for example, with a new market
or product that needs a certain number of ?rms or complementors to give the
new product credibility. For example, in the late 1970s, many businesses hesi-
tated from buying PCs because they were being offered by many startups with-
out credibility as business customers. IBM changed all that when it entered the
market in 1981. It brought in a lot of customers and grew the market for
everyone. We will return to encouraging entry when we explore cooperative
game theory below.
Suppose a ?rm’s efforts to prevent entry fail and a new entrant comes into the
market; what should the incumbent do? The incumbent can either ?ght the new
entrant, accommodate it, or change the rules of the game to make the market
more attractive for the incumbent despite the entry.
Fight or Change the Rules of the Game
An incumbent can ?ght a new entrant using predatory actions such as predatory
pricing, changing the rules of the game, or taking other measures such as
increasing its capacity.
Predatory Activities
An incumbent’s activities are predatory if they eliminate or discipline a rival, or
inhibit a current or potential rival’s competitive conduct.
9
One of the most
studied such activities is predatory pricing. In predatory pricing, a ?rm lowers
the price of its product with the intention of driving out or punishing rivals, or
scaring off potential new entrants who see the low prices as a signal that post-
entry prices will be low. During the period when prices are low, the ?rm and its
rivals lose money. If these rivals are unable to sustain the losses, they go out of
business or start behaving properly. The ?rm is then left with fewer or no rivals,
Coopetition and Game Theory 285
or with well-behaved rivals. The ?rm can then raise its prices and start making a
pro?t again, hopefully enough for it to recover the amounts lost. Predatory
pricing can also be designed to depress the market value of a competitor so that
the predator can buy the competitor or parts of it at below market prices, or to
establish a reputation as a ?rm that tolerates neither entry nor behavior that it
does not consider proper.
Predatory pricing is considered to be anticompetitive and illegal in many
countries, including the USA. In these countries, predatory pricing cases are
usually brought by ?rms (presumed preys), not by governments. In any case, it
is dif?cult to prove predatory pricing. To prove it in the USA, for example, the
plaintiff has to show that the lower price was temporary; that the intention
of the accused predator, in lowering the price, was to drive out the rival; that
by raising its prices again the accused predator could recoup the losses that
it incurred from the price cuts; and that the low price is below the accused
predator’s average cost.
Change the Rules of the Game
Rather than use predatory pricing to ?ght new entrants, an incumbent can
change the rules of the game in its favor. Although, as we will see later in this
book, management literature is full of good examples of new entrants who
attacked an industry by changing the rules of the game, incumbents can also
change the rules of the game in the face of new entrants. One of the best ways to
change the rules of the game is to change the payoffs not only for new entrants
but also for incumbents. The case of Sun Microsystems provides a good
example. In the late 1980s, Sun was an incumbent in the computer workstation
industry and its workstations, like those of incumbents in the industry at the
time, used a technology called CISC. Some new entrants started entering the
industry using a new technology called RISC. In response to the entrants, Sun
also introduced the new technology but rather than keep its version of the
technology proprietary, Sun opened it up to anyone who wanted it.
10
This
contrasted with its old CISC strategy and with the RISC strategies of its com-
petitors. By making its RISC architecture open, Sun attracted many workstation
makers that would not have entered the industry or that would have adopted
incompatible RISC technologies. And the more workstation makers that
adopted the technology, the more software that was developed for that particu-
lar technology. The more software that was developed for a technology, the
more customers that wanted workstations from the technology. Sun’s RISC
technology ended up winning the RISC technology standard for workstations
against other RISC technologies. Sun used its complementary assets—installed
base, brand, distribution channels, and relationships with software develop-
ers—to exploit its open RISC architecture and was pro?table for most of
the 1990s.
Accommodate, Merge, or Exit
Rather than ?ght new entrants, an incumbent may decide to concede some of its
market share. The decision not to ?ght may be because the incumbent does not
have what it takes to ?ght. It may also be because the incumbent is smart
286 Opportunities and Threats
enough to realize that wars—especially price wars—produce no winner, except
some customers. The incumbent may welcome the new entrant and engage in
tacit collusion. Tacit collusion is said to take place when rivals coordinate their
activities and know that they are cooperating but there is no agreement, verbal
or written. When the activity in question is pricing, it is also called price leader-
ship or cooperative pricing. In fact, when many people talk of tacit collusion,
they are talking about price leadership (cooperative pricing) although ?rms can
also collude on when to introduce products, how much to spend on R&D, etc.
Tacit collusion between ?rms can be facilitated by so-called meeting the com-
petition or most-favored customer clauses, which at ?rst may appear to be good
for customers. Consider two such phrases: “We will not be undersold” or “We
will match our competitors’ prices, no matter how low.” When a ?rm issues
such clauses, it is telling its rivals to keep their prices at the high level. If for
some reason the rivals lower their prices, the ?rm will lower its prices too and
everyone will lose money. For fear of everyone losing money when they lower
their prices, rivals may decide to keep their prices high. Tacit collusion is more
likely to take place in a market where (1) the number of ?rms in the market is
small, (2) ?rms in the market face each other repeatedly in some sort of a
“repeated game” without knowing what the end game will be, (3) pro?ts per
?rm in the market are higher under collusion than when there is no collusion,
(4) the discount rate is low, or (5) the incremental pro?ts for deviating ?rms
are high.
11
An incumbent may also be better off merging with a new entrant rather than
?ghting the entrant. That would be the case, for example, if the new entrant
entered using a radical technological change that renders incumbents’ techno-
logical capabilities noncompetitive but an incumbent has important scarce
complementary assets that are needed to pro?t from the new technology. New
entrants, using new games, can also change the structure of an industry so much
that incumbents can no longer compete. In that case, an incumbent may be
better off exiting the industry when it ?nds out that it no longer has what it
takes to compete in the industry.
Cooperative Games
Recall that in noncooperative games, the unit of analysis is a player, usually a
rival that is competing against another rival. Each player seeks to maximize its
payoff no matter what the other player does. Thus, noncooperative game the-
ory can, for example, help a ?rm analyze its decision to raise or lower its prices,
taking the likely reaction of its rivals into consideration. However, noncoopera-
tive game theory tells us little about the bargaining power of suppliers, the
power of complementors, or the bargaining power of buyers and their reserva-
tion prices. Nor does it say much about the role of complements and substitutes
in the pricing decision. Apart from tacit collusion, noncooperative game theory
does not say much else about explicit cooperation. Cooperative game theory
does all these things that noncooperative game theory does not. This is fortu-
nate because, as we have seen throughout this book, the positioning of a ?rm
relative to its coopetitors, cooperation between coopetitors, reservation prices,
and so on all play critical roles in value creation and appropriation. In coopera-
tive games, the unit of analysis is a coalition of players. Each coalition is made
Coopetition and Game Theory 287
up of a subset of coopetitors. Players’ strategies are coordinated so as to maxi-
mize the payoff for the coalitions in the game.
Elements of a Cooperative Game
A cooperative game has two major elements: a set (coalition) of players and a
characteristic function. Usually, the players are some subset of coopetitors—a
subset of suppliers, rivals, complementors, and buyers. The characteristic func-
tion speci?es the value created by different coalitions of players. To illustrate
these elements, consider the following example.
Example 11.1
A biotech startup (S) has discovered a new drug and has three options to get it
approved by the FDA and bring it to market. It can go it alone, form an alliance
with either Firm A or Firm B, or form an alliance with both. If the startup (S)
goes it alone, it earns $100 million from the drug. If it forms an alliance with A,
the coalition earns $150 million since A has the marketing and clinical testing
assets. If S forms the alliance with B, the team earns $200 million because B not
only has marketing and clinical testing capabilities, it also has a strong sales
force that already sells B’s drugs.
The different coalitions and the value created by each are shown in Table
11.1. If the drug is not marketed at all, no value is created. If S markets the
product alone, the value created is 100. Either A or B, without S has no product
to sell and therefore the value created by each is zero. The value created by the
AB coalition is also zero. The value created by the SA, the coalition of S and A,
is 150 while the value created by SB, the coalition of S and B is 200. Note, in
particular, that SAB, the coalition of all three ?rms, results in the same value as
the coalition of S and B. That is because SA is dominated by SB; that is, B does
everything that A would be needed for. The mapping of the coalitions into value
created is the characteristic function. Effectively, the characteristic function can
also be described as the collective payoff that players can gain by forming
coalitions.
Let us introduce some terminology to make things more concise. Let N be the
set of players in a game, and C be any subset of the N players that can form a
coalition. We say that v(C) is the value created when the subset C forms a
coalition. And v(C{p}) is the value created when play p is excluded from coali-
tion (group) C. In our biotech example, N = {S, A, B} since there is a total of
three players; v(S) = 100 since the value of S going it alone is $100 million; v(A)
= 0, v(B) = 0, and v(AB) = 0 since neither each of A or B working alone nor as a
coalition creates value; v(SA) = 150 since a coalition of S and A nets $150
million; and v(SAB) = 200 since a coalition of all three nets $200 million.
Table 11.1 A Mapping of Coalitions into Value Created
Coalition O S A B AB SA SB AB SAB
Value created or collective
payoff (numbers in $M)
0 100 0 0 0 150 200 0 200
288 Opportunities and Threats
Also, the value created when player S is not in the coalition is 0; that is,
v(C{S}) = 0; Also, v(C{A}) = 200; v(C{B}) = 150.
Marginal Contribution and Appropriation of Value Co-
created
So far, we have discussed how different players come together to co-create value
for their coalitions. The question remains, how do members of each coalition
share in the appropriation of the value co-created? Of course, the amount that
each player appropriates depends on many factors, including its bargaining
power vis-à-vis the other co-creators of the value. The amount also depends, in
part, on how much each player contributed to the value creation. It depends on
each player’s marginal contribution or added value. (A ?rm’s contribution to
value creation also contributes to its bargaining power.) A ?rm’s marginal con-
tribution or added value (to coalition) is the amount by which the total value
created would shrink if the ?rm left the game.
12
Thus, to determine the added
value of a ?rm, we calculate the total value with the ?rm in the game and the
total value without the ?rm. The difference between the two numbers is the
?rm’s added value or marginal contribution. In the biotech example:
The marginal contribution of the startup S is:
v(SAB) ? v(C{S}) = v(SAB) ? v(AB) = 200 ? 0 = 200.
The marginal contribution of A is:
v(SAB) ? v(C{A}) = 200?200 = 0.
That for B is:
v(SAB) ? v(C{B}) = 200 ? 150 = 50.
If we assume that the value appropriated (captured) by each actor is pro-
portional to the value created by the actor and that no ?rm can appropriate
more value than it has created, then we can expect A to appropriate none of the
$200 million, since its contribution to the value created is zero. B, on the other
hand, can appropriate up to $50 million while S can appropriate a minimum of
$150 million (200–50) but not more than $200 million. Effectively, of the $200
million created, the value appropriated by S ranges from 150 to 200 while that
captured by B ranges from 50 and 0. Just where in this range S and B make the
split depends on those aspects of their bargaining powers that have little to do
with value creation. We will return to another example a little later.
Changing the Game
Recall that a cooperative game has two major elements: a set (coalition) of
players and a characteristic function that is a function of the interactions
between the players. One depiction of the players that are typically involved
in value creation and appropriation, and the interdependencies among these
players, is shown in Figure 11.6. These players and their interdependencies
Coopetition and Game Theory 289
constitute what Professors Brandenburger and Nalebuff called the value net.
13
Interactions in the value net during value creation and appropriation can be
thought of as being in two dimensions. Along the horizontal dimension are
the now familiar suppliers and customers with whom the ?rm interacts and
transacts to create and appropriate value.
14
Along the vertical dimension are
the complementors and substitutors with whom the ?rm interacts but not
necessarily transacts. Complementors are the players from whom customers
buy complements, or that buy complementary resources from suppliers.
15
Substitutors are players (existing rivals, potential new entrants, providers of
substitutes) from whom customers may buy products or to whom suppliers
can sell their resources. Note that in other strategy frameworks such as
Porter’s Five Forces, substitutors are all seen as competitors that must be
fought and vanquished. In cooperative game theory, they are seen as potential
collaborators with whom a ?rm can cooperate to create value and compete to
appropriate it.
Changing the game entails changing one or more of its elements. Each change
in any of the elements of a cooperative game that we have explored above is
effectively a new game strategy on the part of the player that initiates the
change. This has implications for value creation and appropriation.
Changing Players
A new game can arise from a ?rm changing one of the players, including itself.
Through the right moves or set of activities, a ?rm can change the number of
players, types of player or the roles played by players. Such changes can have a
direct impact on the value created and how much of it a ?rm can appropriate.
The more customers, suppliers, complementors, and sometimes substitutors
that a ?rm has in a game, the higher the value created and the better the chances
of the ?rm appropriating value created. Let us start with the most obvious. The
more customers that a ?rm can bring into the value net, the more valuable the
value net becomes, since it has more players who can pay for the value created.
The more suppliers that are in a coalition, the better the chances of ?nding one
with whom the ?rm can cooperate. The more suppliers, the better a ?rm’s
chances of having bargaining power over them. It is probably for these two
reasons that most major ?rms insist on having second sources for their key
Figure 11.6 Players in a Value Creation and Appropriation Game.
290 Opportunities and Threats
components; that is, such ?rms insist on having more than one supplier of the
same component. More complementors can mean more and better comple-
ments. The more complements, the more valuable a product. Effectively, a ?rm
can change the game in its favor by changing the number of customers, sup-
pliers, and complementors.
A ?rm can also change the game by changing the type of player in its value
net. The classic example is that of Dell when it entered the PC market. It
bypassed distributors and started selling directly to end-customers who
could get computers customized just for them. This move had both value
creation and appropriation effects for Dell. First, by dealing directly with
end-customers, Dell could better co-create the type of value that
customers wanted through its build-to-order capabilities. It could also offer
service to some customers, making the value net more valuable to them.
Second, by changing players from the more concentrated and powerful
distributors to the more fragmented and less powerful end-customers, Dell
increased its bargaining power vis-à-vis customers. It also lowered its sales and
marketing costs.
Increasing substitutors—existing rivals, potential new entrants, and makers
of substitute products—can sometimes be good for value creation. Early in the
life of a product or technology that exhibits network externalities, joining
forces with many competitors can increase the value of a ?rm’s value net. That
is because the more customers that use such a product/technology or compat-
ible one, the more valuable the product/technology becomes to each customer;
and the more competitors that sell the product/technology or compatible one,
the more customers that will use it. Having competitors join forces to push a
product can help the product win a standard. The story of the PC is now a
classic example. By making it possible for new entrants and other rivals to clone
its version of the PC, IBM increased the number of PC manufacturers. The more
such manufacturers, the more software developers that opted to write software
for PCs, thereby increasing the value of the PC value net. Increasing competi-
tion, especially in fast-paced industries, can also force a ?rm to become a better
developer of newer and better products.
Apart from these exceptions, the goal is to eliminate substitutors or greatly to
reduce their number.
Changing Value Added and Interaction Between Players
Recall that a ?rm’s added value = total value created with the ?rm in the game
minus the total value created without the ?rm in the game. Therefore, when the
right player joins a game, it increases the value of the game. Thus, one way to
increase added value is to add the right number of players of the right quality.
The question here is, what can be done to create additional added value in a
value net, without adding players? Additional value can be created by perform-
ing innovation activities that allow a ?rm to deliver better differentiated or
lower-cost products than existing ones. Recall from Chapter 4 that value cre-
ated is the difference between the bene?ts that customers perceive and the cost
of providing these bene?ts. Thus the activities that a ?rm can perform to create
additional value also include those activities that are designed to create cus-
tomer bene?ts and in?uence customers’ perception as well as those that are
Coopetition and Game Theory 291
designed to keep overall costs down. (Chapter 4 was all about value creation
and appropriation.)
Example 11.2
As another example, consider a market in which there are two suppliers, two
?rms, and one buyer.
16
The buyer is willing to pay $60 for Firm X’s product but
only $120 for Firm Y’s product. Each supplier’s cost of supplying the product is
$5. We will call the suppliers S
1
and S
2
, and the buyer, B.
The value created by the different groups or coalitions (submarkets) of play-
ers is shown in Table 11.2. We start our discussion of the example with sup-
pliers. Since suppliers are identical and only one of them is needed, a market
with either one or both suppliers creates the same value. Therefore the value
created by S
1
S
2
XYB, S
1
XYB, or S
2
XYB is the same. Since the buyer is willing to
pay $120 for Firm Y’s product but only $60 for Firm X’s product, the value
created by a coalition of the buyer, Firm Y and any supplier nets $115 (i.e. $120
minus the $5 cost of either supplier), with or without Firm X; that is,
v(S
1
S
2
XYB) = v(S
1
XYB) = v(S
2
XYB) = v(S
1
S
2
YB) = 115. Note that without the
buyer, there is no value created as far as the market is concerned and therefore
v(S
1
S
2
XY) = v(S
1
XY) = v(S
2
Y) = v(S
1
S
2
) = 0. Also note that with Firm X in the
game, without Firm Y, the value created is only $55 ($60 ? $5) since the buyer is
willing to pay only $60 for Firm X’s product. Thus, v(S
1
S
2
XB) = v(S
1
XB) =
v(S
2
XB) = 55.
The value added by each player and the information for calculating these
values are shown in Table 11.3. Column 2 shows the value created without the
player in question. Column 3 shows the value created by a market (coalition) of
all the players. The value added by any player, as we saw earlier, is the value
created with the player in the market minus the value created by the market
without the player; that is, value added by coalition C = v(S
1
S
2
XYB) ? v(C{p}).
Recall that v(C{p}) is the value created when play p is excluded from coalition
C. Suppliers 1 and 2 do not add any value. That is because of the competitive
effect that results from having two identical suppliers. When one is not in the
market, the other can do the job. Firm X does not add any value when Firm Y is
in the market, since the buyer values Firm Y’s product more than Firm X’s.
When Firm Y is not in the market, then Firm X adds value to the market.
Because there is only one buyer, but two ?rms in the market, the buyer can play
the ?rms against each other.
If we assume that no ?rm can appropriate more value than it created, then the
amounts in column 4 (value added column), are the maximum amounts that
each ?rm can expect to capture. These amounts of value added by each player
add up to more than the value of $115 created by the market. The question is,
how are the $115 shared between the buyer and Firm Y? (The suppliers and
Table 11.2 Coalitions (submarkets) and Value Created
Coalition
(submarket)
S
1
S
2
XYB S
2
XYB S
1
XYB S
1
S
2
YB S
1
S
2
XB S
1
S
2
XY S
1
S
2
S
2
Y XY
Value created 115 115 115 115 55 0 0 0 0
292 Opportunities and Threats
Firm X cannot capture more than $0.) Since Firm X provides competition for
Firm Y, the maximum that Firm Y can hope to capture is $60, the value added
by Firm X. (If Firm Y were to ask for more than $60, the buyer would turn to
Firm X, whose product it values at $60.) This means that the buyer is guaran-
teed a minimum of $55 ($115 ? 60). The remaining $60 can be divided between
Firm Y and the buyer, as a function of each ?rm’s bargaining power.
Applying Game Theory to Value Creation and
Appropriation
Now that we have brie?y explored game theory, the question is, of what use is it
in a ?rm’s quest to create and appropriate value using new game strategies? We
answer this question by ?rst summarizing the usefulness of game theory in
business in general, and then by zooming in on its usefulness to value creation
and appropriation in particular.
Usefulness and Limitations of Game Theory in Business
Recall that ?rms create and appropriate value by performing activities of their
value chain. At each stage of its value chain, a ?rm usually has options as to
which value chain activities to perform; how, where, and when to perform
them. Game theory can help ?rms better choose which activities to perform,
when, where, and how to perform them, since it explicitly takes the likely
actions and reactions of coopetitors into consideration. For example, to create
value, an airplane maker has to perform R&D to develop its prototype, turn the
prototype into an airplane that can be manufactured cost effectively, get it
safety certi?ed by government agencies, establish relationships with suppliers of
components, build inbound logistics for components, build manufacturing cap-
abilities, manufacture, price the planes, sell, ?nance, and distribute the planes.
Given that the aircraft maker’s competitors may be just as interested in per-
forming these activities, game theory can help the ?rm to take the likely actions
and reactions of coopetitors into consideration when making decisions about
which of these activities to perform, how to perform them, and when. The
question is, how?
Table 11.3 Value Added and Guaranteed Minimum
Player p Value created without
player p v(C{p})
Value created by all
players v(S
1
S
2
XYB)
Value added
v(S
1
S
2
XYB) ?
v(C{p})
Guaranteed minimum
appropriation
Supplier 1 (S
1
) v(S
2
XYB) = 115 115 0 0
Supplier 2 (S
2
) v(S
1
XYB) = 115 115 0 0
Firm X v(S
1
S
2
YB) = 115 115 0 0
Firm Y v(S
1
S
2
XB) = 55 115 60 0
Buyer v(S
1
S
2
XY) = 0 115 115 55
Coopetition and Game Theory 293
Framing Strategic Questions
Game theory offers a language and structure for describing the interdependence
between a ?rm and its coopetitors. By identifying the players, specifying each
player’s possible moves (strategies), the timing of the moves and payoffs, game
theory enables ?rms to frame strategy questions that anticipate coopetitors’
likely actions and reactions better. This enhanced framing of questions can help
the decision-making that underpins value creation and appropriation. Using
our aircraft maker example, simultaneous games can be used to explore what
happens if the ?rm were to offer the same plane as its major competitor, if it
raised its price, etc. Sequential games can be used to explore what happens if the
aircraft maker were to offer each type of airplane ?rst or second, etc.
Insights, Possibilities, and Consequences
Game theory can also be used to understand the structure of the interaction
between a ?rm and its coopetitors better. It can be used to understand the
options for changing the rules of the game and the consequences. It enables
?rms to ?gure out what the right moves for the particular situation are. Thus,
an aircraft maker can use game theory to help it explore the consequences of
offering different types of aircraft on its suppliers, complementors, customers,
and rivals. It would also help in understanding what would happen if the ?rm
were to form a coalition with one set of coopetitors rather than another.
Anticipating the Future
By using cooperative game theory questions, a ?rm can imagine how its rela-
tionships and industry would evolve if it were not part of it.
17
For example, a
?rm can ask how well-off its alliance is without it in the alliance, and how well-
off it will be in the future without it. This is a powerful question because it
reminds the ?rm not only of what it has to offer to the alliance relative to other
coopetitors in the alliance but also of the self-interest of the coopetitors that
might be changing. For employees, it may also be a good idea to ask themselves
how much value is created without them working for their ?rm and with them
working for the ?rm.
18
Limitations of Game Theory
Game theory models, like any other model, have their limitations. To see some
of these limitations, let us go back to one of the examples that we saw earlier
(Figure 11.3). By taking each other’s likely reaction into consideration, Firm B
and Firm A can avoid building the same plane and ?nding themselves with too
many planes and not enough sales to break even. They also avoid competing for
suppliers of components and skilled employees. Thus, by helping ?rms to decide
which planes to build, game theory helps them better to create and appropriate
value. An underlying assumption in the argument of Figure 11.3 is that both
?rms have the resources and capabilities to develop, manufacture, certify, and
perform every other activity that it takes to offer a plane that customers value,
once each ?rm decides which plane to offer. The fact is that not every ?rm that
294 Opportunities and Threats
decides to build a plane can build it. Game theory says little about why some
?rms have the resources and capabilities that it takes to create and appropriate
value. Nor does it say much about the procedure for creating and appropriating
value.
19
“In business, as in other games, ?rms can only do as well as the hand
they have been dealt.”
20
Game theory also assumes that actors select those actions that maximize their
payoffs, where payoffs can be any measure of performance including pro?ts or
utility. However, ?rms and the managers that take decisions often have
nonpro?t-maximizing behaviors. For example, a ?rm may take a decision for
political reasons that has nothing to do with maximizing pro?ts. Another
assumption of game theory is that actors have no cognitive limitations and will
be able to obtain and process all the information needed to take the decisions,
no matter how complex the information. Most human beings are cognitively
limited. Finally, game theory models usually say nothing about the focal ?rm’s
larger strategy. For example, in the case of Figure 11.3, we do not know if one
of these airplane makers also offers military planes to governments and can
therefore easily modify the plane that it chooses to offer to transport military
gear. These shortcomings notwithstanding, game theory is still a very good tool.
Like any other tool, game theory has to be used with care, paying attention to
its assumptions and the context in which it is used, if one expects to get much
out of it.
Game Theory and New Game Activities
With this summary of the usefulness and limitations of game theory, we return
to our earlier question: how useful is game theory in a ?rm’s quest to create and
appropriate value using new game activities? One way to answer this question
is to explore the extent to which game theory can be used to explain the contri-
bution of new game activities to value creation and appropriation. To do so, we
recall from Chapter 4 that there are two components to the contribution of a
new game activity to value creation and appropriation: (1) the value chain
factor and (2) the new game factor.
The Value Chain Factor and the Usefulness of Game Theory
As we saw in Chapter 4, new game activities, by virtue of being value chain
activities, are most likely to contribute to value creation and appropriation if
they:
a Contribute to lower cost, differentiation, better pricing, more customers,
and better sources of revenue.
b Contribute to improving the ?rm’s position vis-à-vis coopetitors.
c Take advantage of industry value drivers.
d Build and translate distinctive resources/capabilities.
e Are comprehensive and parsimonious.
Coopetition and Game Theory 295
Contribute to Lower Cost, Differentiation, Better Pricing, More
Customers, and Better Sources of Revenues
A ?rm can use noncooperative game theory to explore which product to offer,
which market segment to enter, whether to raise or lower one’s prices, what
brand to build, which sources of revenue to target, and which customers to
target, given the likely reaction of the ?rm’s rivals. This, however, will not say
much about the bargaining that may go on between the ?rm and its customer
(especially in business-to-business transactions). Nor does it do much for any
cooperation the ?rm and its customers may undertake to create better customer
value and possibly raise customer reservation prices. This is where cooperative
game theory comes in. It can help ?rms to understand better how much value
can be created by which coalitions (of itself and its coopetitors). Cooperative
game theory helps in the analysis of the interdependencies between a ?rm and
its coopetitors that can be critical to targeting the right customers with the right
value, and pursuing the right pricing strategies and sources of revenue.
However, while game theory can say something about which brand to build,
given the brands being pursued by one’s rivals, it says little about cultivating the
ability to build brands. While it can help with analyzing whether and when to
offer a new product targeted at the right customers, it says little about the
ability to build new products. An implicit assumption in many game theory
models is that ?rms will be able to offer the new product or brand that they
decide to build, given their rivals’ likely reaction. Many ?rms that invest in new
products targeted at pro?table product market positions have failed because
they did not have what it takes to develop and commercialize the products.
Contribute to Improving the Firm’s Position vis-à-vis Coopetitors
In taking the likely actions and reactions of rivals into consideration, non-
cooperative game theory can help a ?rm to avoid unnecessary competition. For
example, in the game of Figure 11.3, both ?rms can avoid crashing with each
other in two markets, each of which cannot support both ?rms: if one ?rm
offers the SuperJumbo, the other ?rm should offer the DreamLiner. Thus, non-
cooperative game theory can help a ?rm dampen or reverse the competitive
force from rivalry that can impede the ?rm’s ability to create and appropriate
value. Cooperative game theory can be used to explore the bargaining and
cooperation that goes on between a ?rm and its coopetitors. For example, by
working with its customers to help them discover their latent needs in a new
product, a ?rm can raise customer’s willingness to pay. By working with sup-
pliers to help them reduce their costs, the suppliers are more likely to accept
lower prices from the ?rm.
Again, while game theory can help a ?rm to understand what activity to
pursue to improve its position vis-à-vis coopetitors, given rivals’ likely reaction,
it says little about the ability of the ?rm to pursue the particular activity. For
example, in Figure 11.3, while noncooperative game theory suggests that Firm
A should offer the SuperJumbo, knowing that Firm B will offer the DreamLiner,
it says little about how capable Firm A is at building the SuperJumbo; and while
cooperative game theory can help a ?rm to understand which suppliers it can
work with better to create value, it says little about why some ?rms are better at
296 Opportunities and Threats
such cooperation than others. In the automobile industry, for example, Toyota
has done an outstanding job working with its suppliers to innovate and keep
component costs down, compared to Ford and GM. Game theory tells us little
about what the superior capabilities of Toyota are in working with suppliers
and how one would go about building them.
Take Advantage of Industry Value Drivers
Recall that industry value drivers are those industry factors that stand to have a
substantial impact on the bene?ts (low-cost or differentiation) that customers
want, or the quality and number of such customers. For example, in of?ine
retailing, location is critical since it determines the types and numbers of cus-
tomers who can shop there, the cost of operations, cost of real estate, and the
number and types of competitor. A ?rm can use game theory better to take
advantage of industry value drivers. For example, in choosing a retail location,
a ?rm can use game theory to avoid head-on competition with other retailers.
Build and Translate Distinctive Resources/Capabilities
Decisions to increase or decrease R&D spending, whether or not to patent,
where to build what plant, which brand to build, etc. are all decisions about
building resources/capabilities and as previous examples have shown, nonco-
operative game theory can be used to enlighten such decisions. Cooperative
game theory can also help ?rms to understand the extent to which a ?rm can
cooperate with its coopetitors in building such resources and capabilities. While
game theory can be used to understand whether to increase or decrease R&D
spending, for example, it says little about why some ?rms are better at R&D
than others. Sound game theoretic analysis may suggest that, given what a
?rm’s competitors are doing, the ?rm should increase its R&D spending. Game
theory says little about why, even with the increased spending, the ?rm may still
not be able to effectively and ef?ciently carry out the experimentation, trial,
error, and correction that are critical to R&D.
Are Comprehensive and Parsimonious
The idea here is to make sure that a ?rm performs all the activities that make a
signi?cant contribution towards value creation and appropriation while also
making sure that it does not perform activities that add little or no value relative
to their costs. Noncooperative game theory can help a ?rm to determine which
activities yield the highest payoffs and keep or add them. Cooperative game
theory can be used to determine which actions result in coalitions with the most
value created. Effectively, game theory can be useful in determining which activ-
ities to keep or add and which ones to jettison. However, game theory says very
little about why one ?rm may be able to perform a particular activity more
effectively or ef?ciently than its rivals.
Coopetition and Game Theory 297
The New Game Factor and the Usefulness of Game Theory
As we also saw in Chapter 4, new game activities, by virtue of being new game,
are most likely to contribute to value creation and appropriation if they:
a Generate new ways of creating and capturing new value.
b Offer opportunity to build new resources or translate existing ones in new
ways into value.
c Build and take advantage of ?rst-mover’s advantages and disadvantages,
and competitors’ handicaps.
d Anticipate and respond to coopetitors reactions.
e Identify and take advantage of the opportunities and threats of the competi-
tive and macroenvironment.
Generate New Ways of Creating and Capturing New Value
Cooperative game theory can help us to analyze how adding players or chan-
ging the game can create or destroy value. It can tell us which coalitions will
create what value. Noncooperative game theory can tell us which moves by
which players can result in what payoffs. However, game theory cannot tell us
how each player actually improves its own products. It cannot help us under-
stand the nuts and bolts of how Boeing actually designs and builds safe aircraft.
Build and Take Advantage of First-mover’s Advantages and
Disadvantages, and Competitors’ Handicaps
Recall that sequential games are games in which some players move ?rst. As we
saw earlier, the ?rst mover can then decide whether to yield to entry, or work
hard to deter it; and if it yields to entry, whether to accommodate, ?ght, or exit.
For example, an incumbent can decide to increase entry costs by taking advan-
tage of economies of scale in advertising and R&D, or its accumulated scarce
resources. If there is entry, the ?rm can decide whether to ?ght the new entrant
or accommodate the entry. Effectively, game theory can be used to explore
whether to deter entry or yield, accommodate new entrants or ?ght them, which
?rst-mover advantages to pursue or take advantage of, given rivals’ likely
actions and reactions. However, game theory does not help much with how
ef?ciently and effectively one can build and take advantage of ?rst-mover
advantages.
Anticipate and Respond to Coopetitors’ Reactions
Recall that game theory can be used to understand the interaction between a
?rm and its coopetitors and to understand the options for changing the rules
of the game and the consequences. Thus, one of the premier applications of
game theory is to explore how best to perform new game activities, taking the
likely actions and reactions of coopetitors into consideration. In some ways,
the primary advantage of game theory is in taking the likely reaction of one’s
coopetitors into consideration when taking a decision.
298 Opportunities and Threats
Identify and Take Advantage of the Opportunities and Threats of The
Competitive and Macroenvironment
When a ?rm identi?es opportunities and threats in its environment, the chances
are that its rivals also see the same opportunities and threats and would like to
take advantage of them too. Game theory helps ?rms to take into consideration
the likely actions and reactions of competitors in taking advantage of the
opportunities and threats of their environments. Noncooperative game theory
can help a ?rm to explore questions such as whether to enter a new market (say,
opened up by deregulation), where to position its products in the market (iden-
ti?ed white space), and how much money to spend on advertising or govern-
ment regulations. Cooperative game theory helps ?rms to analyze the inter-
action between a ?rm and its coopetitors as it creates and appropriates value.
However, game theory does not say much about what types of resource a ?rm
needs so as to take best advantage of the opportunities and threats.
Summary and Conclusions
If a ?rm views activities as potentially pro?table, the chances are that its com-
petitors would also ?nd the same activities or related ones as pro?table. There-
fore, before pursuing any activities, a ?rm may be better off anticipating the
actions and reactions of its coopetitors—be they rivals, suppliers, complemen-
tors, buyers, or makers of substitute products. In an industry analysis tool such
as Porter’s Five Forces that explores the role of rivalry in pro?tability, emphasis
is on factors such as the number of sellers in the market, whether the industry is
growing or declining, differences in ?rms’ costs, excess capacity, level of prod-
uct differentiation, history of cooperative pricing, observability of prices, and
whether there are strong exit barriers. Beyond these factors that impact over-
arching rivalry in the industry, the interactions that take place among ?rms can
also have a huge impact on pro?tability. This is where game theory comes in.
Game theory encourages managers to factor the likely reaction of coopetitors
into their decisions; that is, it encourages managers to factor into their actions,
not only what coopetitors are planning to do but also what is in the coopetitor’s
best interest.
Both noncooperative and cooperative game theory can be useful tools for
exploring value creation and appropriation activities. The former enables ?rms
to ask questions such as, what should my actions be, given the likely actions and
reactions of my rivals who are acting in their own individual self-interests? It
can be used to explore elements of both value creation and appropriation.
However, noncooperative game theory leaves a ?rm’s interaction with its coo-
petitors—suppliers, customers, complementors, and rivals—largely explored.
Cooperative game theory is about these interactions (bargaining, cooperating,
etc.) between ?rms and their coopetitors. The payoffs are for different coali-
tions and competition is between coalitions. As pointed out by Professor H. W.
Stuart, cooperative game theory opens up even more interesting questions for
?rms, such as: if a ?rm were not around, from whom would its buyers buy?
Would its buyers have a lower willingness to pay for the alternatives? To whom
might its suppliers sell? While cooperative game theory has both cooperative
and competitive elements, noncooperative game theory has largely competitive
Coopetition and Game Theory 299
elements and limited cooperative elements. Ultimately, competitive advantage
comes from a distinctive system of activities or distinctive resources. Game
theory does not say much about the sources of resources or systems of activities.
It does not say much about the procedure for creating or appropriating value.
Exercises
1 In the game of Figure 11.7:
a Would the threat of the incumbent to ?ght the entrant be credible?
b If the $20 payoff were $26, would the threat to ?ght the new entrant be
credible?
c What type of new game activity could the incumbent perform to
increase the payoff from $20 to $26?
2 Consider a market in which there are two suppliers, three ?rms, and two
buyers. The buyers’ willingness to pay for each ?rm’s product is the same:
$60. Each supplier’s cost of supplying the product is $5.
a What is the value added by each player?
b How much value does each player appropriate?
c Suppose there is only one ?rm. What would the value added for each
?rm be?
3 Which one is a better tool for value appropriation: cooperative or noncoop-
erative game theory? Why?
Key Terms
Characteristic function
Cooperative game
Cooperative game theory
Dominant strategy
Dominant strategy equilibrium
Marginal contribution
Nash equilibrium
Noncooperative game
Noncooperative game theory
Prisoner’s dilemma
Simultaneous games
Strategy (in game theory)
Value net
Figure 11.7 For Question 1.
300 Opportunities and Threats
Applications
Chapter 12: Entering a New Business Using New
Games
Chapter 13: Strategy Frameworks and Measures
Part IV
Entering a New Business Using
New Games
One of the most important decisions that a ?rm can take is to enter a new
business. If successful, entering a new business can contribute to a ?rm’s growth
rate and pro?ts. If unsuccessful, entering a new business can drain a ?rm of
important resources that could have been invested elsewhere and may damage
the reputation of the ?rm. In this chapter, we explore a framework that not only
can be used to evaluate a ?rm’s entry into a new business but also can be used to
aid a ?rm in taking the decision to enter a new business. Our de?nition of a new
business is very broad. Entering a new business can range anywhere from enter-
ing a new market segment using one’s existing technologies, to adopting a new
technology that takes one into a new market segment, to diversifying into a
totally unrelated business using radically different technologies. We start off by
looking at some of the reasons that managers—rightfully or wrongfully—often
give for entering a new business.
Why Firms Enter New Businesses
There are several reasons why a ?rm would want to enter a new business: We
explore seven of these reasons: growth, resources/capabilities, economies of
scale and scope, internal ?nancial markets, market power, and personal.
Growth
One of the most popular reasons offered by ?rms when they decide to enter a
new business is the pursuit of growth. A ?rm’s existing business may be in a
mature industry that is stagnant or slowly dying and the ?rm wants to enter an
industry with better growth perspectives to assure its long-term viability. In
some cases, a ?rm may ?nd itself in a situation where it grew a lot for a few
years and because of that growth, its stock is now very highly valued, where the
high valuation has factored in the assumption that the ?rm will continue to
grow at the existing rate. The ?rm may then be tempted to move into other
markets to sustain that growth rate. As we will see later on, the fact that a new
business is fast-growing is neither a suf?cient nor necessary condition to enter
the business.
Chapter 12
Resources/Capabilities
A ?rm may have distinctive resources/capabilities that can be extended pro?t-
ably into different markets. Such a ?rm can use the resources/capabilities to
enter new businesses. A popular example is that of Honda, which has used its
internal combustion engine capabilities to enter different businesses that
include motorcycles, automobiles, lawnmowers, marine vehicles, electric gen-
erators, and airplane engines. As another example, eBay built a brand name
reputation and a large community of registered users that were originally used
by members to trade in antiques and collectibles. As the community grew larger
and its brand became even more popular, eBay was able to use these resources
to enter other categories such as automobiles. Sometimes, ?rms generate lots of
cash and may feel compelled to invest the cash in new businesses.
Economies of Scope and Scale
A ?rm enjoys economies of scope if its per unit costs of offering more than one
product are less than those of offering only one product. If a ?rm enters a new
business and can utilize some of its existing resources/capabilities to perform
activities in the new as well as old business, the cost of each business may be
lower than if the ?rm operated each business without the other. For example,
the more businesses in which Honda can use its engines, the smaller the cost of
some of its R&D on a per unit basis. A ?rm can also enjoy economies of scale by
entering a new business. For example, if the new business has common inputs, a
?rm may be able to combine its purchasing activities, thereby reducing its costs
through increased bargaining power and other cost-saving activities.
Internal Financial Market
If a ?rm has more than one business, some of them may generate more cash
than others. The cash generated can be used to ?nance the activities of the
businesses that are more cash-strapped. For example, a ?rm in a seasonal busi-
ness may be out of cash during the off-season but full of cash during the on-
season. Having another business that generates cash during the existing busi-
ness’ off-season can smoothen the cash cycle. A ?rm can also buy a new
business that generates cash so that it can use the cash to feed fast-growing
businesses that need lots of cash. By advocating the creation of a portfolio of
businesses in which cash from so-called cash cows can be used to ?nance the
activities of so-called stars that usually need lots of cash but do not generate
enough, the BCG Growth/Share matrix framework epitomized this idea. The
argument against entering a new business so as to promote better internal
?nancial management is that in a world of ef?cient capital markets, share-
holders can take the cash from the existing business and invest in any other
business that they want; that is, shareholders are better able to make decisions
on which business to enter than managers. Moreover, if a business needs cash, it
can raise it from the ?nancial markets. The problem with this argument is that
capital markets, especially in developing economies, are not always ef?cient. A
capital market is ef?cient if information about alternate investment opportun-
ities, the ?rms that want to borrow, what these ?rms want to do with the
304 Applications
money, their honest intentions, and so on is easily available to everyone at low
cost. When capital markets are not ef?cient, it may make sense to enter another
business so as to ?nd cash or use existing cash to ?nance businesses internally.
In fact, businesses often create ?nancing units to provide ?nancing to customers
of their other business units. Some of these ?nancing units are often very
pro?table.
Market Power
Consider two ?rms that have the potential to have a Coke and Pepsi-type
coexistence that allows them to thrive. If these two ?rms have multiple busi-
nesses and encounter each other in more than one business, the chances of their
cooperating tacitly are higher, since the bene?ts of cooperating are higher in
more businesses than in only one business. Put differently, the losses from not
cooperating can be very large when ?rms encounter each other in many busi-
nesses. For example, if ?rms engage in price wars in many businesses, they stand
to lose a lot more money than if they did so in just one business. Thus, a ?rm
may enter other businesses so as to better cooperate tacitly with a competitor
that it faces in other businesses. A ?rm with more than one business can also use
its market power in one business to give it an advantage in other businesses.
This may be illegal in some countries. For example, Microsoft was accused of
using its power in operating systems to have an advantage in Web browsers.
Personal Managerial Reasons
Managers’ incentives for performing certain activities can sometimes diverge
from their ?rm’s interests. A manager might enter a new business not so much
because he/she believes that the new business will be pro?table but because he
or she wants to build an empire. That would be the case, especially if the
manager’s compensation is tied to the growth rate of the company and to enter
new businesses increases that growth rate.
Reduce Transaction Costs
If a ?rm’s critical input or complement comes from a competitor or potential
competitor and there are no reliable second sources for the input or comple-
ment, the ?rm may want to start producing the input or complement. Why?
Because the competitor, in looking after its own interests, may decide to use the
component or complement in ways that are not in the ?rm’s interests. For
example, a maker of microchips that also uses the chips to make cameras may
decide to keep the latest and most critical information about upcoming chips
for itself when such information can give it an advantage in cameras that more
than outweigh any advantage from selling the chips to competitors. The ques-
tion becomes, why not enter into agreements that specify what each party is
supposed to do? In cases where there are lots of contingencies to the contract
and there is a lot of uncertainty, it is too costly to draft, monitor, and enforce
such a contract. Thus, many contracts are necessarily incomplete and as
uncertainty unfolds, a competitor who supplies a component or complement
may decide to be opportunistic. The fear of such opportunism can be enough to
Entering a New Business Using New Games 305
force a ?rm to enter the business of producing the component or complement
for its products rather than depending on suppliers and complementors. The
fear of opportunism from complementors may be one reason why Apple intro-
duced Safari, its own Web browser.
Whatever a ?rm’s reasons for entering a new business, in the end the ?rm has
to be as pro?table or more pro?table when it enters the new business than it was
before entering. Whether a ?rm is pro?table in a new business depends on how
well the ?rm is able to create and appropriate value, given the attractiveness of
the business.
Managers may give all sorts of reasons for entering a new business. When all
is said and done, the ?rm has to make pro?ts either from the new business, or
from the old business as a result of entering the new business. This entails
creating and appropriating value in the new business or as a result of the new
business.
Evaluating the New Business for Entry: The Three
Tests
Since ?rms are in business to make money, a ?rm that wants to enter a new
business ought to plan on being at least as pro?table as it was before entering
the new business. That will be the case if the ?rm makes money in the new
business or there is something about entering the new business that increases
the pro?tability of the ?rm’s existing (old) business. Making money in the new
business entails creating value and appropriating it. Doing so entails competing
with rivals for resources and customers, cooperating and bargaining with sup-
pliers and customers, and coping with the threat of substitutes and potential
new entry. Therefore one of the ?rst things to do in evaluating a new business
for potential entry is to understand the nature of the competitive and macro-
environmental forces that ?rms in the new business face. This appraisal of
industry forces is called the attractiveness test since it explores the extent to
which competitive and macroenvironmental forces impact average pro?ts in the
new business.
1
The attractiveness tests tells us something about average pro?t-
ability in the new business but says little about how much of these pro?ts the
?rm can make, relative to its rivals, when it enters the new business. This is
where the second and third tests—the better-off and cost-of-entry tests—come
in. The better-off test evaluates the extent to which a ?rm stands to pro?t by
entering the new industry. Finally, since building entry capabilities cost money,
it is also important to evaluate the cost of entry. This is about how much it costs
to enter a business relative to the pro?ts generated by virtue of entering the
business. We now explore all three tests in detail.
Attractiveness Test
The attractiveness test helps a ?rm that wants to enter a new business to
understand better what it is getting itself into by entering the new business. The
test examines the simple questions: what are the competitive and macro-
environmental forces that the ?rm would face if it were to enter the new busi-
ness? Who are the key competitors that the ?rm would have to worry about if it
were to enter the new business, and what is it about these competitors that the
306 Applications
?rm should worry about? Which suppliers and customers dominate? Do
makers of substitutes//complements or potential new entrants pose a threat?
What is the pro?tability of the new business?
Competitive and Macroenvironmental Forces
A business is attractive if it is, on average, pro?table to the ?rms in it. Recall
that a business’ pro?tability depends, in part, on the competitive forces in the
business—in particular, it depends on the rivalry in the business, the bargaining
power of suppliers and buyers, the threat of potential new entry and the power
of substitutes/complementors. If rivalry is high, buyers and suppliers have bar-
gaining power, the threat of potential new entry, and of substitutes/complemen-
tors is high, then the business is not pro?table and therefore termed unattractive
to ?rms in it. This does not mean that a ?rm cannot make money in the busi-
ness. Firms can and do make money in unattractive industries but doing so is
more dif?cult than in an attractive one. Effectively, a ?rm that plans to enter an
unattractive business must be ready to deal with the repressive forces that exist-
ing ?rms in it face. Such a ?rm should identify what the repressive forces are and
?nd ways to dampen their effect or eliminate them.
If rivalry in business is low, business ?rms have bargaining power over buyers
and suppliers, and the threat of potential new entry and of substitutes/comple-
mentors is low, the business is said to be attractive (to ?rms in it) since it is, on
average, pro?table. The fact that a business is growing does not necessarily
mean that the business is attractive. High growth lowers only one of the com-
petitive forces in an industry and little else. An attractive business is good for
?rms that are already in the business but not necessarily for a ?rm that wants to
enter the business. There are four reasons why an attractive business (for ?rms
already in it) may not be attractive to an outsider. First, one reason why the
business is attractive may be because ?rms in the business have a history of
retaliating against new entrants, thereby decreasing new entry or keeping any
?rms that enter in check. This may be a warning shot to any ?rm that is con-
templating entry. Second, if one reason for the attractiveness of the business is
high barriers to entry, an outsider that wants to make money in the business
must overcome the barriers to entry. Doing so can be very costly. Third, incum-
bent ?rms in the business may have distinctive capabilities (including comple-
mentary assets) that are dif?cult for new entrants to acquire. Fourth, if the
business is attractive, it is possible that many other ?rms want to enter and
enjoy the pro?ts. This desire to enter means that potential new entrants may
end up bidding up the prices of the resources/capabilities that are required to be
pro?table in the business so high that whoever enters would have spent so much
that any pro?ts earned would go to pay for the high cost of entry.
A business’ macroenvironment can also have a large effect on its attractive-
ness. For example, if a government keeps prices in a business arti?cially low or
high, it impacts pro?tability directly. If a government imposes exit barriers, the
business loses some of its attractiveness since ?rms may be forced to sell their
products at very low prices so long as such prices cover their variable costs. In
any case, it is important for a ?rm that wants to enter a new business to under-
stand carefully the environment in which it is going to compete if it enters the
business.
Entering a New Business Using New Games 307
Frameworks of Analysis
A framework for identifying and analyzing the competitive forces that impact a
business and determine average pro?tability for the business is Porter’s Five
Forces. The framework enables one to determine what underpins rivalry, poten-
tial new entry, bargaining power of buyers and suppliers, and the threat of
substitutes. Another framework that can be useful in developing and under-
standing the pro?tability potential of an industry is the Structure-Conduct-
Performance (SCP) framework.
2
In the SCP framework, performance (average
pro?tability of the business) is determined by conduct. Conduct, which is
determined by structure, is about the activities that ?rms, suppliers, and buyers
in the business perform, such as R&D, advertising, strategic alliances, mergers
and acquisitions, pricing, cost reductions, new product introductions, and cap-
acity increases or decreases. Structure refers to the number of ?rms, suppliers,
and buyers; the type of technology utilized; the degree of product differen-
tiation; the degree of vertical integration; nature and level of competition
(regional, domestic, or international), and the level of barriers to entry. By using
the SCP to determine the nature and level of competition, what drives competi-
tion, critical activities, and what drives value, a ?rm is in a better position to
perform well if or when it enters the industry. For example, if industry ?rms
have a habit of retaliating against new entrants via activities such as pricing,
R&D or new product introductions, the ?rm in question should better under-
stand what it is getting into. The Five Forces are a rendition of SCP.
Key Players in the Business
A Five-Forces or SCP analysis tells one a lot about competition by providing
information about the number of competitors, industry growth rate, presence
or lack of product differentiation, and so on. However, it is still important for
the ?rm that wants to enter the new business to ?nd out as much as possible
about the key players in the business. For example, if a ?rm wants to enter the
carbonated soft drinks industry, it may be better off ?nding out about how
dominant players Coke and Pepsi compete against each other and against new
entrants to their industry. If the new business is the main source of pro?ts or
cash for a major player in the business, the player is not likely to roll over when
another ?rm enters the business. For example, Sony’s video game business was
one of its biggest sources of pro?t in 2001 when Microsoft entered the video
game business. Thus, one would expect Sony rigorously to ?ght back Micro-
soft’s attempts to grab market share.
Better-off (and Alternatives) Test
The better-off tests can be thought of as consisting of three questions: what is it
about the ?rm that will enable it to be pro?table in the new business? If there is
nothing, would entering the new business increase the pro?tability of the ?rm’s
existing (old) business? What are the ?rm’s alternatives for making money or
for growth outside of entering the new business?
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What is It About the Firm That Will Enable It to be Profitable
in the New Business? Old Game
One way of asking this question is: does the ?rm bring something to the new
business that will allow it to create and appropriate value, thereby enabling it to
make money in the new business? If the ?rm is going to enter the new business
and be pro?table, it has to create value for customers in the business and be in a
position to appropriate the value. (It can also make money by positioning itself
to appropriate value created by others.) Recall from Chapters 2 and 4 that
creating and appropriating value entails performing activities that:
1 Contribute to low cost, differentiation, and other drivers of pro?tability.
2 Improve position vis-à-vis coopetitors.
3 Take advantage of industry value drivers.
4 Build and translate distinctive resources/capabilities in new value.
5 Are parsimonious and comprehensive.
The extent to which a ?rm’s activities have to meet these ?ve objectives for it to
be better off is a function of how pro?table its existing business is, how much
competition it is likely to face in the new business, and its goal in entering the
business. If a ?rm’s existing business is not very pro?table and competitors in
the new business are accommodating, the ?rm can get away with partially
meeting some of these objectives. If a ?rm’s goal in entering a new business is to
exploit a niche market that does not mean much to the key competitors in the
market, the ?rm may be able to make some pro?ts without attracting a lot of
attention and therefore does not have to worry as much about dampening or
reversing competitive forces.
In performing activities to meet these ?ve objectives, a ?rm can either pursue
the same old game in which it tries to outdo its competitors in the new business
by performing the same value chain activities that are presently being per-
formed in the business, or pursue a new game strategy in which it changes some
of or all the rules of the game for the new business. In this section, we explore
entry using old games, postponing new games for later in the chapter.
Contribute to Low Differentiation, and other Drivers of Profitability
A ?rm with scarce valuable resources/capabilities can use them to offer the right
value (low cost, differentiation) to the right customers in the right market seg-
ments. For example, prior to entering the groceries business, Wal-Mart had
developed superior logistics and information technology capabilities. It used
these capabilities to its advantage when it entered the groceries business, keep-
ing its costs lower than those of competitors so that it could pass the cost
savings to customers in the form of lower prices. Virgin used its brand in trans-
atlantic airlines activities and music records to enter other businesses. In some
cases, a scarce resource such as a luxury brand can allow a ?rm to charge more
for products in the new business.
Entering a New Business Using New Games 309
Improve Position vis-à-vis Coopetitors
The attractiveness test lets a potential new entrant into a new business know
which forces are repressive and which ones are friendly. A ?rm can improve its
position vis-à-vis coopetitors by dampening some of the repressive forces or
reinforcing existing ones using scarce capabilities from its existing business. For
example, a ?rm can bring the power that it has over suppliers or customers in an
existing business into the new business, thereby allowing it to dampen repres-
sive industry forces. For example, Wal-Mart already had a lot of purchasing
know-how and bargaining power over suppliers in its retail business when it
entered the groceries business. It had also learnt how to work with suppliers to
reduce costs. The ?rm was able to use these capabilities to have more power
over suppliers than other groceries suppliers, thereby keeping its costs lower. A
?rm with good government relationships in a country where such relationships
matter can use them to its advantage to enter a new business where competitors
do not have such relationships with the government.
Take Advantage of Industry Value Drivers
Recall that an industry value driver is a factor that has the most impact on cost,
differentiation, or other driver of revenues or pro?t. In retail, location is an
industry value driver since it impacts not only the cost of operations but also the
amount of customer traf?c to the store as well as the image of the store, all of
them key drivers of revenues and pro?ts. By choosing to expand existing retail
stores into superstores when it entered the groceries business, Wal-Mart was
able to take advantage of location—a critical industry value driver in retail.
Taking advantage of industry value drivers can contribute to a ?rm’s pro?t-
ability in a new business.
Build New Distinctive Resources/Capabilities or Translate Existing
Ones Into Superior Value
Many of the examples above are about translating existing capabilities in the
old business into value for the new business. Some of the activities can also
build new resources/capabilities in the new business that the ?rm can use to
create value and better position itself to appropriate the value. For example, in
offering groceries, Wal-Mart has also built capabilities in sourcing perishable
items—capabilities that it previously did not have when it offered only
retail goods.
Are Parsimonious and Comprehensive
Recall that the parsimony and comprehensiveness criteria is about performing
the right number of the right kinds of activities. A ?rm that enters a new busi-
ness by buying another ?rm which performs many super?uous activities, can
lower its costs by eliminating such activities, thereby improving its chances of
being pro?table in the new business. A ?rm can also enter a new business and
perform critical activities that were not being performed before.
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Would Entering the New Business Increase Profitability of
Existing Business?
A ?rm can also be better off entering a new business, not so much because of the
pro?ts that come directly from the new business, but because of how entering
the new business helps improve the pro?tability of the existing (old) business.
We explore three cases: defending existing market position, vertical integration,
and complementing a product line.
Defending an Existing Market Position
A ?rm can enter a new business to prevent competitors from using the new
business to erode the ?rm’s competitive advantage in its existing business. For
example, when Microsoft entered the video game console business, it was
speculated that the ?rm was doing so to prevent Sony from using the video
game console business to erode Microsoft’s competitive advantage in PC oper-
ating systems. The problem with this claim is that it is very dif?cult to prove or
disprove it. This strategy is derived from warfare where by occupying an enemy
in one battle, you prevent the enemy from ?ghting you in another battle. The
problem with it is that one does not have to ?ght to win, and ?ghting often
results in no true winners.
Vertical Integration
A ?rm can integrate vertically backwards into the business of producing its own
inputs or vertically forward into disposing of its outputs so as to improve its
pro?tability. To assure the quality of the coffee that it sells, a retailer of coffee in
the USA may decide to integrate vertically backwards into growing its own
coffee in South America or Africa. A ?rm can also integrate vertically back-
wards to prevent its suppliers from behaving opportunistically. As we saw
earlier, for example, Apple Computers developed its own Web browser called
Safari so as to avoid depending on competitor Microsoft’s Internet Explorer. By
integrating vertically forwards into bottling their colas in some parts of the
world, Coke and Pepsi are better able to assure pro?tability of their
concentrate.
Complement Existing Product Line
It may be the case that a ?rm’s existing products will sell better if it were to enter
a new business and in the process complement existing products, thereby mak-
ing them more valuable to customers. For example, in developing countries
where capital markets are not very ef?cient, a ?rm may enter the ?nancial
services business so as to better ?nance purchases for the many customers who
may not have ?nancing.
Alternatives Outside of Entering New Business
An obvious alternative to entering a new business is to not enter the business
at all. If a ?rm’s goal is to maximize shareholder value, the ?rm might be better
Entering a New Business Using New Games 311
off giving money back to shareholders in the form of dividends rather than
spending the money on an unpro?table new business. Thus, a ?rm may be
making a mistake if it entered a new business only because it had a lot of cash
that it believes it has to invest. Shareholders may be better off reinvesting the
money themselves. More importantly, a ?rm may want to conduct the three
tests on many businesses before deciding which one to enter, if at all.
Cost of Entry
Entering a new business and performing the activities that enable a ?rm to
create and appropriate value can be costly. These costs have to be weighed
against the expected returns from entry. Effectively, cost-of-entry is a relative
term in that costs have to be compared to the revenues that are generated as a
result of entry. The idea is to keep track of the extent to which a ?rm’s rate of
pro?tability after entry is higher than that before. On the one hand, for
example, an attractive business may hold prospects for high margins but the
cost of entry may be so high that any cash ?ows from the business will be more
than dissipated by the very high cost of entry. On the other hand, an
unattractive business may have little prospect for high margins but cost very
little to enter. In any case, such costs have to be carefully explored and com-
pared to the cost of not entering prior to entry.
Drivers of Entry Costs
For several reasons, if an industry is attractive, the cost of entry is likely to be
high. First, as we saw earlier, if a business is attractive (to ?rms in the business)
barriers to entry are likely to be high. If barriers to entry are high, it is likely to
cost a lot to overcome these barriers to enter the business. For example, if a
barrier to entry is the brand equity of incumbents (e.g. Coke’s brand), any new
entrant that hopes to have a competitive advantage may have to build a com-
parable brand equity. This can cost a lot and takes time. Second, as we also saw
earlier, if a business is attractive (pro?table), other pro?t-seeking ?rms are likely
to be interested in also entering. If enough such ?rms want to enter, they are
likely to bid up the cost of the resources that it takes to create and appropriate
value in the business, thereby increasing costs for whoever ends up entering the
business. Third, if the business is attractive, leading ?rms with a competitive
advantage are likely to be pro?table. Such leaders are not likely to give up their
pro?ts to new entrants without a ?ght. In fact, if these leaders have been making
a lot of money, they are likely to have war chests to ?ght new entrants. Thus,
new entrants may ?nd themselves in costly ?ghts. For these three reasons, it can
be so costly for a ?rm to enter an attractive business that even if it can create and
appropriate value as a result of entering the new business, any potential pro?ts
from the entry would be dissipated by the high entry costs.
In addition to depending on the type of business, entry costs also depend on
the type of ?rm that is entering. If a ?rm already has many of the resources that
are needed for the new business, it may be cheaper for the ?rm to enter. That
would be the case, for example, if the resources that the ?rm uses in its existing
business can be pro?tably extended to the new business. The Honda example
that we used earlier comes into play here. Since the company already had engine
312 Applications
capabilities when it entered each new business, its cost of offering the product
for the new business were lower than those of other ?rms that had to develop
the engine from scratch. Sony already had distribution channels in place when it
entered the video game console business, making its cost of entry lower than
those of a startup.
Finally, entry costs can also depend on how the entry process is implemented.
When a ?rm enters a new business, it needs people to run the business. The ?rm
also needs to structure its organization to accommodate the new business, and
establish the systems, processes, and culture that are appropriate to running the
new business. The interaction of people, structure, systems, processes, and cul-
ture cost money and keeping these costs to a minimum can go a long way to
keeping costs low.
Opportunity Cost of Not Entering
In addition to the cost of entry, there can also be “costs” to not entering, also
called the opportunity cost of not entering. That would be the case, for
example, if the new business is rooted in a disruptive technology that may later
invade the existing business. In that case, if a ?rm in the existing business does
not enter the new one, it may be too late when it ?nally has to do so. For
example, the PC was a disruptive technology to minicomputers because it even-
tually did a lot of what minicomputers used to do and therefore rendered them
noncompetitive in many markets. Those minicomputer makers who had not
taken the PC seriously saw their minicomputer businesses eroded by the PC.
Disruptive technologies were explored in great detail in Chapter 8.
Estimating Relative Cost of Entry
We consider two ways of estimating the cost of entry: breakeven and cash ?ow
analyses.
Breakeven Analysis
3
A breakeven analysis offers an alternative and sometimes complementary
approach to cash ?ow analysis. Before beginning the analysis, let us quickly
review some basics.
Pro?ts = revenues ? variable costs ? ?xed costs
= PQ ? V
c
Q ? F
c
= (P ? V
c
)Q ? F
c
= Contribution margin ? F
c
= (Contribution margin per unit)Q ? F
c
(1)
where P is the price per unit of the product, V
c
is the per unit variable cost, Q is
the total number of units sold, and F
c
is the up-front or ?xed costs. The quantity
“PQ ? V
c
Q” or revenues minus variable costs, is called the contribution margin
and represents the amount over variable costs that goes to contribute towards
recovering ?xed costs. The quantity “P ? Vc,” the difference between price per
unit, and per unit variable costs, is called the contribution margin per unit.
Entering a New Business Using New Games 313
We can now begin the breakeven analysis. If the contribution margin is
positive, then as the quantity sold goes up, there reaches a certain quantity
where all the ?xed costs have been recovered. This is the quantity at which
revenues equal total costs and is called the breakeven point. It is the point where
the ?rm has zero pro?ts from the investment. Below the breakeven point, the
?rm loses money. Above the breakeven point, the ?rm makes money. This point
can be determined by equating equation (1) to zero since pro?ts are zero. If we
do that, we obtain:
Pro?ts = PQ ? V
c
Q ? F
c
= (P ? V
c
)Q ? F
c
= 0
From this,
Q =
F
c
(P ? V
c
)
. (2)
Recalling that P ? V
c
is the contribution margin per unit, breakeven quantity
can be computed as:
Breakeven quantity =
Fixed Cost
Contribution Margin Per Unit
(3)
For several reasons, breakeven time, the time that it takes a company to break
even, is also important. First, the longer it takes to break even, the longer
resources may have to be tied up performing unpro?table activities, thereby
forgoing potentially pro?table investment opportunities. Second, the longer it
takes a ?rm to break even, the more time competitors have to catch up or put
more distance between themselves and the ?rm if they are ahead. Breakeven
time is obtained by dividing the breakeven quantity by sales rate; that is,
breakeven time (in years) is the breakeven quantity divided by sales per year.
Mathematically,
Breakeven time =
Breakeven Quantity
Sales Rate
(4)
=
F
c
(P ? V
c
) × (Sales Rate)
Example
A software company called PrintMoneySoft spent a total of $500 million in
R&D, marketing, promotion, and other upfront ?xed costs to offer a software
package that it sells for $100 a copy. Since the company has posted the software
on the Web for customers to download, each copy that it sells only costs the
company $10 dollars to produce and sell. Because of its huge installed base of
customers, the company estimates that it can sell 25 million units a year. What
is the breakeven quantity and how long will it take for the company to
break even?
314 Applications
Breakeven quantity =
F
c
(P ? V
c
)
=
$500M
$100 ? $10
= 5.56 million
Since the sales rate is $25 million per year, breakeven time (in years)
5.56M
25M
years = 0.22 years
Alternatively,
Breakeven time (years) =
Breakeven Quantity
Sales Rate
=
F
c
(P ? V
c
) × (Sales Rate)
=
$500M
($100 ? $10) × (25M)
= 0.22 years
Thus, in less than three months, PrintMoneySoft has recovered the $500 million
dollars that it invested and in the next ?ve years, the billions of dollars that it
collects will contribute directly to pro?ts.
Cash Flow Method
When a ?rm enters a new business, it receives revenues from the business and
related sources of revenue. The ?rm must also pay out money to cover the costs
that it incurs in creating and appropriating value. Moreover, it must also cover
all the costs that it incurred in entering the new business. Ideally, in evaluating a
business for entry, one would determine all the future cash ?ows net of all
expenses and discount them to the present to determine the pro?tability of the
venture. If C
t
is the difference between revenues and costs at time t, the present
value of these cash ?ows, V
t
, is given by is
V
t
= C
0
+
C
1
(1 + r
k
)
+
C
2
(1 + r
k
)
2
+
C
3
(1 + r
k
)
3
+ . . .
C
n
(1 + r
k
)
n
=
?
t = n
t = 0
C
t
(1 + r
k
)
t
(5)
where r
k
is the ?rm’s discount rate. This is the ?rm’s opportunity cost of capital.
It is the expected rate of return that could be earned by investing money in
another asset instead of the company. It re?ects the systematic risk—that is,
risk that is speci?c to the ?rm’s business model and therefore cannot be elimin-
ated by diversi?cation. This can be estimated using a model such as the capital
asset pricing model (CAPM) which states that:
r
k
= r
f
+ ?
i
(r
m
? r
f
) (6)
That is, the discount rate consists of two parts: a risk-free rate, r
f
, and a risk
Entering a New Business Using New Games 315
premium, ?
i
(r
m
= r
f
). The risk free rate, r
f
, can be proxied with the interest rate
on treasury bills. The idea is that if one were to invest one’s money in US
Treasury bills, one would get a sure return, since the government is always
going to be there and will pay its debts. This interest rate is low since it is risk
free. The risk premium, ?
i
(r
m
? r
f
) re?ects the additional interest that should be
expected, on top of the risk-free rate, since one is investing in a business that is
more risky than treasury bills. This risk premium is equal to the systematic risk,
?
i
, of the ?rm, times the excess return over the market return r
m
. The ? (beta) of
similar businesses (within or outside the ?rm’s industry) is used.
A major drawback for this cash-?ow valuation method is that forecasting
future cash ?ows accurately is extremely dif?cult. The further out into the
future, the more dif?cult it is to forecast cash ?ows. Equation (1) can be further
simpli?ed by assuming, as we did in Chapter 2, that the free cash ?ows gener-
ated by the ?rm being valued will reach a constant amount (an annuity) of C
f
,
after n years. If we do so, equation (6) reduces to:
V =
C
f
r
k
(1 + r
k
)
n
(7)
If we further assume that the constant free cash ?ows start in the present year,
then n = 0, and equation (3) reduces to:
V =
C
f
r
k
(8)
Another way to simplify equation (4) is to assume that today’s free cash ?ows,
C
0
, which we know, will grow at a constant rate g forever. If we do so, equation
(4) reduces to:
V =
C
0
r
k
? g
(9)
Using New Games to Enter
The attractiveness test tells a ?rm if the new business is, on average, pro?table
for ?rms that are already in the business or not and why? A ?rm can use new
game activities to make the business more attractive for itself, enabling it to be
more pro?table than its rivals in the new business. It can also use new game
activities to lower the cost of entry, insuring that any rents that it generates in
the new business are not dissipated by the cost of entry. We explore both. In
either case, the type of strategy that is pursued by incumbents in the old business
can also play a major role.
Using New Game Activities to Make a Business Attractive for
a Firm or Lower Entry Costs
As we saw above, if a business is attractive to ?rms in the business, then one of
316 Applications
several things may be happening: either barriers to entry are high, ?rms have
power over suppliers or buyers, the threat of substitutes is low, or rivalry is low.
The question is, what type of new game activities can a ?rm use to enter such a
business and make the business more attractive for itself than the incumbents
who have been in the business longer? Recall that new game activities can:
1 Generate new ways of creating and capturing new value.
2 Build new resources or translate existing ones in new ways into value.
3 Create the potential to build and exploit ?rst-mover advantages.
4 Attract reactions from new and existing competitors.
5 Have their roots in the opportunities and threats of an industry or
macroenvironment.
We now explore how a ?rm can take advantage of each of these characteristics
of new game activities to make a new business attractive for itself.
Take Advantage of the New Ways of Creating and Capturing
New Value
A ?rm can enter a new business by identifying and meeting a need in the market
that is presently not being met—by occupying so-called “white space” in the
market or what is considered at the time a niche.
4
A classic example is that of
Wal-Mart, which located its stores in small rural towns which discount retailers
at the time shunted, preferring instead to locate their stores in large towns. This
unmet need can also be in providing a product with attributes that other prod-
ucts do not offer or it can be in providing products at a lower price point than
existing products. Note that new value here does not necessarily mean that a
?rm has to outdo its rivals in offering products or services with more and better
attributes. New value can sometimes mean stripped down attributes or even
inferior product attributes. For example, when Ikea entered the US furniture
industry, it did not try to outdo other furniture companies by offering better in-
store service, better delivery, or more durable furniture.
5
Rather, it offered little
or no in-store service compared to its high-end competitors, no delivery, and
furniture that was not as durable as competing furniture from incumbents.
Most of the PC’s attributes were inferior to those of the minicomputer and
mainframe that served the needs of most computer users when the PC was
introduced.
By locating in white space and meeting the needs of customers that are not
being met by ?rms in the business, a ?rm avoids immediate competition with
rivals for customers and resources. This lowers the effect of rivalry on the ?rm.
Moreover, because the ?rm is the ?rst to offer the product to the market seg-
ment, these customers are less likely to have as much power over the ?rm as
they would if it had more rivals in the market segment. In those cases where the
product offered has stripped-down or inferior attributes, the cost of offering
them may be lower and therefore somewhat reduces barriers to entry. If the ?rm
rides a change such as a disruptive technological change, the cost of offering the
new value can also be lower. Most important of all, since the ?rm is the ?rst in
the white space (market segment), it can build ?rst-mover advantages. For
example, it can build switching costs at customers, establish a brand-name
Entering a New Business Using New Games 317
reputation with these customers, or build relationships with customers and
complementors. The ?rm can also preempt scarce important resources such as
location, input factors, customer mental space, or complementary assets. The
?rm can go up the learning curve for providing products for the particular
market segments and seek intellectual property protection for the patents or
copyrights acquired in doing so. New game activities can also be geared
towards increasing the number of valuable customers that the ?rm can reach
with its products when it enters the new business.
Some new game activities can better position a ?rm to appropriate value
without necessarily creating any in a new business. A popular example that we
saw in Chapter 1 is that of Dell when it decided to bypass distributors and sell
directly to end-users. This was new game in the industry at the time and enabled
Dell to bypass the more concentrated and powerful distributors and sell directly
to the more fragmented and less powerful users. Decreased buyer power meant
a more attractive business for Dell than competitors.
Take Advantage of Opportunity to Build New Resources or Translate
Existing Ones in New Ways Into Value
When a ?rm enters a new business, it can build some or all of the resources that
it needs. If the ?rm occupies white space or a niche, it can preemptively build
resources the way Wal-Mart did. The new business can also be a brand new
industry or market that is in the ?uid stage and it is not clear what resources will
be needed. In that case, the ?rm can compete to build a competitive advantage
in the new resources.
Take Advantage of the Opportunity to Build and Exploit First-mover
Advantages
If in entering the new business, a ?rm locates in “white space” or a niche, it is
effectively moving ?rst as far as the new games are concerned. Thus, as we have
seen above, such a ?rm has an opportunity to take advantage of ?rst-mover
advantages. Recall from Chapter 6 that ?rst-mover advantages include:
•
Preemption of total available market with associated economies of scale,
size (beyond economies of scale), early collection of economic rents and
equity, chance to build network externalities, and relationships with
coopetitors.
•
Lead in technology and innovation with associated intellectual property
(patents, copyrights, trade secrets), learning, organizational culture.
•
Preemption of scarce resources such as complementary assets, location,
input factors, parts, and equipment.
•
First-at-buyers through building buyer switching cost, making smart
choices under and building a brand (preemption of consumer perceptual
space).
•
First to establish a dif?cult-to-imitate system of activities for creating and
appropriating value.
A ?rm that enters a new business using new games and builds ?rst-mover
318 Applications
advantage can make the new business more attractive for itself. For example, a
?rm that enters a new business using new games and preemptively accumulates
scarce resources in the industry can make the industry more attractive for itself.
Anticipate and Respond to the Actions and Reactions of New and
Existing Competitors
If a ?rm enters a new business using new game activities, some of the incum-
bents in the business are likely to react to the entry. They can welcome the entry,
?ght it, or pursue some combination of both. In either case, how the new
entrant behaves can be critical. It is better off taking into consideration the
likely reaction of its new rivals. Finding ways to cooperate with rivals, when
permitted by government regulations, may be better than engaging in destruc-
tive competition such as price wars. In markets that exhibit network external-
ities, a ?rm may be better off cooperating to build a large network, since the
more customers in any particular network, the more valuable the network is to
customers. If a ?rm has to compete, it is better off going after ?rms whose prior
commitments, dominant managerial logics, and sunk investments prevent them
from trying to replicate or leapfrog the ?rm. These incumbent handicaps give
the ?rm more degrees of freedom in building ?rst-mover advantages and trans-
lating them into superior value that the ?rm can appropriate.
Take Advantage of the Opportunities and Threats of the Environment
In entering a new business, a ?rm can take advantage of the opportunities and
threats of its environment to pursue new game activities that allow it to have a
competitive advantage in entering the new business. For example, eBay took
advantage of the Internet, a disruptive technology, to enter the auction market.
So did the numerous other ?rms that took advantage of the Internet to enter
new businesses.
Type of New Game
The type of new game strategy that a ?rm uses to enter a new business as well as
the type of game being played by incumbents in the new business also play a
role in making the industry attractive to the new entrant or lowering its entry
costs (Table 12.1).
Table 12.1 Type of New Game to Pursue when Entering a New Business
Existing game in new business Preferred entry new game
Regular Revolutionary, resource-building, position-building
Resource-building Position-building, revolutionary
Position-building Revolutionary, resource-building
Revolutionary Revolutionary
Entering a New Business Using New Games 319
Face Firms in Regular Game in New Business
If the dominant ?rms in a market pursue a regular game, trying to beat them at
their game is likely to be dif?cult. Recall that in a regular new game, a ?rm
builds on the existing resources that underpin industry competitive advantage
to offer a new product that customers value but the product does not totally
replace existing products in the market. A new entrant to the business is better
off pursuing either a revolutionary, resource-building, or position-building new
game (Table 12.1). The idea here is that it would be dif?cult for a new entrant to
the carbonated soft drinks industry to beat Coke and Pepsi by making incre-
mental improvements to cola drinks or to the way the drinks are marketed. One
cannot beat Coke at being Coke. Rather, one has a chance if one pursues a
revolutionary strategy in which the resources used and the product-market-
position pursued are so different that existing resources cannot be used to offer
the new product and the resulting new product renders existing ones noncom-
petitive. By pursuing a revolutionary strategy, a ?rm is in a better position to
build and take advantage of ?rst-mover advantages, making the new business
more attractive for the new entrant ?rm. One can also take advantage of any
handicaps that incumbents in the new business may have such as prior com-
mitments from which they cannot separate themselves. If a ?rm has distinctive
resources that it can use to pursue a resource-building strategy in the new
business, the ?rm might be better off using such a strategy to enter a new
business where the major actors play regular games. Recall that in a resource-
building game, a ?rm uses resources that are radically different from those
presently used in the market to offer products but existing products remain
competitive. A ?rm can also pursue a position-building game in which it uses
resources that build on existing resources in the new business but offers a prod-
uct that renders existing products noncompetitive. That would also make the
entry more attractive for the ?rm.
Face Resource-building New Game in New Business
If the game pursued by dominant ?rms in the new business is resource-building,
a potential new entrant into the business may be better off pursuing either a
position-building or revolutionary new game. The idea here is that if incum-
bents in the business have been pursuing a resource-building game, some of
them are likely to have built ?rst-mover advantages in the new resources. Thus,
trying to beat these incumbents at being them is likely to be dif?cult. Therefore,
a new entrant may be better off using a revolutionary new game that renders
incumbents’ existing resource advantages obsolete and their existing products
noncompetitive. A new entrant could also pursue a position-building new game
by identifying new needs and meeting the needs using resources that build on
existing resources. This is the new game that Sony played when it entered the
video console business. Its 32-bit video game technology built on existing skills,
knowledge, and know-how in video games to develop consoles that addressed
the needs of a new market segment: adults who wanted to play video games.
The 32-bit games eventually rendered existing 16-bit machines noncompetitive.
320 Applications
Face Position-building New Game in New Business
If the game pursued by incumbents in the new business is predominantly
position-building, these incumbents are likely to have developed competitive
advantages in their PMPs. Thus a new entrant is better off pursuing a revo-
lutionary or resource-building new game if it hopes to make the new market
more attractive for itself. A revolutionary new game renders incumbent’s exist-
ing products noncompetitive and the underpinning resources obsolete, and the
new entrant has an opportunity to build ?rst-mover advantages in resources
and product-market positions.
Face Revolutionary New Game in New Business
If the new game pursued by incumbents in the new business is revolutionary,
new entrants can also pursue the revolutionary new game. By de?nition, things
are in a state of ?ux in the market if incumbents are still pursuing a revolution-
ary new game and no one has a competitive advantage, yet. Thus, new entrants
may be better off also pursuing the same revolutionary new game until such a
time as they can focus on their competitive advantages using either resource-
building or position-building strategies.
When to Apply the Framework
From the title of this chapter, it is clear that when entering a new business,
especially when diversifying from one’s existing business, one is better off
exploring the three tests. However, the tests could also be very useful when
moving from one market segment to another, especially if the new segment has
different coopetitors. Also, when a ?rm adopts a new technology, it is worth-
while to explore the three tests because new technologies often result in new
ways of creating and appropriating value. Consequently, coopetitors and their
interactions usually change, the industry becomes more or less attractive, and
what it takes to have a competitive advantage also changes.
Key Takeaways
•
A new business can be the source of pro?ts and pride for a ?rm or the source of
losses and regret. Thus a ?rm should not take entering a new business lightly.
•
However, it is not usual to ?nd ?rms that enter new businesses solely
because their existing businesses are mature and declining while the new
business is growing, or because the ?rms have lots of cash to invest. The
growth rate of an industry is only one driver of industry pro?tability or
attractiveness. The attractiveness test explores the factors that determine
the extent to which the industry is pro?table, on average, and helps ?rms to
understand the competitive forces that they would face if they were to enter
the new industry. This test can be performed using a Porter’s Five Forces or
the Structure-Conductor-Performance framework.
•
Even if an industry is, on average, pro?table, a ?rm that enters the industry
may still not be pro?table. Factors speci?c to the entering ?rm also play a
major role in determining its pro?tability; that is, there should be something
about the ?rm that will enable it to enter the new business and earn a higher
Entering a New Business Using New Games 321
rate of return in the new business than in the old, or there should be some-
thing about entering the new business that will allow the ?rm to improve
the pro?tability of its old business. Effectively, a ?rm also needs to explore
the extent to which it is better off in the industry than other ?rms or than
being elsewhere. This exploration is the better-off test.
•
In any case, it usually costs money—sometimes a lot—to enter a new busi-
ness. Thus, a ?rm that wants to enter a new business may want to make sure
that it does not spend so much in entering the new business that any pro?ts
ultimately generated go to cover entry costs. If barriers to entry are high, for
example, it can cost a lot to overcome them. If, for example, one reason why
an industry is attractive is the ability of ?rms to retaliate against new
entrants or noncooperators, a ?rm that enters the business is likely to face
hostility. Thus, the cost of entry relative to the pro?ts from entry is also a
major factor in considering entry. This is the cost of entry test. Entry costs
should also be carefully weighed against the opportunity cost of not enter-
ing the new business.
•
Effectively, it is wise to explore the attractiveness, better-off, and cost-of-
entry tests carefully before entering a new business. A ?rm can use these
tests to evaluate different businesses before making its choice. There is
always the alternative of investing in the old business or giving money back
to shareholders.
•
New game activities not only can enable a ?rm to make an industry more
attractive for itself, they can also lower entry costs. Because of their new
value creation property, new games can enable a ?rm to lower its cost or
differentiate its products, thereby reducing the effect of rivalry, and substi-
tutes on the ?rm. Differentiated products from new game activities also
reduce the power of buyers and the negative effects of potential new entry.
•
The type of new game strategy that a ?rm uses to enter a new business
should also be a function of the type of strategy that ?rms in the industry are
pursuing at the time of anticipated entry.
•
Managers may give all sorts of reasons for entering a new business. But
when it is all said and done, a ?rm has to make pro?ts. This entails creating
and appropriating value. The three tests can be very helpful in evaluating,
ex ante, one’s potential for doing well in a new business.
•
The three-test framework applies not only to entering new businesses and
new market segments but also to adopting new technologies. This is par-
ticularly true when the new technology generates new ways of creating and/
or appropriating value, and the attractiveness of the market or industry has
changed.
Key Terms
Attractive business
Attractiveness test
Better-off test
Contribution margin
Contribution margin per unit
Cost of entry test
Systematic risk
322 Applications
Strategy Frameworks and
Measures
Reading this chapter should provide you with an introduction to, or a recap of
the following strategy frameworks:
•
SWOT Analysis (early 1960s)
1
•
PEST (1967)
•
Growth/Share matrix (late 1960s)
•
GE/McKinsey matrix (late 1960s)
•
Porter’s Five Forces (1979/1980)
•
Business systems (1980)
•
Value chain (1985)
•
Value con?gurations (1998)
•
Balanced scorecard (1992)
•
VRIO (1997)
•
VIDE (1998)
•
S
3
PE Framework (1998)
•
4Ps (marketing, 1960s)
•
AVAC (2008)
The chapter also summarizes some simple but useful accounting measures.
Introduction
When we explored the AVAC framework in Chapter 2, we noted that it had
some advantages over existing strategy models for assessing the pro?tability
potential of a strategy, product, brand, resources, business units, and so on. In
this Chapter, we brie?y summarize thirteen strategy frameworks and one mar-
keting framework that have been used to explore not only the pro?tability
potential of strategies but also strategy drivers and outputs. We also brie?y
summarize some useful accounting measures that can come in handy when
quantifying a ?rm’s performance. These summaries are meant to be just that—
summaries. They are meant to serve three purposes: (1) act as a quick reference
for the reader who has encountered them before and needs to be reminded
about where they ?t in the overall picture of strategy frameworks, (2) act as a
motivator to the reader who has not been exposed to them before to ?nd out
more about them in the references provided, and (3) remind the reader of the
advantages and shortcomings of each framework.
The question is, why would anyone need to understand thirteen strategy
Chapter 13
frameworks? After all, some of them are either too old, have too many short-
comings, or apply to questions that you do not care much about. There are
three reasons why students of strategic management need to understand these
models. First, one of the models—and God knows which one—may be the only
one that your interviewer, employer, client, potential ally, competitor, acquirer,
consultant, venture capitalist, or acquisition target understands. Although fan-
cier models exist, most people stick with the model that has worked for them,
despite the push from consulting ?rms to change to newer and better models.
For example, although many strategy scholars regard the SWOT analysis as
antiquated, it still plays an important role in the strategic planning processes of
some major ?rms. Second, strategic management is a very complex subject and
therefore no one framework can apply to all questions. No one model ?ts all
bills. Therefore, understanding as many models as possible gives the strategy
scholar more options and ?exibility in exploring different questions. Better still,
it helps one understand where others may be coming from. Third, we explore
the frameworks chronologically, thereby providing a sense of the history of
strategic management. This history can be important in understanding different
points of view, and in guessing where the ?eld might be heading.
Advantages and Disadvantages of Using Frameworks
We start the chapter with an outline of the advantages and disadvantages of
using frameworks in strategic management.
Advantages
Although each framework has some advantages that are speci?c to it, there are
some advantages that pertain to frameworks in general.
Simplicity
Frameworks are usually simple and easy for managers to get their minds
around. Some of them take the form of a 2 × 2 matrix, which is easy to visualize
and understand. Such simplicity makes it easier for more people to understand
and make contributions to the discussions and arguments that lead up to a
manager’s ?nal decision.
Common Language and Platform
Frameworks provide a common language and platform for framing questions,
proposing different scenarios, and expressing alternate solutions to a problem.
They provide common starting points for discussions. A framework may not
provide a ?nal solution to a question, but can provide a starting point from
where managers can work their way to a ?nal solution.
Parsimony and Comprehensiveness
A good framework is both comprehensive and parsimonious; that is, a good
framework has all that needs to be in it (comprehensive), but at the same time,
324 Applications
avoids not throwing everything in it (parsimonious). As such, users do not have
to reinvent the wheel and go through the exercise of deciding what should be
included and what should not, again.
Starting Point for Collecting Data
One of the biggest problems with strategic analysis is to decide which data to
collect for an analysis. The cases that students are usually asked to analyze
normally have lots of tables of data and graphs attached to them, giving the
students some hints as to what the solution to the case is all about. In real life,
managers who face decisions usually do not have that much data and often have
no idea what variables they should be collecting the data for, and where to start
looking for the data. Having a framework considerably narrows down the
scope and cost of data collection. One can simply collect data for the variables
that are in the framework.
Disadvantages
Many of the qualities of frameworks that are advantages can also be disadvan-
tages. Take simplicity, for example. Very simple frameworks, while easy to use,
usually leave out important variables, making such frameworks less applicable
to other contexts. That is one reason why strategy models should be used very
carefully. When a framework constitutes a language and platform, it necessarily
locks out some ideas that fall outside that language and framework. There is
also the danger that some students will understand one framework well and try
to apply it to any question that they are asked. These disadvantages are not a
big issue if one understands the advantages and disadvantage of each frame-
work well before applying it.
SWOT
SWOT stands for Strengths, Weaknesses, Opportunities, and Threats. The
SWOT framework came out of research lead by Albert Humphrey at Stanford
University in the 1960s and 1970s. It was developed as a strategic planning tool
to be used to evaluate a ?rm’s internal strengths and weakness as well as those
external opportunities and threats that the ?rm faced and could exploit. The
SWOT analysis ?ts in very well with Professor Alfred Chandler’s 1962 popular
de?nition of strategy as the “determination of the basic long-term goals and
objectives of an enterprise, and the adoption of courses of action and the allo-
cation of resources necessary for carrying out these goals.”
2
The idea is that
for a ?rm to meet its goals and objectives, it has to pursue certain courses of
action using the appropriate resources. Depending on the goals and objectives,
a ?rm’s courses of action and resources can be strengths or weaknesses. By
matching these strengths and weaknesses to the opportunities and threats of its
environment, a ?rm could meet its goals and objectives, relative to its
competitors.
Strategy Frameworks and Measures 325
Key Elements of SWOT Framework
The elements of a SWOT analysis are shown in Figure 13.1. Strengths and
weaknesses are usually referred to as internal factors, since they are speci?c to a
?rm’s activities and resources, while opportunities and threats are referred to as
external factors because they are exterior to a ?rm, in its competitive and macro
environments.
Strengths
In a SWOT analysis, a ?rm’s strengths are those characteristics that make a
positive contribution to the attainment of its goals and objectives. For example,
if a ?rm’s goals and objectives are to have a competitive advantage, then its
strengths are those characteristics that make a positive contribution to its ability
to earn a higher rate of pro?ts than its competitors. Such strengths would
include distinctive valuable resources and capabilities such as a brand, patents,
copyrights, distribution channels, shelf space, relationships with customers, and
so on. If the goal is to win a war, the strengths are those factors that make a
positive contribution to winning the war.
Weaknesses
A ?rm’s weaknesses are those characteristics that handicap attainment of its
goals and objectives. If a ?rm’s goals and objectives are to have a competitive
advantage, then its weaknesses are those characteristics that handicap its ability
to earn a higher rate of pro?ts than its competitors. A ?rm’s weaknesses to
attaining a competitive advantage include a lack of distinctive resources and
capabilities as well as a bad reputation or bad relationships with coopetitors.
Ford and GM’s weaknesses in the 2000s were that they did not have the ability
to produce cars with good gas mileage that enough customers wanted to buy.
Location can also be a weakness. Being born in an underdeveloped country can
be a serious weakness.
Figure 13.1 SWOT Framework.
326 Applications
Opportunities
Opportunities for a ?rm are those external factors that make a positive contri-
bution to the attainment of its goals and objectives. If a ?rm’s goals and object-
ives are to perform better than its competitors, then opportunities are those
external factors that make a positive contribution to the ability of the ?rm to
create and appropriate value better than its competitors. Opportunities for a
?rm include customer needs that the ?rm can satisfy, a new technology that a
?rm can use to attack another ?rm’s competitive position, and so on.
Threats
Threats to a ?rm are those external factors that handicap its attainment of its
goals and objectives. If a ?rm’s goals and objectives are to make more money,
then the threats to the ?rm are those external factors that handicap its ability to
earn a higher rate of pro?ts than its competitors. The threats to a ?rm attaining
a competitive advantage would include things such as changes in customer
tastes, and technological changes or hostile government regulations that reduce
the ?rm’s ability to create and appropriate value.
Context Dependence of Elements
Whether a ?rm’s characteristic is a strength or weakness depends on the context
in which the characteristic is being used. For example, a video rental ?rm’s
long-term lease contracts to video stores in good locations were a strength in a
brick-and-mortar era; but in the face of the Internet, such contracts can be
weaknesses if the ?rm cannot get out of them. An opportunity for one ?rm can
be a threat to another. For example, a disruptive technology is an opportunity
for startups that want to attack incumbents, but is a threat to the incumbents.
Application of SWOT
A SWOT analysis has been used as a tool to help formulate strategies, business
plans, etc. Whatever the application, the analysis starts with an establishment of
goals and objectives. Once goals and objectives have been established, the fol-
lowing questions can be explored.
•
Strengths: what are the strengths for the goals and objectives in question?
How can each strength be reinforced? Can each strength be utilized to
achieve other goals and objectives? When might these strengths become
weaknesses?
•
Weaknesses: how can each weakness be dampened or eliminated? How can
each weakness be turned into a strength?
•
Opportunities: how can each opportunity be exploited? What might turn
the opportunity into a threat?
•
Threats: what can a ?rm do to dampen or eliminate the effect of threats?
Can the ?rm turn threats into opportunities?
Strategy Frameworks and Measures 327
Advantages and Disadvantages of SWOT
Advantages
1 The framework is simple, easy to understand, and therefore many managers
can use it right away. Thus a ?rm has an opportunity to obtain feedback
from many employees.
2 It provides terminology for discussing the drivers of a ?rm’s ability to match
its internal environment to its external environment to attain its goals and
objectives.
Disadvantages
The SWOT framework has several disadvantages:
1 It is dif?cult to narrow down the list of strengths, weaknesses, opportun-
ities, or threats to only the important ones. Firms risk generating a long
laundry list that is of little use.
2 The lists of strengths, weaknesses, opportunities, and threats generated
usually says little or nothing about how these elements are going to be
translated into goals and objectives. For example, a SWOT analysis that
lists a pharmaceutical company’s patents as its strengths says little about
how patents are translated into medicines and pro?ts.
3 The framework is static since it says little about what happens to each
element of SWOT over time. Will strengths, weaknesses, opportunities, and
threats today be the same tomorrow?
4 It is dif?cult to tell strengths from weaknesses sometimes, or distinguish
opportunities from threats. Is the Internet an opportunity or threat to
banks?
PEST
In a SWOT analysis, opportunities and threats usually come from the competi-
tive or macro environment. A Political, Economic, Social, and Technological
(PEST) analysis can be used to explore the threats and opportunities of the
macroenvironments. The PEST analysis is usually attributed to Francis J. Agui-
lar who, in his 1967 book, analyzed the environment using the four com-
ponents: economic, technical, political, and social (ETPS).
3
The assumption
here is that the macroenvironment is limited to these ?ve components; but as we
saw in Chapter 10, other components of the macroenvironment can also be a
source of the opportunities and threats that ?rms face. For example, the natural
environment plays an important role. Thus, the version of PEST shown in
Figure 13.2 is a modi?ed version called PESTN, where N stands for natural
environment. As we argued in Chapter 10, the extent to which any of the
factors that determine each component constitutes a threat or opportunity for a
?rm is a function of the industry in which the ?rm operates and the ?rm’s
strategy. For example, while in pharmaceuticals, “intellectual property protec-
tion” is important in the USA, it is usually not the case in retail and elsewhere in
the world. Moreover, technological factors that matter at one time may not be
328 Applications
that important at other times. Thus, the number of factors that matter for any
particular analysis will always be only a subset of those shown in Figure 13.2.
Advantages and Disadvantages of a PEST analysis
Advantages
•
A PESTN analysis enables ?rms to dig deeper into the sources of the threats
and opportunities that they face in their macroenvironments. For example,
including the natural environment in the analysis forces ?rms to pay more
attention to it, increasing the chances that ?rms will ?nd some opportunities
in it or identify threats in it before it’s too late.
•
It can be used as a starting point for generating new game ideas.
Disadvantages
•
The framework does not provide a means to narrow down the list of factors
to the few that are really important. Thus, a PEST analysis usually runs the
Figure 13.2 Elements of a PESTN Framework.
Strategy Frameworks and Measures 329
risk of generating a laundry list with no way of determining which item on
the list is more important than the other.
•
The PEST analysis, unlike a Five Forces and an AVAC framework, offers no
concrete way of linking the list of factors that impact each component to
pro?tability variables.
•
A PEST analysis is a static model. It is usually performed at a point in time
and says very little about what happened in the past or will happen in the
future.
BCG’s Growth/Share Matrix
In the late 1960s and the 1970s, more and more ?rms increasingly added new
businesses to their portfolios and therefore found themselves managing multi-
businesses. With more than one business to manage, these ?rms faced some
important questions: how much of a ?rm’s scarce resources, such as capital,
should be allocated to each unit? What businesses should a ?rm be in, to begin
with? Which ones should be disposed of? What should the performance targets
of each business be? The Growth-Share Matrix, developed by the Boston Con-
sulting Group (BCG) in the early 1970s, could be used to explore these ques-
tions. It grew out of work on “experience curve effects” done by Bruce Hender-
son of BCG.
4
The idea with the experience curve was that if a ?rm’s per unit
cost fell as its cumulative output increased, the ?rm stood to have a cost advan-
tage, considered by some at the time to be the advantage. The framework
gained lots of acceptance at the time as ?rms used it to analyze business units,
product lines, regional units, and international units of ?rms. It was popular not
only in strategic management but also in international management, brand
marketing, product management, and portfolio analysis. It would become a so-
called portfolio analysis model since it could be used to explore different port-
folios of businesses.
Elements of the Growth/Share Matrix
The key elements of the Growth/Share Matrix are shown in Figure 13.3. The
vertical axis captures the market growth rate while the horizontal axis captures
the relative market share. Recall that a ?rm’s performance is driven by both
industry as well as ?rm-speci?c factors. Thus, since market growth rate is a
function of industry factors, and relative market share is a function of ?rm-
speci?c factors, the framework could give managers some information on the
performance of the different units. This was considered particularly true at the
time because BCG touted experience curve effects as a key driver of ?rm per-
formance and therefore strategic success. The idea was that a ?rm’s per unit cost
fell as its cumulative output increased. Thus, a business or unit with a high
relative market share meant more cumulative units sold and therefore lower
cost. Lower cost meant better ?nancial performance; that is, the position of a
business or unit on the matrix is a function of its performance. The matrix is
divided into four quadrants: cash cows, stars, dogs, and question marks.
330 Applications
Cash Cows
Cash cows represent units that have high market shares but are in industries
with low market growth rates. Their large relative market shares mean that the
cumulative number of units that they sell gives them lower unit costs. Because
they are in industries with low market growth rates, they do not need to spend a
lot on new capital, and therefore a lot of the cash from the low-cost products is
free. Hence the name cash cow. BCG suggested that one strategy for such a unit
was to milk the cow by using some of the cash generated to invest in stars that
needed cash. Industries with such cows were so-called mature industries that
did not need the large amounts of cash needed in high growth industries.
Stars
Stars are units with high relative market shares in high growth industries. The
high market share means low per unit cost. However, because the industry
growth rate is high, such a unit often must invest a lot to maintain its leadership
position in the growing market and therefore is not likely to have a positive cash
?ow. The strategy suggested by BCG was to invest the cash from the cash cow in
the star and grow it into a future cash cow. If the right cash were not invested in
the star, it might be relegated to a future dog.
Dogs
Dogs are units with low market shares in low growth industries. They generate
little or no cash and have little potential for future growth. The strategy is to
Figure 13.3 BCG’s Growth/Share Matrix.
Strategy Frameworks and Measures 331
divest of such a unit and focus attention on more viable units. These units may
generate enough cash to break even and sustain themselves. Although such a
unit may possess some synergies with other units and provide jobs for
employees, it is not very useful from an accounting point of view since it gener-
ates no cash and depresses the ?rm’s return on assets ratio. Thus, a ?rm ought
to get rid of dogs.
Question Marks
Question marks are units in industries with high growth rates, but that have
low market shares relative to the leader in the market. The name question mark
comes from the fact that it is not clear whether these units will become stars or
dogs. Since they have very small market shares, their per unit costs are likely to
be high relative to those of their competitors with larger market shares. Because
they are in fast-growing industries, they need lots of cash to gain large market
shares and become stars. The strategy is to take a deep look at the question
marks and see whether they will become stars or dogs. If there is a good chance
that they will become stars, the cash can be invested in them. If they lean
towards dogs, they may as well be divested of.
Application of Framework
The Growth/Share matrix framework is illustrated using the four units shown
in Figure 13.4.
5
The positions of the four units in 2006 and 2008 are shown by
the circles. Shaded circles show the position of each unit in 2006 while blank
circles show the positions of the units in 2008. The area of each circle is pro-
portional to the revenues earned by the business. Thus, Unit 2 in 2008 had the
most revenues while Unit 1 in 2006 had the least revenues. The horizontal axis
of the matrix captures relative market share and represents a unit’s market
share relative to the largest competitor in the market in which the unit com-
petes. Thus, a relative market share of 0.5, such as Unit 3’s share in 2006,
means that the unit has 50% of the market share of the largest competitor in the
market. However, a unit such as Unit 2 with a relative market share of 4.0 in
2008, has four times the market share of its closest competitor and is clearly the
leader in the market. The relative market shares of Units 1 and 2 increased from
2006 to 2008 while that of Unit 3 decreased and that of Unit 4 changed very
slightly. Not only did Unit 3’s relative share decrease, its revenues also went
down. In general, since the vertical line that divides the matrix into two crosses
the horizontal axis at 1.0, units that are located to the left of this line are market
leaders while those to the right of the line are not.
The vertical axis of the matrix captures the market growth rate and measures
the rate at which the market is growing, adjusted for in?ation. It is assumed that
high, as far as market growth is concerned, means a growth rate of 10% or
higher and therefore the horizontal dividing line between high-growth and low-
growth businesses is at 10%. High-growth units are above the line while low-
growth units are below the line. Since a ?rm’s pro?tability depends on both
industry and ?rm-speci?c factors, market growth rate proxies industry factors
while relative market share proxies ?rm-speci?c factors.
332 Applications
Advantages and Disadvantages of Growth/Share Matrix
Framework
The Growth/Share matrix framework has advantages and shortcomings that
should be considered carefully before using it as an analysis tool.
Advantages
•
The Growth/Share Matrix framework provides a common language, plat-
form, and starting point for managers of multibusiness ?rms to explore the
critical questions of: how much of the ?rm’s scarce resources should be
allocated to each unit? What businesses should the ?rm be in? Which ones
should be disposed of? What should the performance targets of each busi-
ness be?
•
It could be used to explore not only the performance of a business unit but
also to explore the performance of units in different countries or regions,
different products, different technologies, brands, major customers, revenue
models, and sources of revenue.
•
The framework has only two simple variables: market growth rate and
relative market share. This simplicity makes it easier for managers to under-
stand and participate in a discussion of “what next” questions.
Figure 13.4 Illustration of Growth/Share Matrix.
Strategy Frameworks and Measures 333
Disadvantages
•
Although using only two variables makes it easier for people to understand
and participate in decision-making debates, two simple variables do not
capture the drivers of a unit’s performance and therefore may be an over-
simpli?cation. It is worthwhile exploring other variables.
•
The experience effects, which were a cornerstone of the model, turned out
not to be the key driver of performance in many industries. Experience
effects were important only in semiconductors and aerospace. Even in these
two industries, the suspicion was that other factors were also critical.
•
The framework assumes that an industry that is not growing today will not
grow tomorrow; that is, the model is static. Research in technological
innovation suggests that technological discontinuities can revive an indus-
try, drastically increasing growth rates.
•
Labeling a group as dogs or cows may not be a good idea. Who wants to be
called a dog or a cow?
•
Divesting of a business just because it is a dog may be discounting any
synergies that may exist between the dog and stars or cash cows that have
allowed these other units to be high performance.
GE/McKinsey Matrix
In the 1960s, General Electric Company (GE) was one of those multibusiness
?rms that faced the corporate level questions that we stated above, viz:
•
How much of its scarce resources, such as capital, should be allocated to
each business?
•
What businesses should it be in?
•
Which ones should be disposed of?
•
What should the performance targets of each business be?
In exploring these questions, GE worked with McKinsey as a consultant. One
output of the work performed by both ?rms in the late 1960s and early 1970s
was the GE/McKinsey matrix. Like the BCG Growth/Share matrix before it,
the GE/McKinsey matrix is also a portfolio analysis model. It exploits the fact
that ?rm performance is driven by both industry and ?rm-speci?c factors.
In the model, industry factors are proxied by Industry Attractiveness while
?rm-speci?c factors are proxied by Business Strength/Competitive Position
(Figure 13.5).
Elements of the Framework
The vertical axis of the matrix captures industry attractiveness while the hori-
zontal axis captures business strength/competitive position.
Industry Attractiveness
The industry attractiveness of the GE/McKinsey matrix replaces the market
growth rate variable of the Growth/Share matrix. Moreover, industry
attractiveness is a composite measure of the following:
334 Applications
•
Barriers to entry and exit
•
Cyclicality
•
Emerging opportunities and threats
•
Industry pro?t margins
•
Intensity of competition
•
Macroenvironmental factors
•
Market growth rate
•
Market size
•
Seasonality
•
Technological and capital requirements.
The Business Strength/Competitive Position of the GE/McKinsey matrix
replaces the relative market share variable of the Growth/Share Matrix. This
was measured by a combination of the following:
•
Ability to match or beat rivals on product quality and service
•
Knowledge of customers and markets
•
Management strength
•
Possession of desirable distinctive capabilities
•
Pro?t margins relative to competitors
•
Relative cost position
•
Relative market share
•
Technological capability.
In the GE/McKinsey matrix, the size of each circle represents the size of the
market for the unit in question while the shaded part of the circle represents the
unit’s share in the market (Figure 13.5). (This contrasts with the Growth-Share
Figure 13.5 GE/McKinsey Matrix.
Strategy Frameworks and Measures 335
Matrix where the size of the circle represents the size of revenues, and its rela-
tive market share is represented by where the circle is located.) In the 3 × 3
matrix, units that fall into the quadrant where industry attractiveness is high
and a ?rm’s business strength/competitive position is strong, are very pro?table
and a ?rm ought to invest in them and take other strategic steps to build them.
A ?rm should also invest in and build (1) those units that are in industries whose
attractiveness is medium but the ?rm’s business strength/competitive position is
strong, or (2) those that are in industries whose attractiveness is high and the
?rm’s business strength/competitive position is median (Figure 13.5). A unit in
an industry whose attractiveness is low or medium and the unit’s strength/com-
petitive position in the industry is weak, ought to be divested or harvested in
some other way; so should units in industries whose attractiveness is low and
the unit’s business strength/competitive position is average. The units that fall
into the other quadrants should be held and different strategies explored to
make them more pro?table.
Advantages and Disadvantages of the GE/McKinsey Matrix
The GE/McKinsey Matrix has some of the strengths and weaknesses of the
BCG Growth/Share Matrix, with the important difference that the former has
more complex measures.
Advantages
•
Like the BCG Growth/Share matrix, the GE/McKinsey matrix framework
provided a common language, platform, and starting point for managers of
multibusiness ?rms to explore the critical questions faced by multibusiness
?rms.
•
It could be used to explore not only the performance of a business unit but
also to explore the performance of units in different countries or regions,
different products, different technologies, brands, major customers, revenue
models, and sources of revenue.
•
The more complex measures for industry attractiveness and business
strength provided a more realistic measure of the industry and ?rm-speci?c
factors, two key determinants of ?rm performance.
Disadvantages
•
By using a combination of many other variables to measure industry
attractiveness, the GE/McKinsey matrix becomes very complex and dif?cult
for managers to understand. It makes the model more dif?cult for managers
to put their minds around. The list of variables that constitute the combin-
ation to measure either industry attractiveness or business strength can
quickly become a laundry list.
•
The framework is still a static model because it says nothing about how the
variables change with time.
•
Divesting of a unit because the industry is not attractive today and the unit’s
business strength is low may be discounting synergies that may exist
between the unit and more pro?table ones.
336 Applications
Porter’s Five Forces
As its name suggests, Porter’s Five Forces framework was developed by Profes-
sor Michael Porter of the Harvard Business School and introduced to the world
in his 1979 Harvard Business Review paper that was followed by his 1980
book, Competitive Strategy.
6
It is a framework for determining the average
pro?tability of an industry. Although the SWOT analysis had allowed analysts
to produce a list of factors that posed threats to a ?rm and another that offered
opportunities for a ?rm, there was no way of directly linking these factors to
pro?tability. Porter’s Five Forces enabled analysts to link the competitive
threats and opportunities of an industry to the pro?tability of the industry. In
the framework, there are ?ve competitive forces that act on industry ?rms and
determine the average pro?tability of an industry (Figure 13.6). How do these
forces lower or raise industry pro?tability? Let’s consider each force, starting
with Barriers to Entry. If Barriers to Entry are high—that is, if the Threat of
Potential New Entry is low—industry ?rms can afford to keep their prices high
without attracting many new entrants. That tends to increase industry pro?ts.
However, if Barriers to Entry are low, new entrants would enter the industry if
?rms charge high prices for their outputs or sell lots of the output, thereby
indicating to new entrants that there is a lot of money to be made in the indus-
try. Rational industry ?rms, for fear of attracting many new entrants, are there-
fore inclined to keep their prices low, thereby tending to reduce industry pro?ts.
If the Bargaining Power of Suppliers is high—that is, if suppliers have bar-
gaining power over industry ?rms—the suppliers are likely to demand high
prices for the inputs that industry ?rms need to make and deliver products. If
Figure 13.6 Porter’s Five Competitive Forces.
Strategy Frameworks and Measures 337
suppliers have high bargaining power, they are also more likely to force industry
?rms to take lower quality inputs than they would ordinarily like. If industry
?rms are forced to pay higher prices for their inputs, their costs are going to be
higher, thereby reducing their pro?ts. If they are forced to take inferior com-
ponents, industry ?rms are not likely to command the type of premium that
they would like from their own customers. They may also have to spend more
to improve the poor quality from suppliers. In either case, industry ?rm pro?t-
ability goes down. The opposite would be true if industry ?rms had bargaining
power over their suppliers. They (industry ?rms) would dictate the terms of
exchange and would be more likely to extract low input prices and higher
quality inputs from their suppliers. The result would be higher pro?tability for
industry ?rms.
If Bargaining Power of Buyers is high, buyers can force industry ?rms to take
lower prices or force them to deliver higher quality products than they would
like to deliver at the prices of lower quality products. The result is that industry
pro?tability is likely to be lower. If the Bargaining Power of Buyers is low,
industry ?rms can extract higher prices out of buyers, or force them to take
lower quality products at high prices. The result is higher industry pro?tability.
If Rivalry Among Existing Firms is high—for example, because industry
growth is low, or ?rms are selling undifferentiated products—industry ?rms are
forced to keep their prices low or end up with a lower market share. They may
also be forced to spend more to differentiate themselves without the appropri-
ate price premiums. The result is that industry pro?tability is lower. If rivalry is
low, ?rms can afford to keep their prices high, thereby maintaining pro?tability.
If the Threat of Substitutes is high—that is, industry products are such that
customers can use substitutes—industry ?rms are compelled to keep their prices
low, otherwise customers will switch to substitutes. The result is that industry
pro?ts are likely to be lower. If the threat of substitutes is low, industry pro?ts
are likely to be higher.
Elements of the Five Forces
The determinants of each of the forces are shown in Figure 13.7. Since space in
this chapter is limited and more detailed information on the Five Forces is
readily available elsewhere, we will explore only the ?rst two determinants of
each force.
7
Determinant of Barriers to Entry (Threat of Potential New Entry)
Barriers to entry tend to be high when Economies of scale are high—that is, if
the Minimum efficient scale is high relative to market share. Why? The more of
a particular product that a ?rm produces, the lower the per unit cost of the
product. However, beyond a certain volume, the decrease in unit cost stops.
This volume is called the minimum ef?cient scale (MES), the minimum volume
that a ?rm has to produce in order to attain the minimum per unit cost possible
in the market.
8
A new entrant must produce at least at this volume to have the
same low per unit cost that incumbents have. If the MES is high, an entrant
faces two major problems. First, it has to have enough customers that want the
large volume dictated by the high MES that it has to attain. Second, if the new
338 Applications
entrant produces that huge MES volume, it is effectively adding that much more
product to the market. The larger the MES and therefore the more of the prod-
uct that a new entrant would have to bring into the market, the lower the prices
would be. Thus, if the minimum ef?cient scale is large, rational potential new
entrants are less likely to enter since they can expect prices to drop consider-
ably, given how much they have to add to the industry’s capacity. Effectively,
high economies of scale (MES relative to market share) can constitute a high
barrier to entry.
Another barrier to entry is product differentiation. If a ?rm sells a highly
differentiated product in a market, any potential new entrant that hopes to
wrestle away market share from the ?rm has to be able to replicate the product
or differentiate its own product in some other way. Doing so can be dif?cult.
Why? It may take a lot of time and money to acquire those attributes that
differentiate the product. Take Toyota’s Lexus cars. First, it is dif?cult to put a
?nger on what it is that gives the car its reliability, fun and feel, and perception
by customers. Second, even if one were able to identify what it takes to build all
these attributes, it may still not be possible to replicate or leapfrog them. It takes
time, effort and money to build such capabilities. Many potential new entrants
may not have such capabilities. For these reasons, product differentiation can
Figure 13.7 Components of Porter’s Five Forces.
Strategy Frameworks and Measures 339
be a high barrier to entry. The other determinants of barriers to entry are brand
identity, switching costs, capital requirements, access to distribution, absolute
cost advantages, government policy, and expected retaliation (Figure 13.7).
Determinants of the Bargaining Power of Suppliers
If the products that suppliers supply to ?rms are highly differentiated—that is, if
inputs are differentiated—?rms are less likely to switch from the supplier to
another supplier. That is, differentiated inputs give the suppliers of such inputs
bargaining power. Such a supplier can extract higher prices from industry ?rms
or force them to take inputs with inferior quality than would ordinarily be
expected. Firms are not likely to ?nd another supply with the differentiated
quality of the input. For example, microprocessors are highly differentiated
inputs to PCs since they have unique features that PCs need. This gives makers
of microprocessors more bargaining power over PC makers than one would
ordinarily expect suppliers to have over their buyers. Another determinant of
the bargaining power of suppliers is the switching cost that ?rms incur if they
were to switch to another supplier. The higher these switching costs, the higher
the bargaining power that suppliers are likely to have. A ?rm’s switching costs
are the costs that the ?rm incurs when it switches from one supplier to another.
For example, people who learnt to drive using a car with an automatic trans-
mission have high switching costs if they were to switch to a car with a manual
transmission. The other determinants of supplier bargaining power are shown
in Figure 13.7.
Determinants of the Bargaining Power of Buyers
The bargaining power of buyers is a strong function of the concentration of
buyers relative to that of ?rms. The more buyers that there are vying for ?rms’
products, the better off ?rms are since they can play buyers against each other. If
one buyer does not agree to their terms, ?rms can go to another buyer. There-
fore, if buyers are in an industry that is concentrated relative to the ?rm’s
industry, buyers are likely to have bargaining power. In some cases, the buyer
industry may not be concentrated but may have one or more dominant buyers
who can wield a lot of power by virtue of the large quantities of products that
they buy, and in that case, set the trend for prices. For example, the retail
industry is not concentrated relative to industries for suppliers of items such as
detergents, etc. Yet, the sheer volume of purchases that large companies such as
Wal-Mart makes gives them considerable bargaining power. Product differen-
tiation also plays a part in the bargaining power of buyers. If the products that
buyers purchase from ?rms are undifferentiated, buyers are more likely to play
?rms against each other than would be the case when the products are differen-
tiated. Buyers are even more likely to play ?rms against each other if the prod-
uct has no switching costs; but if industry ?rms offer differentiated products,
their chances of having bargaining power over buyers are increased.
The remaining determinants of the bargaining power of buyers are shown in
Figure 13.7. These determinants are sometimes divided into those that have to
do with Bargaining Leverage and those that have to do with Price Sensitivity.
Bargaining leverage determinants are those determinants that depend more on
340 Applications
the ?rms themselves while price sensitivity determinants are those that have to
do with the products and their attributes rather than ?rms.
Determinants of Industry Rivalry
Many ?rms are usually under pressure from investors to increase earnings. If
industry growth is high, ?rms can meet expectations of such earnings without
having to steal market share from each other. However, if industry growth is
slow or declining, ?rms may be tempted to try to steal market share from their
rivals. In trying to steal market share, ?rms may resort to price wars, or
unnecessary product promotion or introduction, which can sap industry
pro?ts. Effectively, the lower the industry growth rate, the more likely that
industry rivalry will be high. Also, high fixed costs, relative to variable costs,
can increase industry rivalry. Why? Each time a ?rm sells a unit of a product,
the revenues from the product go to cover variable cost, ?xed costs, and pro?t
margin. In bad times, ?rms may be tempted to sell their products at a loss, so
long as the prices cover their variable costs. The higher the ?xed costs relative to
variable costs, the lower that the ?rm can set its prices (below pro?table prices)
and still cover variable costs. This can reduce industry pro?ts considerably.
Effectively, the higher the ?xed costs, relative to variable costs, the higher we
can expect industry rivalry. The remaining determinants of industry rivalry are
shown in Figure 13.7.
Determinants of the Threat of Substitutes
Substitutes are products from outside the industry or market that customers can
buy instead of industry products. Customers will turn to substitutes if the sub-
stitutes perform the tasks that products usually perform for customers and do
so at a good price; that is, substitutes can be a problem for industry products if
the substitutes have the right relative price-performance. To start buying substi-
tutes, existing customers have to switch from industry products to the substi-
tutes. If the costs of switching from industry products to substitutes are high,
substitutes are less likely to be a threat to industry ?rms. The remaining
determinants of the threat of substitutes are shown in Figure 13.7.
Advantages: Applying Porter’s Five Forces
Industry Attractiveness
One of the primary applications of Porter’s Five Forces is to use it to analyze an
industry’s attractiveness—use it to explore the extent to which an industry is,
on average, pro?table. If the competitive forces acting on industry ?rms are
low—that is, the bargaining power of suppliers, threat of new entry, the bar-
gaining power of buyers, the threat of substitutes, and rivalry among existing
?rms are low—the industry is said to be attractive, since the forces suggest that
industry ?rms are, on average, pro?table. If the competitive forces that act on
industry ?rms are high, the industry is said to be unattractive, since industry
?rms are, on average, unpro?table. It is important to understand that if a Five
Forces analysis shows that an industry is, on average, unpro?table, it does not
Strategy Frameworks and Measures 341
mean that all the ?rms in the industry are unpro?table. A Five Forces analysis
determines only the average pro?tability of the ?rms in an industry, not the
pro?tability of individual ?rms. A ?rm’s pro?tability is determined by both
industry and ?rm-speci?c factors. A Five Forces analysis tells us something
about the industry factors component of performance but says very little or
nothing about the firm-specific factors component. Firm-speci?c factors are
those things that enable a ?rm to outperform its rivals in the industry in which
they all compete; that is, ?rm-speci?c factors are what enable a ?rm to have a
competitive advantage. For example, a Five Forces analysis of the PC industry
would indicate that it is not a very attractive industry. Yet, Dell was extremely
pro?table between 1994 and 1999. Several ?rm-speci?c factors contributed to
Dell’s strategy, to more than compensate for the industry unattractiveness and
make Dell a pro?t generator. One of them was the ?rm’s new game strategy of
selling directly to end-customers and focusing on those business customers that
had sales of over $1 million.
Determine Opportunities and Threats
In analyzing the determinants of each force, one is effectively identifying the
opportunities (friendly forces) and threats (repressive forces) of the competitive
environment. A ?rm can then use its strengths to take advantage of the
opportunities while trying to mute the threats. For example, if there is only one
supplier that supplies a critical input to several ?rms, a ?rm can work with the
supplier to create second sources for the component. Doing so effectively
dampens the power of suppliers. Consider another example. If ?rms are able to
differentiate their products using brand name reputations, such brands can be
reinforced with the right marketing investments. For example, Coke and Pepsi
spend huge amounts of money advertising to maintain their brands. Effectively,
a Five Forces analysis can be seen as a framework for identifying both friendly
and hostile forces so that managers can then formulate the right strategies to
mute repressive forces and reinforce friendly ones. In this respect, the Five
Forces model has a huge advantage over a SWOT analysis. A SWOT analysis
generates a list that can quickly degenerate into a laundry list. More import-
antly, a SWOT analysis does not link the weaknesses and threats generated to
pro?tability. A Five Forces analysis does.
Organizing Framework for Data
A Five Forces analysis can also be used as an organizing framework for discus-
sions leading up to a decision. For example, in a strategic planning meeting,
managers can use the framework to sketch out scenarios of what would happen
if any of the determinants of each of the ?ve forces were to change. The model
provides a common language and understanding for exploring the industry
context in which ?rms operate.
Disadvantages
Like any model, the Five Forces framework has some disadvantages.
342 Applications
No Mechanism for Narrowing Down
The framework has no mechanism for narrowing down the list of factors to
important ones. Suppose three of the ?ve forces are low while the other two are
high. Is the industry attractive or unattractive? Now, take rivalry among exist-
ing firms, which has eleven determinants (Figure 13.7). Suppose ?ve of the
determinants suggest that rivalry should be high while six suggest that rivalry
should be low. Should rivalry among existing ?rms be indicated as being low
or high?
Neglects the Role of Complementors
Complementors are the ?rms that make complements. In many industries, the
role of complements is critical. For example, PCs would not be as valuable as
they are without software. Therefore neglecting the role of complementors, as
the Five Forces model does, may not be a good idea.
Framework is Static
Like most strategy frameworks, the Five Forces framework is a static model. It
is about the average pro?tability potential of an industry at a point in time. It
says nothing about what the pro?tability potential of the industry was yester-
day or what it will be tomorrow. The Five Forces takes a cross section of the
average attractiveness of an industry, which is OK, so long as none of the key
determinants of each of the forces changes over time. Effectively, the model
neglects the dynamic nature of most industries and one should use it carefully
when dealing with fast-changing industries.
No Cooperation Included
The model says little or nothing about cooperation. The Five Forces introduced
the notion of extended competition—the notion that suppliers, customers, sub-
stitutes, and potential new entrants should be viewed as competitors, the way
rivals are viewed. This is a great idea. But there is also a lot of cooperation that
takes place between ?rms and their suppliers, buyers, rivals, complementors,
and makers of substitutes. As we argued in Chapter 4, ?rms often have to
cooperate and compete with coopetitors to create and appropriate value. Seeing
coopetitors as competitors, the way a Five-Forces analysis does is incomplete.
Role of MacroEnvironment not Considered
The Five Forces framework does not explicitly consider the role of macroenvi-
ronmental effects. The effects of the political, macroeconomic, sociological,
technological, and natural environment are not directly considered.
Business Systems
The concept of a business system was developed in work at McKinsey by Carter
F. Bales, P. C. Chatterjee, Frederick W. Gluck, Donald Gogel, and Anupam
Strategy Frameworks and Measures 343
Puri.
9
It was introduced to the outside world in Frederick Gluck’s and Buaron’s
1980 articles in The McKinsey Quarterly.
10
A business system consists of the
different elements of the system of activities which a ?rm uses to make and
deliver products or services to a market. One such system is shown in Figure
13.8 for a technology-based manufacturing ?rm.
11
At each stage of the system,
the ?rm has different options for performing the activities at that stage. For
example, take the activities at the technology stage. As we saw brie?y in Chap-
ter 1, the ?rm can choose to license the technology from another ?rm, develop
the technology internally alone, form an alliance to develop the technology, or
outsource the whole product development and design process to someone. If it
performs its own R&D, it can choose to patent aggressively, decide not to
patent and instead depend on keeping its technology secret, or open up the
technology to any one who wants. And so on. At the distribution level, a ?rm
can choose to use all the distribution channels available to it, use only some of
the channels, or bypass all of them and sell directly to end-customers. If the ?rm
decides to use distribution channels, it can own them or outsource the distribu-
tion to someone else. It can build up inventories before and warehouse the
components or build the product only after a customer has ordered it. Again,
the options abound.
All these options are opportunities for new games. For example, if ?rms in an
industry all use distributors to sell their products to end-customers, a ?rm can
pursue a new game by selling directly to the end-customers. If ?rms in an
industry keep their technologies proprietary, a ?rm can pursue the new game of
opening up its technology to any ?rm that wants it; and so on.
Application of the Business Systems Approach
The business systems concept is about asking option-generating questions at
each stage of the system.
12
These questions include:
•
How is the ?rm performing the activities of the stage now?
•
How are competitors performing the activities of the stage?
•
What is better about competitors’ ways of performing the activities?
•
What is better about the ?rm’s ways?
•
How else might the activities be performed?
•
How would the options affect the ?rm’s competitive position?
Figure 13.8 Business System for a Technology Firm.
344 Applications
•
If the ?rm were to change the way it performs activities at the stage in
question, how would doing so impact the other stages of the business
system?
One of the primary lessons of the business systems concept is that there are
many other ways, beyond product innovation, to gain a strategic advantage.
One can change the conventional system for getting an existing product to
the market.
13
Using the Internet to sell old books or movies is a good
example.
Value Chain Analysis
The idea behind a value chain is that at each of the stages of a business system,
something is done to the work-in-process to get it closer to the product that
customers value. To see how, consider the business system for a ?rm such as an
automobile maker shown in Figure 13.9. The product design unit adds value
when it designs a car. After the design, a customer, C, that looks at the design
has some idea about what the car will look like. The manufacturing unit adds
value when it transforms the design into a car that has the features speci?ed in
the design, getting the car closer to what customers want. Marketing adds value
by bringing information about the car to customers that makes customers per-
ceive the car as being more valuable to them than they would have perceived
had they not received the marketing messages. Distribution adds value by bring-
ing the car to where customers can touch and feel, test-drive, kick the ties, or
buy and drive away. The service unit adds value be servicing or repairing the
car, or assuring the potential buyer that there will be service when he or she
needs it.
The term value chain was coined by Professor Michael Porter of the Harvard
Business School in his 1985 book, to designate the chain of activities that a ?rm
performs to add value—as it transforms its inputs into outputs.
14
He divided
the activities of a generic value chain into primary and supporting activities
(Figure 13.10).
Elements of a Value Chain
Primary Activities
These consist of inbound logistics, operations, outbound logistics, marketing
and sales, and service.
•
Inbound logistics: these are the activities performed to receive, sort, store,
retrieve, and distribute inputs to a product or service. Depending on the
industry, these activities can include scheduling, inventory control,
Figure 13.9 An Automobile Maker’s Business System.
Strategy Frameworks and Measures 345
allocation of inputs to different distribution centers, and handling of returns
to suppliers.
•
Operations: these are the activities that transform inputs into the ?nal
product. Depending on the industry, these activities can involve fabrication,
machining, milling, assembly, testing, quality control, and so on.
•
Outbound logistics: these are the activities that are performed to take the
?nished product to buyers. Depending on the industry, these activities can
include gathering of the ?nished product, storing, distribution, and hand-
ling of returns from buyers
•
Marketing and sales: these are the activities that get customers to buy the
?nished product at good prices. They include channel selection, promotion,
pricing, advertising, responses to requests for information or quotations,
merchandising, and so on.
•
Service: these are activities such as installation, training, repair, spare parts
supply, and disposal that enhance or maintain the value of a product.
Support Activities
Support activities for a generic value chain consist of technology development,
procurement, ?rm infrastructure, and human resources management.
•
Technology development: technology development cuts across all the pri-
mary activities. At inbound logistics, technology development can entail
inventory management, transportation, materials handling, information
technology, or communications. In operations, technology development
can entail materials, manufacturing, packaging, building and information
technology. In outbound logistics, technology development can entail
transportation, materials handling, and information systems. In marketing
and sales, technology development can entail communications and informa-
tion systems. In services, technology development can be in testing and
information systems.
Figure 13.10 A Generic Value Chain.
346 Applications
•
Procurement: these are the activities to purchase the inputs that are used in
the primary activities. They include sending out requests for information or
quotations, bargaining with suppliers, etc. The purchases include materials,
equipment, buildings, land, etc.
•
Firm infrastructure: these are activities such as accounting, ?nance, general
management, planning, legal and government services, information sys-
tems, and quality management that complement the other activities.
•
Human resource management: these are the activities to locate, recruit, hire,
train, develop, and compensate employees.
Applying the Value Chain Analysis
The value chain analysis has several applications.
Estimating Firm-specific Effects (Estimating Value Created and Costs)
Just as Porter’s Five Forces analysis can be used to estimate industry
attractiveness and therefore the industry factors that can impact a ?rm’s per-
formance, a value chain analysis can be used to estimate the ?rm-speci?c
factors that contribute to the ?rm’s performance. By identifying the different
stages of a ?rm’s value chain, the value added at each stage, how much it costs
to add the value, the capabilities needed, and the value drivers, a ?rm can
isolate which stages of its value chain add the most value and why. Such
information can help a ?rm decide where to invest more so as to increase its
chances of attaining or maintaining a competitive advantage in the markets in
which it competes.
Organizing Framework for Data
Like a Five Forces analysis, a value chain analysis can also be used as an organ-
izing framework for managers to guide them in their scenario analysis of which
activities to perform. Firms can also compare their value chains to those of their
competitors.
Value System
Although we have focused our attention on a focal ?rm’s value chain, suppliers
and buyers also have value chains. The system that is made up of a supplier’s
value chain, the focal ?rm’s value chain, and buyer’s value chain is called a
value system (Figure 13.11). Effectively, each value chain is part of a larger
system of value chains called a value system. Unfortunately, however, most
people usually just call the value system a value chain, without making any
distinction between the two.
Figure 13.11 A Value System.
Strategy Frameworks and Measures 347
Shortcoming of a Generic Value Chain Analysis
The generic value chain of Figure 13.10 fairly represents the activities that are
performed to add value in many manufacturing industries. However, it does not
represent the value-adding activities in many other industries. Consulting,
?nancial services, insurance, software, hospitals, search engine companies, real
estate, and numerous other service organizations do not have inbound and
outbound logistics. Moreover, the activities in these industries are not per-
formed in chains as the value chain framework suggests. What is so value chain
about the activities at hospital or at a Google? We explore alternate business
systems.
Value Configurations
Professors Charles Stabell and Oystein Fjeldstad of the Norwegian School of
Management argued that the value chain is but one of three con?gurations for
conceptualizing the value created when ?rms perform value-adding activities.
15
The other two are value network and value shop. In their work, published in
the Strategic Management Journal in 1998, Professors Stabell and Fjeldstad
called the value chain, value shop, and value network value con?gurations
since they are about different arrangements for adding value.
16
Recall that, in
the value chain, adding value is about bringing in the right inputs, transforming
them into the right outputs, and disposing of the outputs. In a value network,
adding value is about building a network of customers and enabling direct and
indirect exchanges among the customers. In a value shop, adding value is about
resolving customer problems. Since we explored the value chain above, we now
focus on value shop and value network.
Value Network
The value network is the con?guration that ?rms, which mediate between other
?rms or between individuals, use to add value. Such ?rms include commercial
banks which mediate between borrowers and savers, auctioneers who mediate
between sellers and buyers, credit card companies which mediate between
cardholders and merchants, and distributors which mediate between producers
and end-customers. A bank adds value by building the right network of bor-
rowers and savers and using savings to make loans. The more savers that a bank
has, the better off the depositors at the bank are likely to be and vice versa. An
auctioneer such as eBay adds value by creating a large network of sellers and
buyers, enabling exchanges between them. The more sellers that there are, the
better off the buyers, and vice versa. A credit card company adds value by
building the right network of merchants and cardholders, and enabling card-
holders to use their cards to make purchases from merchants. The more card-
holders that use a particular card, the better off the merchants that accept the
card. The more merchants that accept the card, the better off each cardholder is
likely to be. For these ?rms that mediate between different parties, adding value
is about building the network that the parties value, and performing the types of
activities that enable direct or indirect exchanges between members of the net-
work. Contrast this with a manufacturer with a value chain that must worry
348 Applications
about incoming and outgoing logistics, transformation of physical inputs into
outputs, and disposal of these outputs. Value network con?gurations get their
name from the fact that value addition is about building and exploiting a
network.
The elements of a value network (a bank in this case) are shown in Figure
13.12. Support activities are very similar to the support activities for a value
chain that we saw earlier. Therefore we focus on primary activities.
Primary Activities
•
Network promotion and contract management: These are the activities
to invite and select potential customers to join the network. They include
initialization, management, and termination of contracts.
•
Service provisioning: These are the activities to establish, maintain, and
terminate links with customers. They also include activities to bill
customers.
•
Network infrastructure operation: These are the activities to maintain
?rm’s physical and information infrastructures.
Value Shop
Adding value in organizations such as hospitals, consulting ?rms, law ?rms,
architecture ?rms, and engineering professional services such as petroleum
exploration, has a lot more to do with solving problems than inbound and
outbound logistics, and therefore requires a different con?guration from the
value chain.
17
It is about working with customers to identify their problems and
solve them. Consider the example of a hospital. When a patient walks into a
hospital or is carried there, doctors have to ?nd out what is wrong with the
patient. They examine the patient using their banks of knowledge, skills, know-
how, and equipment. After the examination, they may decide that there is noth-
ing wrong with the patient and send him or her home. They may also decide
that they need to conduct some laboratory tests or more diagnostics. Depending
on the result of the tests, more tests may be needed, the patient may be referred
to an expert, admitted into the hospital, sent home, or sent for yet more tests.
Effectively, hospitals are more about solving problems than about inbound
Figure 13.12 A Value Network.
Strategy Frameworks and Measures 349
logistics, transformation of physical inputs, and disposal of outputs. Hospital
employees work with a patient to identify his or her illness and work to cure the
illness. Patients are not input materials, all of whom are given the same treat-
ment, and the same product expected at the end of some chain. The con?gur-
ations in which problems are identi?ed and solved are called value shop and are
better conceptualizations for hospitals, consulting services, law ?rms, engineer-
ing professional ?rms, and architecture ?rms than the value chain or value
network. The elements of the value shop are shown in Figure 13.13.
Primary Activities
•
Problem-?nding and acquisition: working with customers to determine the
exact nature of their problem or need. Activities include those to record,
review, and formulate the problem. Choice of general approach to solve the
problem.
•
Problem-solving: activities to generate and evaluate alternative solutions.
•
Choice: activities to choose among alternative solutions among alternative
problem solutions.
•
Execution: activities to communicate, organize, and implement the chosen
solution.
•
Control and evaluation: activities to measure and evaluate the extent to
which implementation of the solution has solved the problem targeted.
Balanced Scorecard
The balanced scorecard framework is a performance measurement system that
was developed by Professor Robert Kaplan of the Harvard Business School and
Dr. David Norton.
18
It takes four measurement perspectives—?nancial, cus-
tomers, business processes, and learning and growth—that provide a snapshot
of not only current operating performance but also the drivers of future per-
formance. Traditional ?nancial measures such as income, return on assets,
Figure 13.13 A Value Shop.
350 Applications
return on investments, economic value added, etc., usually re?ect the results of
past actions and say very little about what might drive future ?nancial perform-
ance. They also say little about the intellectual capital embedded in relation-
ships with customers, suppliers, and employees. By including measures from
the perspective of customers, business processes, and learning and growth,
the balanced scorecard captures measures of some of the drivers of future
performance.
Elements of the Balanced Scorecard
The key elements of the Balanced Scorecard are shown in Figure 13.14. A ?rm’s
vision and objectives are translated into measures that take customer, business
process, learning and growth, and ?nancial perspectives. In each perspective, a
?rm asks a driving question and answers the question by outlining its object-
ives, ?eshing out measures of the objective from the perspective in question,
stating the targets that the ?rm wants to meet as far as the perspective is con-
cerned, and detailing the initiatives that the ?rm would need to meet the targets
(Figure 13.14).
Figure 13.14 Elements of the Balanced Scorecard.
Strategy Frameworks and Measures 351
Customer Perspective
The primary question that a ?rm should ask itself is, how do customers see us?
The idea here is for a ?rm to translate the customer-related aspects of its vision
and objectives into measures that re?ect those things that matter to customers.
For example, measures such as delivery lead times, product quality, perform-
ance and service, and costs are important to most customers and therefore make
good measures.
Internal Business Perspective
The primary question that a ?rm should ask itself as far as the internal business
perspective is concerned is, at what must we excel? The idea here is to identify
those things that a ?rm does well to meet customer needs, and then identify
those measures that enable the ?rm to track these things that it does so well.
Some of these measures include cycle time, quality, employee skills, and
productivity.
Learning and Growth Perspective
Because of the rapid rate of change, especially technological change, it is
important for a ?rm to be able to continue to do well in the face of change. Thus
a ?rm needs to ask the question, how can we sustain our ability to change and
improve? This ability can be tracked using measures such as the ability to
launch new products, create more value for customers, and improve operating
ef?ciencies.
Financial Perspective
The ?nancial perspective measures whether a ?rm’s strategy and implementa-
tion have been working for shareholders. Hence the question, how do we look
to shareholders? How a ?rm looks to shareholders can be tracked using meas-
ures such as pro?tability, shareholder value, cash ?ow, operating income,
return on equity, and so on.
Objectives, Measures, Targets, and Initiatives
Throughout our discussion of the balanced scorecard, we have focused on
measures; but as indicated in Figure 13.14, each perspective has four parts:
objectives, measures, targets, and initiatives. A ?rm’s objectives for each per-
spective are where the ?rm would like to be as far as the perspective is con-
cerned. For example, in the customer perspective, a ?rm’s objective may be to
increase customer satisfaction. A measure of customer satisfaction would be,
for example, customer ratings of their satisfaction with the ?rm’s products or
service. A speci?c target for measuring customer satisfaction would be, for
example, a rating of 5 out of 5. Initiatives are action programs put in place to
meet the objective. Initiatives to increase customer satisfaction could include
listening to customers more, training customer service representatives, and
building a better product.
352 Applications
Advantages and Shortcoming of the Balanced Scorecard
Advantages
•
Before the balanced scoreboard, one of the few ways to determine whether
or not a ?rm’s strategy was working was to use ?nancial measures; but
?nancial measures usually re?ect the results of past actions and say very
little about future performance. Moreover, it was not easy to link ?nancial
performance to ?rm activities. By complementing these ?nancial measures
with measures from the perspective of the customer, internal business, and
learning and growth, a ?rm can track its progress towards meeting its
objectives and future performance goals better. If the adage that “You can’t
manage what you don’t measure” is true, these added measures of a bal-
anced scorecard expand the scope of what managers can manage better.
•
The balanced scorecard offers managers a common language, display for-
mat, and starting point for management discussions on the extent to which
a ?rm’s strategy is meeting its objectives.
•
The balanced scorecard also provides a common language for benchmark-
ing the performance of competitors, acquisition targets, and potential alli-
ance partners.
Disadvantages
•
The balanced scorecard is a set of measures, not a strategy. While it enables
managers to track the performance of a strategy, it does not say what the
strategy is and how it could be improved. The framework says very little
about the activities that are driving a ?rm’s performance and why the
activities are indeed responsible for the performance. This is where frame-
works such as the AVAC that we saw in Chapter 2 and will touch on below
come in.
•
If the adage that “You can’t manage what you don’t measure” is true, then
settling on the wrong measures can mislead a ?rm into thinking that it is on
the right track.
VRIO Framework
The VRIO (Value, Rare, Imitate, Organized) framework was developed by Pro-
fessor Jay Barney of the Fisher College of Business at the Ohio State Uni-
versity.
19
The framework is about exploring the extent to which a ?rm can
expect to have a sustainable competitive advantage from its resources. The
central argument of the framework is that, if a ?rm has resources that are
valuable, rare, costly to imitate, and the ?rm is organized to exploit these
resources, then the ?rm can expect to have a sustained competitive advantage. It
is rooted in the resource-based view of strategic management that we explored
in Chapter 5.
Elements of the Framework
The framework can be understood by exploring four questions.
Strategy Frameworks and Measures 353
The Question of Value
Value in this case is about the extent to which external opportunities can be
exploited or external threats neutralized. Thus the question that a ?rm poses is,
does the resource enable the ?rm to exploit external opportunities or neutralize
an external threat? If the answer is Yes, the ?rm is likely to increase its revenues,
decrease its costs, or both—it is likely to increase its pro?ts using the resource.
The Question of Rarity
If the resource is not rare, many other ?rms will acquire it and be able to exploit
the same opportunities or neutralize the same threats, considerably reducing
any pro?ts that the ?rm would have made from the resource. Rarity does not
necessarily mean that the ?rm is the only one with the resource. A few ?rms can
have the resource, but just few enough for there still to be scarcity, enabling
them to make money from the resources.
The Question of Imitability
If a resource is valuable and rare, a ?rm can have a competitive advantage; but
such an advantage is likely to be only temporary if the resource can be imitated.
Effectively, the advantage is likely to be sustainable only if competitors face a
cost disadvantage in imitating the resource.
The Question of Organization
A valuable, rare, and inimitable resource still has to be exploited. Thus a ?rm’s
structure and control systems must be such that employees have the ability and
incentive to exploit the ?rm’s resources.
Advantages and Disadvantages
Advantages
•
Since a ?rm’s valuable, rare, and inimitable resources are its strengths, the
VRIO framework provides the link between strengths and pro?tability that
a SWOT analysis does not.
•
It can be used to narrow down the list of a ?rm’s resources to only the very
relevant ones, allowing a manager to make better choices on where to
invest. Managers can also use it to identify the areas in which they have
weaknesses (in resources), allowing them to plan better on how to reduce
the weaknesses.
•
A VRIO analysis can also be used to determine the quality of competitors’
resources.
Disadvantages
•
The VRIO framework says very little about coopetitors—the suppliers, cus-
tomers, complementors, rivals, and other organizations with whom a ?rm
354 Applications
often has to cooperate to create value and compete to appropriate it; that is,
the industry component of the determinants of a ?rm’s pro?tability is
largely neglected.
•
The framework says very little about change. In the face of some changes,
valuable, rare, and inimitable resources can become a handicap.
20
VIDE
In 1990s, following Professors C.K. Prahalad’s and Gary Hamel’s seminal art-
icle on the core competence of the ?rm, and research by other scholars, many
?rms wanted to determine their core competences and nurture them.
21
Some of
the ?rms that tried this exercise ended up with an endless list of resources and
capabilities, with no way of determining which ones were really the critical ones
that deserved to be nurtured. The VIDE (Value, Imitability, Differentiability,
and Extendability) analysis was one attempt to narrow down the list of core
competences to the ones that really matter to a ?rm.
22
It consists of providing
answers to four questions about resources/capabilities and classifying them
based on the answers. It was derived from the de?nition of a core competence.
Recall from Chapter 5 that a core competence is a resource or capability that
meets the following criteria:
23
(1) makes a signi?cant contribution to the bene-
?ts that customers perceive in a product or service, (2) is dif?cult for competi-
tors to imitate, and (3) is extendable to other products in different markets.
Elements of the VIDE Analysis
The primary questions in a VIDE analysis are summarized in Table 13.1.
Value
Since money comes from customers, a core competence must be translated into
something that they perceive as valuable to them. Hence the ?rst question that a
?rm may want to ask, in determining the extent to which a resource/capability
is likely to amount to a core competence, is to ask whether the resource/capabil-
ity makes a signi?cant contribution towards the Value that its customers per-
ceive. The skills of a plastic surgeon who performs cosmetic face surgery adds
value if his/her patients can look in a mirror and say, “I like my new face.” If the
answer is No, then there is little chance that the resource/capability is likely to
be a core competence, unless the ?rm ?nds a way to make it more valuable to
customers.
Table 13.1 Elements of a VIDE Analysis
Element Question
Value Does the resource or capability make an unusually high contribution to the value
that customers perceive in the firm’s products?
Imitability Is it difficult for other firms to duplicate or substitute the resource or capability?
Differentiation Is the type or level of the resource or capability unique to the firm?
Extendability Can the resource or capability be used in more than one product area?
Strategy Frameworks and Measures 355
Imitability
If a resource or capability makes a signi?cant contribution to the value that
customers perceive, the ?rm may not be able to make money from it for a long
time if the skill can be duplicated or substituted by many competitors. Thus an
important question to ask is, is it dif?cult for other ?rms to duplicate or substi-
tute the resource or capability?
Differentiation
If a resource or capability can be imitated, the question is, can a ?rm set itself
apart from imitators by differentiating the capability? For example, a ?rm can
differentiate itself by having a higher level of capability. Many cosmetic sur-
geons can perform face surgery but some of them can do a much better job than
others. Thus, an important question is determining whether a resource is a
core competence is, is the type or level of the resource or capability unique to
the ?rm?
Extendability
If a resource or capability is valuable, dif?cult to imitate, and a ?rm has found a
way to differentiate the resource from copycats, the next big question is, can the
resource or capability be used in more than one product area? For example,
Honda’s ability to design reliable high-performing engines is extendable
because its engines are used not only in cars but also in boats, lawnmowers,
motorcycles, electric generators, and airplanes.
Effectively, by answering Yes or No to the questions of Table 13.1, a ?rm can
rank its resources/capabilities with the ones with the most Yesses at the top
since they have the highest likelihood of being core competences.
Advantages and Disadvantages of VIDE
Advantages
•
The VIDE analysis offered one of the ?rst ways to determine the extent to
which a resource or capability was likely to be a core competence and
therefore presented ?rms with a method for narrowing down their lists of
resources to a more manageable few.
•
A VIDE analysis can be used to analyze the resources/capabilities of com-
petitors and potential targets for acquisition or cooperation.
Disadvantages
The VIDE analysis has some of the same disadvantages as the VRIO analysis
discussed above.
•
The only mention of coopetitors in the VIDE analysis is in the Extendability
component. That is because in moving to a different product area, a ?rm is
likely to face competition; but like the VRIO, the VIDE says very little about
356 Applications
coopetitors—the suppliers, customers, complementors, rivals, and other
organizations with whom a ?rm often has to cooperate to create value and
compete to appropriate it. The industry component of the determinants of a
?rm’s pro?tability is largely neglected.
•
Like the other frameworks that we have explored, the VIDE says very little
about change. In the face of radical changes, core competences can become
handicaps.
24
S
3
PE
As we saw in Chapter 7, S
3
PE stands for Strategy, Structure, Systems, People,
and Environment. The rationale behind the S
3
PE framework is that strategies
are formulated and executed by people. Therefore, people are important to the
success of a strategy. They are more than just a part of a pro?t-maximizing ?rm.
The structure of a ?rm—to which people report, and who is responsible for
what activities—is important, as are the systems that the ?rm has in place for
determining how performance is measured, how people are rewarded or pun-
ished, what information goes to whom, and so on. Of course, whether a ?rm’s
strategy, structure, systems, and people enable the ?rm to perform well is also a
function of the environment in which the ?rm functions.
Elements of the S
3
PE
The components of the S
3
PE are shown in Figure 13.15. These are the same
components that we saw in Chapter 7 and therefore we will not spend any time
on them.
Advantages and Disadvantages of the S
3
PE
Advantages
•
The S
3
PE framework goes beyond the underlying economic assumption that
employees’ incentives are well aligned with those of their ?rm and are
pro?t-maximizing. It pays attention to the incentives of employees and to
the culture of organization.
•
It brings in the implementation component of strategy analysis.
Disadvantages
•
Like the SWOT and PEST analysis, the S
3
PE framework does not establish a
link to pro?tability. As Figure 13.15 indicates, strategy, structure, systems,
people and environment drive performance but it is dif?cult to tell the direc-
tion of the performance based on the elements of the framework.
•
One of the components, environment, is too broad.
The 4Ps of Marketing (The Marketing Mix)
When a ?rm pursues a target market, it usually has marketing objectives for the
target. To achieve these objectives, a ?rm needs marketing tools. The set of
Strategy Frameworks and Measures 357
marketing tools that a ?rm uses to pursue its marketing objectives in its chosen
target market is its marketing mix.
25
These marketing tools can be grouped into
four groups called the 4Ps.
26
In other words, the 4Ps have come to be synonym-
ous with the marketing mix. The 4Ps were developed in the 1960s by Professor
E. Jerome McCarthy of Michigan State University. They are the marketing
variables that managers can control to meet their marketing objectives in the
target market.
Elements of the Model
The elements of the 4Ps are shown in Figure 13.16.
Product
These are the actual speci?cations of the goods or services being marketed and
their relationship to customer’s needs and wants. These speci?cations include
not only the inherent characteristics of a product/service such as functionality,
?t, quality, safety, packaging, and reliability, but also peripheral ones such as
warrantees, brand name, guarantees, repairs/support, accessories, and service
(for products). A ?rm must choose from all these.
Figure 13.15 Elements of the S
3
PE.
358 Applications
Pricing
This is the process of setting a price for a product or service. The price is
whatever the product/service is exchanged for, including money, time, energy,
attention, or psychology. Pricing decisions include the type of pricing (?xed,
auction, bundling, etc.), pricing strategy (discriminate, skim, penetration,
everyday-low-prices, etc.), discounts (volume, wholesale, cash, early payment,
etc.), ?nancing, allowances, credit terms, and leasing options.
Placement
Also commonly referred to as place, placement is about distribution, how the
product reaches customers. It refers to the channel through which a product is
sold (retail, resellers, wholesalers, directly, online, mobile, etc.), the market
Figure 13.16 Elements of the 4Ps.
Strategy Frameworks and Measures 359
segment (business, consumer, government, upper class, families, college edu-
cated, etc.), and geographic region or national market. Decisions involved
include which distribution channel to use (retail, resellers, wholesalers, directly,
online, etc.), who should be within each channel, geographic location (which
country) what type of inventory management to use, how to process orders,
what type of market coverage (exclusive or inclusive distribution), and what
type of warehousing and order processing.
Promotion
This is about the different ways that can be used to promote the product, brand,
or ?rm. These include advertising, personal selling, promotional strategy, word
of mouth, and viral. They also include the type of promotion, publicity, and
budget. It is about communicating product/service, ?rm, and brand informa-
tion to customers with the goal of improving the perception of the product,
?rm, or brand.
Applications of the 4Ps
As we stated above, the 4Ps are marketing tools that a ?rm uses to pursue its
marketing objectives in the chosen target market.
Advantages and Disadvantages of 4Ps
Advantages
•
It is simple, easy to remember, and a great starting point for students who
are being introduced to marketing.
•
It provides a common language and platform for marketing discussions
about how to attain objectives in a target market.
Disadvantages
•
Like the SWOT analysis, the 4Ps consist of a list of factors—close to a
laundry list—with no clear link to ?rm pro?tability. There is no way of
telling whether one set of 4Ps chosen by a ?rm will be more pro?table than
another.
•
The 4Ps are a static framework that says little about how the Ps change with
time.
•
The model is primarily for consumer products, not industrial products.
•
It is more oriented towards products than towards services.
•
The 4Ps are not necessarily all that a ?rm may need to attain its objectives in
a target market. For example, it has been argued that a ?rm also needs
people to attain its objectives and therefore there should be a ?fth P for
people (see below).
4Ps and New Games
In using the 4Ps to pursue marketing objectives, a ?rm has many options from
which to choose. Take pricing, for example. In formulating its pricing strategy,
360 Applications
a ?rm can choose from skimming, pricing to penetrate, everyday-low-prices,
and price discrimination. In choosing the type of pricing, the ?rm has the option
of ?xed pricing, Dutch auction, or reverse auction. Each of the components of
the other Ps offers similar options. Therefore, the 4Ps offer plenty of opportun-
ities for new games. For example, if industry ?rms practice price skimming a
?rm may decide to pursue penetration pricing in its new game.
5Ps and 7Ps
Since people play such a critical role in using the 4Ps to meet a ?rm’s marketing
objectives for a target market, it has been suggested that People should be a ?fth
P. In service industries, for example, it is dif?cult to separate the person who
delivers a service from the service itself and customer experience. In fact, in
some cases, customers also add to the experience that fellow customers obtain
from a service. Thus, we have 5Ps (Product, Prices, Placement, Promotion, and
People) where the choices that have to be made about People include training,
motivation, ?t, etc. Some marketers take it even further, suggesting that two
more Ps ought to be added to the ?ve, especially when services are concerned.
These are the Processes that are involved in offering service, and Physical evi-
dence. The latter is about giving potential customers physical evidence for what
the service will be like, for example, using case studies, testimonials, or
demonstrations.
AVAC
The AVAC framework was the subject of all of Chapter 2. Therefore we will
only very brie?y restate some of the points about the framework. It gets its
name from the ?rst letter of each of its four components (Activities, Value,
Appropriability, and Change), and can be used to explore the pro?tability
potential of a strategy and more. It can be used to analyze the extent to which a
strategy creates value and/or positions a ?rm to appropriate value created in its
value system, and what else the ?rm could do to improve its performance.
Elements of the Framework
The drivers of the four components of the AVAC are shown in Figure 13.17.
Activities
Recall that a ?rm’s strategy is the set of activities that the ?rm performs to
create value and/or position itself to capture any value created in its value
system. Each activity which a ?rm performs, when it performs it, where it
performs it, and how it performs it determine the extent to which the activity
contributes to value creation and appropriation, and to the level of competitive
advantage that the ?rm can have. Therefore the ?rst thing to do in assessing the
pro?tability potential of a strategy is to identify the set of activities that consti-
tute the strategy and determine the extent to which each of the activities con-
tributes to value creation and appropriation. This consists of determining the
extent to which each activity:
Strategy Frameworks and Measures 361
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1 Contributes to low cost, differentiation, better pricing, reaching more cus-
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2 Contributes to improving its position vis-à-vis coopetitors.
3 Takes advantage of industry value drivers.
4 Contributes to building new distinctive resources/capabilities or translating
existing ones into unique positions and pro?ts (including complementary
assets).
5 Fits the comprehensiveness and parsimony criteria.
Value
Next, we determine if the contributions of all the activities, when added
together, are unique enough to make customers prefer the ?rm’s products to
competitors’ products. This is done by answering the following simple
questions:
1 Do customers perceive the value created by the strategy as unique?
2 Do many customers perceive this value?
3 Are these customers valuable?
4 Are there any nearby white spaces?
Appropriability
The fact that a ?rm offers unique value to customers does not always mean that
the ?rm will capture the value that it creates. Firms do not always make pro?ts
commensurate with the value that they have created. The Appropriability com-
ponent tells us whether a ?rm has a superior position vis-à-vis coopetitors, and
whether the ?rm translates the customer bene?ts created and its position vis-à-
vis coopetitors into money. The analysis consists of asking whether:
1 The ?rm has a superior position vis-à-vis its coopetitors.
2 The ?rm exploits its position vis-à-vis its coopetitors and customer bene?ts.
3 It is dif?cult to imitate the ?rm.
4 There are few viable substitutes but many complements.
Change
Change can have a profound effect on a ?rm’s ability to create and appropriate
value. The extent to which a ?rm can take advantage of it is explored in two
parts. First, the ?rm’s strengths prior to the change are sorted out and a
determination is made as to which of these strengths remain strengths and
which ones become handicaps. Second, the extent to which a ?rm can take
advantage of change is explored. This is done by exploring the extent to which
the ?rm takes advantage of:
1 The new ways of creating and capturing new value generated by the change.
2 The opportunities generated by change to build new resources or translate
existing ones in new ways.
Strategy Frameworks and Measures 363
3 First mover’s advantages and disadvantages, and competitors’ handicaps
that result from change.
4 Coopetitors’ potential reactions to its actions.
5 Opportunities and threats of environment. Are there no better alternatives?
Using the AVAC: Advantages
•
Can be used to explore not only the pro?tability potential of a strategy but
also that of business models, business units, products, technologies, brands,
market segments, acquisitions, investment opportunities, partnerships such
as alliances, functional units, corporate strategies, and ventures.
•
More importantly, the framework can be used to determine which com-
ponents (activities, value, appropriability, or change) have the potential to
give a ?rm a sustainable competitive advantage. The ?rm can then sort out
which activities and resources it needs to reinforce a sustainable advantage
or build on. Within each component, a ?rm can determine which driver of
the component constitutes a strength or weakness. Such a ?rm can then ?nd
ways to reinforce the strengths and reverse the weakness or dampen their
effects.
•
Like most frameworks, the AVAC constitutes a language and platform for
strategy discussions. It can be used as the starting point for strategic plan-
ning sessions, scenario planning, new strategic move, and so on.
•
Like the Five Forces, the AVAC provides a link between components and
pro?tability.
•
The AVAC is about a ?rm’s performance, and incorporates both industry
and ?rm-speci?c factors.
•
The AVAC incorporates change.
Summary Statement
A comparison of the frameworks that we have explored is shown in Table 13.2.
Since the ultimate goal of most ?rms is to have a sustainable competitive advan-
tage, we use the drivers of sustainable competitive advantage as the basis for
comparison. These are (1) industry and macroenvironmental factors (external
factors), (2) ?rm-speci?c factors, which include both resource-based factors and
position-based factors, (3) change, and (4) link to pro?tability. The rationale
for choosing these variables as the basis for comparison is as follows. Since
most ?rms are in business to make money for their owners, and strategy is
about winning, a strategy framework ought to have some way of linking elem-
ents of the framework to pro?ts. Moreover, we know that a ?rm’s performance
is a function of both industry and macroenvironmental factors as well as ?rm-
speci?c factors. Firm-speci?c factors can be resource-based or position-based.
Finally, change plays a critical role in the inability of ?rms to sustain competi-
tive advantages.
A SWOT analysis is clearly about industry and macroenvironmental factors
(opportunities and threats), and resource-based and position-based factors. The
Growth/Share Matrix proxies industry factors with market growth rate and
?rm-speci?c factors with relative market share. Thus, it incorporates industry
factors and position-based factors. Relative market share provides a link to
364 Applications
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pro?tability. The GE/McKinsey framework is also about industry factors and
position-based factors. The Five Forces framework is about industry factors
and clearly provides a link between each of the forces and industry pro?tability.
Business systems, value chain, value network, and value shop are about ?rm-
speci?c factors—both resource-based and position-based. The balanced score-
card is about measures and really does not say much about the industry and
?rm-speci?c factors that impact pro?tability. The VRIO and VIDE analyses are
grounded in the resource-based view of the ?rm and clearly provide links to
pro?tability. Since a PEST analysis is about digging deeper into macroenviron-
mental factors, it tells us something about the macroenvironmental opportun-
ities and threats that a ?rm must face. An S
3
PE framework is primarily about
people, and the structure and systems in which they operate; but it is also about
strategy and the environment in which strategy is being formulated and oper-
ated. Hence the S
3
PE framework is about both industry and ?rm-speci?c factors
but provides no link to pro?tability. The 4Ps are about a ?rm’s position in a
market. The AVAC incorporates all four factors: industry and macroenviron-
mental factors, ?rm-speci?c factors, which include both resource-based factors
and position-based factors, change, and link to pro?tability.
Some Financial Measures
27
Since strategy case analysis often involves numbers, it is worthwhile reviewing
some elementary but useful ?nancial measures (Table 13.3). A ?rm’s pro?ts are
its revenues minus costs. Managers and ?nancial analysts regularly track the
pro?tability of ?rms. Sooner or later, most ?rms have to be pro?table. What
managers mean by pro?ts often differs from what economists call pro?ts.
Economists’ de?nition of pro?ts uses opportunity costs rather than straight
accounting costs. For economists, costs are not just straight accounting costs
but the cost of what is forgone by not using the inputs some place else where
they could have fetched more money. Another measure which analysts and
?rms track carefully is gross pro?t margin. This is a measure of the extent to
which a product’s revenues cover its variable costs and what is left over con-
tributes towards covering ?xed costs and generating a pro?t. The higher a
product’s pro?t margin, the more of that product the ?rm would want to sell,
since the product covers not only its variable cost but also contributes towards
covering ?xed costs and generating a pro?t. Closely related to pro?t margins is
the breakeven point. The breakeven point is the quantity at which ?xed and
other upfront costs have been recovered. The breakeven time is the time that it
takes to reach the breakeven point.
When a ?rm makes payments for salaries, supplies inventories and other
accounts payable, there should be cash available in deposits at a ?nancial insti-
tution somewhere to cover the payment made to these creditors. Thus, it is
important to make sure that cash in?ows exceed cash out?ows. Cash ?ow is the
difference between cash in?ows and cash out?ows. Note that although pro?ts
are highly correlated with cash ?ows, a ?rm can be pro?table and still have
negative cash ?ows. Another measure of a ?rm’s performance is its stock price.
This is the net present value of the ?rm’s expected future cash ?ows. It is a
re?ection of how the market expects the ?rm to perform in the future. Another
measure is earnings per share. This is the after-tax pro?ts that are available to
Strategy Frameworks and Measures 367
holders of common shares for each share of the company that they own. A ?rm
usually reinvests its after-tax pro?ts in the company or pays it out as dividends
to shareholders. Creating bene?ts for customers usually requires investment in
plants, equipment, inventories and so on. Return on investment (ROI) measures
how well the investment in capital is generating pro?ts. Financial analysts can
use ROI to compare how different ?rms use capital.
Another measure of performance is Economic value added (EVA).
28
EVA
should not be confused with the customer bene?ts that customers value in
products or services. EVA is calculated by adjusting after-tax pro?ts by the cost
of capital. The rationale behind the popularity of the measure is as follows. It
takes money (capital) to invest in all the assets (tangible and intangible) and
activities that are used to create and appropriate value. This capital consists of
borrowed and equity capital. Borrowed or debt capital is the money that ?rms
borrow and its cost is the interest that ?rms have to pay on the debt. Equity
capital is the money that shareholders provide when they buy a company’s
stock. By investing their money in a ?rm’s stocks, shareholders are forgoing
earning opportunities elsewhere. Thus, a ?rm’s cost of equity capital is the price
Table 13.3 Summary of Some Financial Measures
Financial measure Expression
Breakeven point (quantity): quantity at which
fixed and other upfront costs are recovered.
Fixed cost
Contribution margin
Breakeven time: the time taken to reach the
breakeven quantity.
Breakeven quantity
Sales rate
Cash flow: the difference between cash that a
company receives and the cash that it pays out. A
measure of cash that is available to fund a firm’s
activities or pay out to shareholders.
After-tax profits + depreciations
Earnings per share: amount that is available to
owners of common shares.
Profits after taxes ? Preferred stock dividends
Common stock shares outstanding
Economic value added (EVA): a measure of
economic profit.
After-tax profits ? cost of capital
Gross profit margins: a measure of the extent to
which revenues cover the cost of generating the
revenues and still generate a profit (after covering
fixed costs).
Sales ? cost of goods sold
Sales
=
Profits
Sales
Return on assets: the return on the assets that
have been invested in the firm.
Profits after taxes
Total assets
Return on equity: the return on total shareholder
equity in the firm.
Profits after taxes
Total shareholder’s equity
Marker value (capitalization): present value of
expected future cash flows.
=
?
t = n
t = 0
C
t
(1 + r
k
)
t
where C
t
is the free cash flow at time t, and r
k
is
the firm’s cost of capital.
368 Applications
appreciation and dividends that shareholders could have earned if they had
invested their money in another asset (for example, a portfolio of companies)
that is as risky as the ?rm whose stocks they bought. Effectively, since capital
costs money, this cost of capital should be taken into consideration when meas-
uring how well a ?rm is performing as it uses capital to generate pro?ts. EVA is
therefore after-tax pro?ts adjusted by the cost of capital that is used to generate
the pro?ts.
Economic value added (EVA) = Operating pro?ts ? Taxes ? Cost of capital
where
Cost of capital = total capital used × weighted average of cost of debt and
cost of equity.
Strategy Frameworks and Measures 369
Cases
Case 1: The New World Invades France’s Terroir
Case 2: Sephora Takes on America
Case 3: Net?ix: Responding to Blockbuster, Again
Case 4: Threadless in Chicago
Case 5: Pixar Changes the Rules of the Game
Case 6: Lipitor: The World’s Best-selling Drug (2008)
Case 7: New Belgium: Brewing a New Game
Case 8: Botox: How Long Would the Smile Last?
Case 9: IKEA Lands in the New World
Case 10: Esperion: Drano for Your Arteries?
Case 11: Xbox 360: Will the Second Time be Better?
Case 12: Nintendo Wii: A Game-changing Move
Part V
The New World Invades France’s
Terroir
The French government of?cial could not believe that there was talk of one
more threat to his country’s dominance of the global wine industry. First, it was
the so-called invasion by New World wine producers. Now there was talk of
transgenic wine. Scientists had unraveled the genetic secrets of the pinot noir
grape that was used to produce the world’s ?nest wines, making it possible to
now produce the grape in places where cultivation had been inhospitable.
1
What would be next? Should France be worried about the New World’s
invasion of this ancient European industry? How about transgenic grapes?
What should the country do?
The Wine Industry in 2008
In 1999, California’s E&J Gallo was the world’s largest producer by volume
with a 1% market share.
2
The region of Bordeaux, France alone had over
12,000 producers while Italy had over a million. But in the USA, the ?ve largest
?rms had a 62% share, in Australia the top four ?rms had an 80% share, while
in Chile the top ?ve ?rms had a 50% share. In the USA, 45% of wine was sold
in supermarkets while in the Netherlands, the number was over 60%.
3
At the
low end of the market, many producing countries drank their own, and New
World producers were making inroads at large importers such as the UK. At the
middle of the market, Europeans were ceding dominance to New World produ-
cers such as Australia (in Britain, for example). At the high end, Old World
?rms still dominated.
The Rise and Dominance of French Wine
The history of wine may go as far back as 6,500 years in Greece where
researchers say wine was ?rst produced.
4
It would become such an integral part
of life in the Mediterranean and early Europe that even monasteries grew
grapes, and made wine. In the nineteenth, twentieth, and early twenty-?rst
centuries, France dominated the wine world. It had the largest market share of
any country, by value, and the words ?ne wine had come to be associated
with France. This dominance is usually attributed to several factors. First,
France had the terroir—that unique mix of natural factors such as the soil,
rainfall, temperature, humidity, altitude, slope of terrain, and orientation
towards the sun—that held one of the secrets to producing the right grapes for
?ne wines. Second, there was a lot of local demand for wine. Whereas in the
Case 1
USA, prohibition made the sale of wine illegal, in Europe, it was just another
beverage that most people drank and that had become part of many liturgical
services. Third, there was pasteurization of wine, invented by France’s own
Louis Pasteur, which enabled wine to last much longer. The Fourth factor was
the series of innovations that led up to mass production of glass bottles and the
introduction of the cork stopper. Wine could be pasteurized, put in bottles, and
corked to last until someone wanted to drink it. The ?fth factor was a series of
innovations in transportation—canals, railways, steamers, horse-driven carts,
and later, automobiles—which enabled wine produced in one region to be
transported to other regions for consumption. Ironically, these transportation
innovations gave birth to fraud.
5
Before the transportation innovations, wine
was usually consumed locally and consumers had a better chance of knowing
who produced what; but with the innovations, opportunists could produce
wine anywhere and claim that it came from a more reputable region.
The Sixth factor was a different type of innovation. Because there were hun-
dreds of thousands of producers, each with a different quality of wine, it was
dif?cult for consumers to tell who was producing what, and which producers
were making the right claims. In preparation for the 1855 World Exposition
of Paris that he had conceived, Emperor Napoleon III ordered a group of
wine producers in the Bordeaux region to classify vineyards in the area
into ?ve groups, as a function of quality.
6
They came up with the premiers crus
(?rst growth), deuxièmes crus (second growth), trosièmes crus (third growth),
quatrièmes crus (fourth growth), and cinquièmes crus (?fth growth). This sys-
tem simpli?ed customers’ choices, and both customers and producers liked it. In
1935, the French government formalized most of it in the form of the Appella-
tions d’Origine Contrôlée (AOC) laws which stipulated not only what cru
could come from what region, but also what could be put into what wine, how
it could be made and labeled, the alcohol content of different wines, what types
of grapes could be grown in what region, and what type of grape varieties could
go into what wine category. Growers could not use irrigation systems since that
would temper with the terroir. Only grapes from the region speci?ed on a bottle
could be used to make the wine in the bottle. The idea was to protect the good
name of each region and assure customers that they were getting what they
believed they were getting. Several European countries established similar laws.
Later, other wine regions of France were of?cially classi?ed as the Vin
Délimité de Qualité Superieure (VDQS). Right below VDQS wines were the Vin
de Pays, and Vin de Table. The hierarchy of wines is summarized in Exhibit 1.1.
Exhibit 1.1 Hierarchy of French Wines. (2005 market shares are shown in percentages.)
1. Appellation d’Origine Contrôlée (AOC, 53.4%): Wines that follow the strict AOC laws and
classifications. High end wines.
2. Vin Délimité de Qualité Superieure (VDQS, 0.9%). Do not conform to the AOC rules. Used to classify
wines from smaller areas, or as a “waiting room” for potential promotion to AOCs. Middle wines.
3. Vin de Pays (33.9%). Subject to very few or none of the AOC restrictions. Lower quality too. Low-
end wines. Region within France is specified.
4. Vin de Table (11.7%). Even fewer restrictions. Only has to show the producer and the designation
that it is from France. Lowest end wines.
Source: Retrieved June 21, 2008, from http://en.wikipedia.org/wiki/French_wine.
374 Cases
Many farmers grew and sold their grapes, by weight, to local winemakers or
formed cooperatives to make the wine. Because some of the farms had been
inherited by more than one sibling from one generation to the other, many
farms tended to be very small. Some large growers made their own wine. A lot
of the wine was then sold to middle people who then resold it to consumers or
other middle people.
The Rise of the New World Winemakers
The New World winemakers came from Argentina, Australia, Canada, Chile,
New Zealand, South Africa, and the USA. Many of these players were vertic-
ally integrated backwards into growing their own grapes, and because their
countries had inexpensive widely available land compared to the old continent,
they could own large vineyards. Many of them used drip irrigation systems, not
permitted by France’s AOC rules, not only to bring more land into production
but also to control the variability of grape quality and yield better.
7
They also
used mechanical harvesters and experimented with different kinds of fertilizer.
In making wine, the New World winemakers used large steel tanks, controlled
by computers, rather than the small oak barrels of the Old World. To obtain the
oak taste of wine from oak barrels, they added oak chips to the steel tanks, a
practice seen as repulsive by some French.
8
Effectively, these new ?rms could
experiment with lots of things that Old World ?rms were not allowed to pursue.
They were constantly pursuing new ways of making and marketing wine. For
example, around 1999, Australia produced 20% of the world’s scienti?c papers
on viticulture and oenology.
9
The biggest marketing innovation, pioneered in California, was putting
the grape variety on the wine label.
10
This was in contrast to the labeling speci-
?ed by the AOC and related laws in Europe. Customers could now worry
whether they were buying a chardonnay, pinot noir, Chablis blanc, cabernet, or
sauvignon rather than worry about the rather intimidating regions in France
and the different categories in each region. Moreover, the European Union
would later ?nd that it was illegal for New World ?rms to use the names of
regions in Europe, such as Champagne, to refer to wine from their own coun-
tries. New World winemakers could also brand their products. A good brand
gave consumers some type of guarantee that they would get what they paid for.
It was also a good starting point for beginners. Although Old World Cham-
pagne producers had some good brands, many winemakers did not have widely
recognizable brands à la Coca Cola. New World winemakers were also verti-
cally integrated into distribution, making it easier for them to experiment with
new brands, products, and labels.
The pièce de résistance of the New World marketing activities came in a 1976
blind-tasting challenge set up by British wine merchant Steven Spurrier.
11
In this
challenge, that would later be called “the Judgment of Paris,” 15 of the most
in?uential French wine critics were invited to a blind tasting of top wines from
France and California. They used white wines made from chardonnay grapes
and red wines from cabernet sauvignon. The results of the taste astonished
everyone including the tasters: California wines won in both white and red
wines. The French protested, arguing that the event had been rigged. In a
rematch, two years later, California still won. In any case, France’s worldwide
The New World Invades France’s Terroir 375
market share had begun to drop. For example, from 1994 to 2003, the market
share of French wine sold in the USA fell from 26% to 16% and from 37% to
23% in Britain.
12
See also, Exhibit 1.2.
Other Threats to France’s Position
Beyond the threat from New World winemakers, there were others. To reduce
alcohol consumption for health and public safety reasons, France had intro-
duced a law in 1991 that forbade winemakers from sponsoring advertisements
that used anything but the most basic characteristics of their products.
13
From
1999 to 2007, wine consumption in France fell from 32.2 million hectoliters to
29.9, while the share of French people drinking wine each day had fallen from
30% to 23% in the ten years to 2004.
14
In the mid-1960s, the average French-
man had drunk 130 bottles of wine but by the mid 2000s, the number had
dropped to about 75 bottles.
15
Only 5% of the wine consumed in France was imported. This led some to
speculate that other countries might want France to reciprocate and import
more. Then there was always the threat posed by China and even Africa. If
indeed genetically engineered grapes could bring all sorts of land into produc-
tion, and all the experimentation undertaken by New World winemakers found
cheaper and faster ways of making wine, then the old continent would have to
compete with more than just the New World. It might also be possible to raise
the levels of those ingredients in wine—such as resveratrol, quercetin, and
ellagic acid—by genetically inserting the right genes in the right grapes, taking
wines to a different level. These grapes may even be grown in deserts.
Was the threat to the Old World wine industry anything to worry about?
What should the French government do if anything? What would happen to
France’s advantage from its terroir if, with transgenic grapes, just about any soil
anywhere could be brought into cultivation? Was it time to scrap the AOC
rules? France’s wine sales in China had been growing fast but the question was,
for how long? Would France have to move from the traditional production push
to more marketing pull?
Exhibit 1.2 World Wine Exports in 1999 and 2007
Exporter 1999 2007
Million hectoliters (%) Million hectoliters (%)
European Union (EU) 10.9 51 18.4 39
Argentina 1.0 5 3.5 8
United States 2.8 13 4.1 9
South Africa 1.3 6 5.0 11
Chile 2.5 12 6.1 13
Australia 2.6 12 7.8 17
Others 0.3 1 1.6 3
Total 21.0 100 47.0 100
Source: Kosko, S. (2008). World Markets and Trade: Wine. United States Department of Agriculture. Foreign Agricultural
Service.
376 Cases
Sephora Takes on America*
David Suliteanu, CEO of Sephora USA, rubbed his temples as he contemplated
the materials in front of him. All day long he had been reviewing the 2007
performance of the US beauty industry and his company’s place in it because
some executives from Sephora’s parent company, LVMH Moët Hennessy Louis
Vuitton, would be visiting the following week to discuss Sephora’s competitive
strategy. LVMH executives visited to discuss Sephora’s performance periodic-
ally, but David felt added stress for this meeting because of rumors that had
been circulating recently speculating that LVMH viewed Sephora as a noncore
asset and was considering a sale.
Launched in the USA in 1998, Sephora took the US beauty industry by storm
with its unique retail concept that combined a wide assortment of brands and
products with distinctive store designs and knowledgeable sales consultants in a
low-pressure sales environment. Sephora offered customers a choice of more
than 250 brands as well as the company’s own private label across a range of
product categories that included skin care, make-up, fragrances, bath & body,
and hair care. Most interesting, however, was the company’s model which
allowed customers to “try before they buy” in a hands-on, self-service shopping
environment.
Company History
Sephora was founded in France in 1969. In 1993, Dominique Mandonnaud, a
major shareholder in Altamir, the holding company for Shop 8, bought Sephora
from the UK-based drugstore, Boots, for $61 million (360 million francs).
Mandonnaud, who was also chairman and chief executive of?cer of the French-
based Shop 8 beauty and cosmetic retailer, merged his 11 Shop 8 boutiques
with the 38-store Sephora perfumery chain. The new entity was given the
more recognizable Sephora name but kept the Shop 8 stores format. This
format consisted of having spacious shopping areas and self-service shopping
with beauty products grouped by type rather than by brand.
1
By the end of
1996, Mandonnaud had opened a 16,200 square foot Sephora superstore at
the Champs-Elysees in Paris, France and given the brand major worldwide
* This case was written by Kathryn Morrison, Jason Paradowski, Stefan Pototschnik, Matthew
Smucker, and Spiro Vamvaka, under the supervision of Professor Allan Afuah as a basis for
class discussion and is not intended to illustrate either effective or ineffective handling of a
business situation.
Case 2
publicity. With over 100 employees and 10,000 visitors stopping by each day,
Sephora aimed to create a total beauty experience featuring beauty-related
advertising, online information, literature, and exhibits.
2
The company continued to expand throughout the mid-1990s, including in
the USA and in Europe. However, by 1997, Mandonnaud was ready to retire
from the business and along with his partners decided to sell. Luxury retailer
LVMH (Louis Vuitton, Moët, Hennessy) then entered the scene and acquired
Sephora for 344 million. Under LVMH, the company quickly doubled its
number of stores, and by the end of 1997, Sephora’s sales had increased to
FRF 2 billion.
3
In 2000, Sephora hired David Suliteanu as the US CEO. With his experience
at Home Depot where he had been Group President/Diversi?ed Businesses, he
was charged with the US market expansion. In 2008, Sephora was France’s
leading chain of fragrance and cosmetics stores, as well as the second largest
chain in Europe with a total of 420 stores located in nine countries. It operated
more than 190 stores in North America, with annual sales in the US market of
over $750 million.
4
Sephora also boasted the world’s “top beauty website,”
Sephora.com.
Overview of the Beauty Products Industry
“Personal care products” have long been a part of human civilizations with
evidence of cosmetics dating back to as far as 4,000 BC in Egypt. Since that
time, the industry evolved with fashion trends and new consumer demands, but
it wasn’t until the twentieth century that the cosmetics industry began to take
off with the manufacture of lipstick in 1915.
5
The 1920s brought the launch of
various dime and chain stores throughout the USA, which helped boost the
distribution and appeal of cosmetics. The economic boom following World War
II further stimulated growth in the cosmetics industry, which continued to
evolve with a wide variety of new products. In the eleven years from 1988 to
1999, US cosmetics and fragrance stores experienced strong growth averaging
approximately 5% per year.
6
In particular, the US economic boom of the late
1990s boosted the market with strong growth rates of 4.6% in 1998, 5.5% in
1999, followed by 10.2% in 2000.
7
Following this boom, growth dropped
along with the slowdown in the US economy. Between 2000 and 2003, the
troubles in the US economy had an adverse impact upon the industry as con-
sumer spending declined.
Competition in the industry was based on image, price, range and quality of
products, level of service, and location. Products included mass market, private
label, professional and prestige brands which were sold everywhere from stand-
alone boutiques and department stores to drug stores and mass retailers (i.e.
WalMart).
Despite many changes in the industry, mass merchandisers remained the larg-
est outlet for cosmetic and beauty products in the US with just under 30% of the
market, followed by food stores, drug stores, and department stores. Specialty
beauty, cosmetic and fragrance stores such as Sephora were estimated to
account for 10% of all cosmetic and toiletry sales in the USA.
8
Within this
subsegment, the top four participants held a market share of less than 40%,
re?ecting the generally fragmented nature of the industry.
9
378 Cases
Cosmetics Retailing and Sephora’s New Game
In 2008, the overall value chain for beauty products consisted of four primary
activities: design and development, manufacturing, distribution, and retailing.
While Sephora sold and marketed its own line of cosmetics, it primarily per-
formed the retail portion of the value chain.
Prior to the arrival of Sephora stores in the USA, there were two primary
means for consumers to purchase beauty products, and speci?cally cosmetics.
The ?rst was through “low-end” purchasing at self-service retailers such as
pharmacies, convenience stores, and mass retailers. Mass-marketed, typically
inexpensive brands were displayed on a shelf, but customers were unable to
sample products before purchasing them. Little or no customer assistance
was available, and selection was limited. The experience was primarily one of
convenience and price.
Department stores sat on the opposite end of the retail spectrum as the other
primary outlet for purchasing cosmetics in the USA. These stores, which were
typically located in shopping malls, maintained brand-speci?c cosmetics coun-
ters staffed with sales personnel who provided individual attention to each
customer. Customers were typically unable to serve themselves or sample prod-
ucts without the assistance of a salesperson, leading to a somewhat high-
pressure sales environment. Each brand’s sales counter was often staffed with
the brand’s own employee. While each brand’s sales counter provided a wide
variety of brand-speci?c cosmetics, there were a limited number of brands
available within each department store. In addition, the customer had to go to a
separate counter for each individual brand in order to purchase or try multiple
brands.
Sephora’s assisted self-service model ?tted nicely between these two retailing
models, combining the best of each extreme. Upon entering a Sephora outlet,
customers would see a wide variety of more than 200 brands, openly displayed
for customer sampling and a well-trained sales staff standing ready to provide
assistance with any product.
Like department stores, there was a knowledgeable and helpful sales force
available to provide assistance; but unlike department stores, Sephora
employees did not promote one speci?c brand and were trained to make the
sales experience welcoming and less aggressive. Perhaps most signi?cantly, all
products were openly displayed for sampling and testing, and make-up remover
was available throughout the store, encouraging customers to freely try mul-
tiple products, further differentiating Sephora from other cosmetics purchasing
environments.
Since cosmetics and perfumes were “experience” products, the Sephora
model provided signi?cant value to customers, and was a good ?t for the
products themselves. Stores even had specialized lighting meant to recreate
natural daylight inside the stores, further aiding and enabling customer
sampling.
Increased revenue came from multiple sources. First, customers were more
likely to try multiple brands, increasing the probability that they would ?nd and
purchase a product that matched their needs. Additionally, customers might
purchase more products since so many products (200+ brands) were available
in one location. Notably, product-sampling allowed for ease of comparison
Sephora Takes on America 379
shopping, which was unique to Sephora. The presence of a well-trained sales
force that was knowledgeable of all brands and products, rather than speci?c-
ally focused on one brand, provided additional value by ensuring that cus-
tomers saw all options available to them.
At convenience stores, comparison-shopping was limited to price compar-
isons and brand advertising claims, since product sampling was not available.
At department stores, a customer could not try products from multiple brands
without waiting for assistance at each individual brand’s counter, which typic-
ally restricted the customer’s ability to compare products.
In addition to the assisted-self service brick and mortar stores, Sephora had
a signi?cant online sales business. Through its online presence, Sephora
attempted to create an all-inclusive “beauty” world, with advertising, advice,
and literature available to consumers. In-store customers were referred to
Sephora’s website, keeping them involved in the company well after leaving
the store.
In 2006, it was announced that Sephora would open a “store-within-a-store”
concept within J.C. Penney department stores; and by mid-2007 it had stores
within 39 J.C. Penney stores. It also became the exclusive seller of beauty prod-
ucts for the chain, as well as for Penney’s website (JCP.com). Some analysts
estimated that the move might bene?t J.C. Penney, a mid-tier department store
that wanted to upgrade its image. In fact, “J.C. Penney’s new campaign, with
the slogan ‘Every Day Matters,’ built on the retailer’s efforts to convince shop-
pers that it had shed its dowdy image and become a stylish retailer stocked with
fashionable merchandise.”
10
Competitors
Ulta Salon, Cosmetic & Fragrance, Inc.
Ulta Salon, Cosmetic & Fragrance, Inc. (Ulta) was founded in 1990 by Dick
George, using $12 million of venture capital.
11
George, a former president of
Osco Drug, had studied the shopping habits of women and realized that there
was a great opportunity in the beauty product market. Women, who used up to
12 different beauty products each day, had to go to as many as three different
stores to buy prestige beauty products, mass-market products, and salon prod-
ucts. George’s vision was that Ulta would make all of these products available
in one store, and offer salon and spa services as well. In this way, Ulta’s stores
would serve as relaxing retreats for the middle- to upper-class women who were
its target customers.
When Ulta opened its ?rst location, its value consisted of offering the widest
range of beauty products and fragrances possible at a discounted price. It dis-
counted items as much as 50% from suggested retail prices, and even offered
to match prices from other retailers, including low-cost competitors such as
Wal-Mart.
12
In keeping with this strategy, Ulta avoided large shopping malls and instead
located its stores in strip malls with convenient parking. This strategy proved
successful, and by 1995 Ulta operated 50 stores employing 800 people.
13
Sales
for that year had doubled from 1994 levels, and were expected to double again
the next year. Such success could not continue inde?nitely, however, and by
380 Cases
1999, increased competition in the beauty industry motivated Ulta to change its
strategy.
In 2000, Ulta’s new president, Lyn Kirby, started making moves to reposition
Ulta in the market and move away from the discount strategy. Stores were
renovated and redecorated to provide a more luxurious atmosphere, more pres-
tigious product lines were added, and store employees were educated so that
they could provide beauty expertise if a customer needed assistance. These
changes proved successful and Ulta kept growing, from 129 stores and sales of
$423 million in 2003 to 249 stores and sales of $912 million in 2007 (Exhibit
2.1).
14
In October of 2007, Ulta went public in a well-received IPO that raised
more than $153 million and is now traded on the NASDAQ.
15
Macy’s, Inc.
Macy’s marketed most of its cosmetics using the standard department store
model. However, in 1999 it tried to offer an alternative sales model which
caused Sephora to ?le a lawsuit against it. Macy’s had opened a number of
“Souson” cosmetics stores which utilized an “open-sell” model, and in prepar-
ation to open these stores, Macy’s employees had gone so far as to visit Sephora
stores with cameras and sketch pads in order to copy the store’s look.
Sephora’s lawsuit claimed that Macy’s had infringed on their distinctive trade
dress and could make shoppers think that the Souson stores were owned or
operated by Sephora.
16
A judge concluded that the lawsuit had enough merit to
issue a preliminary injunction freezing the further expansion of Souson stores
until the lawsuit was resolved.
17
The lawsuit was eventually settled out of court
and terms were not disclosed.
Bath & Body Works, Inc.
Founded in 1990 in New Albany, OH, Bath & Body Works, Inc. (BBW)
expanded rapidly throughout the 1990s, and by 2008 it had become the largest
competitor that operated exclusively in the beauty, cosmetics, and fragrance
store industry.
18
BBW offered a wide variety of natural skin, fragrance, aroma-
therapy, and spa products. BBW did not offer brand-name designer products,
but instead focused almost exclusively on private-label products offered under
the BBW name.
In 2003, BBW acquired the rights to the C.O. Bigelow name, an apothecary
Exhibit 2.1 Comparison of Industry Competitors in
2007
Competitor Stores US sales ($million)
US Total
Sephora 177 756 825
Ulta 249 249 912
Bath & Body Works 1,592 1,592 2,494
Macy’s 850 850 26,313
Sephora Takes on America 381
that had operated in New York’s Greenwich Village for over a century, and
positioned stores with this name to target the high-end market.
19, 20
These stores
featured an open-sell sales approach and even had sinks available where cus-
tomers could wash off products before they try others. In 2008, BBW operated
over 1,500 stores in the USA, and planned to expand the C.O. Bigelow name to
150 stores nationwide.
Where to Go from Here?
David sat back, took a deep breath, and re?ected on Sephora’s position in the
beauty products market. While Sephora changed the game when it created the
“open-sell” approach to perfume and cosmetics, it was in danger of becoming a
victim of its own success. Many other competitors had since entered the market
using the same approach and selling similar products. In fact, Sephora’s closest
competitor, Ulta Salon, went signi?cantly beyond the products sold by Sephora
and offered salon and spa services to its customers. David was also concerned
about the company’s recent decision to partner with J.C. Penney. While this
move could rapidly and signi?cantly increase Sephora’s potential customer
base, he worried that J.C. Penney’s value-based competitive position would
erode the luxury-based position of Sephora and could hurt business in the long
run. How could Sephora maintain its momentum in this highly competitive
industry? Should it try to expand its services to match those of Ulta? Also, was
the move into J.C. Penney stores a wise one or would it serve to distance
Sephora from its core consumers? Then ?nally, and most importantly, was
there a new game that Sephora could play that would change the industry again
and allow the company to take control of the market?
382 Cases
Netflix: Responding to Blockbuster,
Again*
Reed Hastings re?ected on the ?rst half of 2008 as he drove through Los Gatos,
CA on his way to Net?ix headquarters. Net?ix was still a growing and pro?t-
able company but several threats loomed on the horizon. Late in 2006, Block-
buster Entertainment had revamped its online movie rental site, renaming it
Blockbuster Total Access. The commercials for Blockbuster Total Access were
clearly aimed at stealing customers from Net?ix.
1
At the same time, new tech-
nology offered the opportunity to have movies delivered to customers directly
through their cable television provider or over their computer. Either Block-
buster or this new technology could make the Net?ix business model obsolete.
Indeed, these new technologies led Business 2.0 to label Reed Hastings one of
2006’s “10 People Who Don’t Matter,” citing the availability of movies
through cable or Internet as the future of movie rental.
2
Reed wanted Net?ix to be more than the midpoint between brick-and-mortar
rental stores and downloaded movie rentals. He knew he would be spending a
lot of time in the near future reviewing and updating the Net?ix strategy to deal
with these threats. They had several initiatives in place, but would these be
enough to overcome the competition and continue the growth of the company
he founded?
Movie Rental before Netflix
In 1977, the ?rst brick-and-mortar video rental store opened in a 600 square
foot storefront on Wilshire Boulevard in Los Angeles.
3
At that time, only 50
video titles from 20
th
Century Fox were available on Betamax and VHS for
consumers to rent. However, business was strong enough for the business
owner, George Atkinson, to add 42 af?liated stores within 20 months. The
business was renamed The Video Station, and Atkinson announced that he
would start franchising the stores. The Video Station paved the way for thou-
sands of other video rental stores, including Blockbuster Video, which opened
its ?rst store in Dallas, Texas in 1985. Within three years, Blockbuster Video
captured the top video retailer spot in the USA with more than 500 stores and
revenues exceeding $200 million.
4
Video rental stores quickly discovered that rental revenues roughly followed
* This case was written by Christian Chock, Tania Ganguly, Chad Greeno, Julie Knakal, and
Tony Knakal under the supervision of Professor Afuah as a basis for class discussion and is not
intended to illustrate either effective or ineffective handling of a business situation.
Case 3
Pareto’s rule where 80% of the revenues were driven from 20% of the video
titles. Therefore, for the 4,000–5,000 titles in stock at a typical store, most shelf
space was dedicated to displaying multiple copies of new release, “hit” movies.
5
The dynamics of the industry shifted signi?cantly in the spring of 1997 with
the introduction of the DVD-video format. The DVD player passed the 10%
adoption rate milestone by late 2000 making it one of the most rapidly adopted
consumer electronics products in history. By 2005, the DVD format would
dominate the global recorded video sales and rental market with 91.8% market
share.
6
In 1999, while Net?ix and movie rental through the Internet and snail mail
were still new, Blockbuster held a 24% market share in this $18.5 billion
industry.
7
Blockbuster continued to lead the industry in market share in 2006 with
approximately 35% of the market.
8
Netflix’s Entry into Rentals
The size and weight of the physical DVD facilitated shipping videos directly to
customers’ homes, and a new branch of the video retailing industry began with
the founding of Net?ix. Founded in 1997 by Marc Randolph and Reed Hast-
ings, Net?ix began offering DVD rentals requested over the Internet and
delivered through the mail in 1998. The initial business model charged a fee per
rental, as was typical of brick-and-mortar stores at the time. By late 1999,
Net?ix had changed to a subscription fee that allowed subscribers to rent as
many videos as they wanted on a monthly basis.
9
It made various subscription
plans available to subscribers that allowed customers to determine how many
movies they wanted to have at their home at a time. This allowed Net?ix to
differentiate customers by how often they watched rented movies. The subscrip-
tion model eliminated aggravation related to due dates and late fees. Indeed,
Reed Hastings cited the unlimited-use-for-one-fee model used by his health club
as one of the inspirations for Net?ix’s subscription model.
10
In February 2003,
Net?ix surpassed the one million subscriber mark, landing it ?rmly at the top of
the online DVD rental industry.
Through Net?ix’s website, subscribers could create a queue of movies that
they wanted to rent. These movies could be prioritized to re?ect when the
subscriber wanted to receive each ?lm. Whenever a subscriber returned a movie
via a prepaid mailer, the next movie in the queue was sent out. Users could
create a large rental queue and not be required to visit the website while they
viewed movies sent from their queue, or they could update their queue every
time a movie was returned.
The Net?ix subscription-based service offered several advantages over the
brick-and-mortar rental store model that had been prevalent in the industry. By
having a few centralized shipping centers, rather than a large number of store-
fronts, Net?ix was able to pool resources and offer a wider range of titles than
possible at a single rental store. Operating a few centralized shipping centers
also offered several cost advantages over operating stores in every neighbor-
hood. Net?ix was aggressive in recruiting new customers. It increased its mar-
keting expenses every year and its number of customers increased every year
(Exhibit 3.1).
384 Cases
Cinematch Recommendations System
To help customers identify which titles may interest them, Net?ix used a rec-
ommendation engine called Cinematch. Cinematch used customer movie rat-
ings to predict what other movies customers might be interested in. About 60%
of movies requested through Net?ix were identi?ed through this recommenda-
tion system.
11
The combination of a large movie selection and a recommenda-
tion system to help customers ?nd movies they might like appeared to increase
the number of movie titles that customers rented. In June of 2006, Net?ix had
an inventory of 60,000 titles and on any given day 35,000 to 40,000 of these
titles were rented by Net?ix customers.
12
Net?ix even released some independent ?lms that were not popular enough
for a traditional distribution contract through its Red Envelope Entertainment
division. When video stores only stocked 4,000–5,000 titles, these movies
would not have been popular enough to justify the required shelf space. With
Net?ix distribution centers that served a larger number of customers and a
recommendation system to help those customers ?nd titles that may interest
them, a market for these movies was created.
13
In October 2006, it offered the “Net?ix Prize” of up to one million dollars to
anyone that could substantially improve its existing recommendation algo-
rithm.
14
Net?ix had also rolled out a Net?ix Friends feature that let users see
Exhibit 3.1 Summary of Netflix’s Income Statements ($US millions, except where indicated)
FY 2007 FY 2006 FY 2005 FY 2004 FY 2003 FY 2002
Total subscribers at end of
period (1,000 people)
7,479 6,316 4,179 2,610 1,487 857
Gross subscriber additions
during period (1,000 people)
5,340 5,250 3,729 2,716 1,571 1,140
Subscriber acquisition cost ($/
customer)
40.88 42.96 38.77 37.02 32.8 32.83
Total revenue 1,205.34 996.66 682.21 500.61 270.41 152.81
Cost of revenue, total 785.74 626.06 464.55 331.71 179.01 97.5
Gross profit 419.6 370.6 217.66 168.9 91.4 55.3
Total selling, general, and
admin. expenses
274.93 266.21 185.72 122.64 70.25 51.35
R&D 67.7 44.77 30.94 29.47 17.88 14.62
Depreciation/amortization
Total operating expense 1,114.18 932.25 679.22 481.26 265.94 163.48
Operating income 91.16 64.41 2.99 19.35 4.47 ?10.67
Interest Income (expense), net
nonoperating
20.34 15.9 5.35 2.42 2.04 ?10.28
Income before tax 111.5 80.32 8.34 21.78 6.51 ?20.95
Income after tax 66.95 49.08 42.03 21.59 6.51 ?20.95
Net profit margin 4.90% 6.20% 4.30% 2.40%
Source: Netflix’s annual financial statements.
Netflix: Responding to Blockbuster, Again 385
what their friends were renting and how they rated different movies. This fea-
ture enabled users to create communities of movie watchers through the Net?ix
Web page. The friends feature utilized past user ratings of users on Net?ix,
taking advantage of its longer history in the online rental business.
Watch Now Feature
In June of 2007 Net?ix added a “Watch Now” section to their website. This tab
allowed Net?ix subscribers to have movies streamed to their computer to watch
instantly. Only about 2,000 nonrecent movie titles and some current television
series were available through this feature at launch, a much smaller selection
than available for rental through the mail.
15
Subscription Plans
In 2007, Net?ix offered a range of subscription choices, each allowing the
customer a different number of movies that could be simultaneously rented.
These ranged from a basic plan allowing up to two rentals per month, rented
one at a time, to a plan allowing four rentals out at one time with unlimited
total monthly rentals. Each plan also included a varying amount of instant
viewing hours that could be used to have movies streamed directly to the cus-
tomer’s computer. The 2007 prices are summarized in Exhibit 3.2.
Early Competition with Netflix
Wal-Mart
The world’s largest retailer, Wal-Mart, entered the online DVD rental market in
2002, with a catalog of over 12,000 titles from which customers could choose.
The system was essentially the same as that offered by Net?ix, with customers
creating a list of titles they wanted to see, and then ordering them online, with
shipping by mail. Its subscription rates undercut Net?ix by about $1, with a
three movies rented at any one time DVD package costing $18.86.
16
Executives
at Net?ix predicted that Wal-Mart could only guarantee overnight delivery
within a limited radius of its Georgia distribution center, and would have to
settle for three- to ?ve-day delivery for the rest of the country.
17
In June 2004,
Wal-Mart opened three new distribution centers to support the online DVD
Exhibit 3.2 Summary of Netflix’s Movie Rental Plans
Plan Maximum rentals
per month
Price per month
($)
Instant viewing hours
per month
4 DVDs at-a-time Unlimited 23.99 24
3 DVDs at-a-time Unlimited 17.99 18
2 DVDs at-a-time Unlimited 14.99 15
1 DVD at-a-time Unlimited 9.99 10
1 DVD at-a-time Limit 2 per month 4.99 5
Source: Retrieved June 10, 2007 from www.netflix.com.
386 Cases
rental business. Additionally, it expanded its rental catalog to 15,000 titles (at
the time, Net?ix offered about 22,000 titles for rent). By mid-2005, however,
Wal-Mart had given up on the online DVD rental business. In leaving, Wal-
Mart directed its customers to Net?ix, and established a deal whereby former
Wal-Mart customers could get a discounted two-DVD rental plan if they signed
up for a one-year Net?ix subscription (regularly priced at $14.99, and dis-
counted to $12.97).
18
The reason for Wal-Mart’s exit was thought to be a lack
of suf?cient subscriber sign-up, an important ?gure in the online rental
business.
Blockbuster
On August 11, 2004, Blockbuster announced its entry into the US online movie
rental business with the creation of Blockbuster Online, a move they had been
discussing since that spring.
19
Like Net?ix and Wal-Mart, they had a tiered
monthly fee system based on the number of movies the consumer wanted to
have at a time. Initial pricing was positioned between Net?ix and their low-
price rival, Wal-Mart. Blockbuster subscribers chose from a catalog of 25,000
titles, compared with 30,000 titles available from Net?ix at that time. Part of
Blockbuster’s strategy was for the online service to encourage foot traf?c in its
physical stores, with two coupons for free rentals at the stores being sent to each
online customer once a month.
Relying on its strong brand recognition among consumers and physical pres-
ence with over 5,600 company-owned and franchised brick-and-mortar stores
at the time of the launch, Blockbuster hoped to reach many of the over four
million estimated online renters that made up the market at the time of the
launch.
20
The market for online rentals was estimated at $8 million at the time,
and Blockbuster saw it as a growing area within the overall rental business.
While only 8% of industry revenue came from online rentals in 2005, growth
was strong, increasing from 5% in 2003, according to Adams Media
Research.
21
To accommodate the new online service, Blockbuster established a new dis-
tribution system, separate from its existing network that handled its bricks-and-
mortar stores. To handle the mailing of DVDs, Blockbuster had to establish a
set of distribution centers, similar to Net?ix’s, from which it could mail the
rented DVDs. The separate distribution was also put in place to accommodate
the different rental preferences of online subscribers as compared to in-store
patrons.
22
The launch of Blockbuster Online was at an estimated initial cost of $50
million, with additional losses in operating revenues for several quarters after
launch. These ?gures, combined with the loss of revenue from late fees (usually
a good source of income for Blockbuster that previously made up 13% of
revenue), contributed to a dif?cult ?nancial situation. Subscriber growth was
thought to be a key statistic, and subscriber acquisition was expensive. By the
fourth quarter of 2005, Blockbuster Online had about one million subscribers,
versus four million subscribers for Net?ix. This was after a 39% increase in
advertising for the ?rst three quarters of 2005.
23
In 2005, Blockbuster’s stock had dropped 50% from its 52-week high.
To stem the bleeding, it announced a cost-cutting program that included
Netflix: Responding to Blockbuster, Again 387
advertising reductions. These cuts were to take effect from the second quarter of
2005 through the second quarter of 2006 (Exhibit 3.3). After the poor sub-
scriber acquisition results, Blockbuster announced that it would increase adver-
tising for its online service, despite the cost-cutting initiative.
24
By 2005, price wars between the major online renters had broken out. Block-
buster dropped its three-out DVD rental monthly subscription by $3 to under-
cut Net?ix (Exhibit 3.4). Also, it rolled out a trial program in Seattle where
online customers had the option of returning DVDs to their local Blockbuster
store,
25
foreshadowing the 2006 launch of Blockbuster Total Access.
Exhibit 3.3 Summary of Blockbuster’s Income Statements ($US millions, except where
indicated)
CY 2007 CY 2006 CY 2005 CY 2004 CY 2003 CY 2002
Total subscribers (1000
people)
2,000 1,000
Total revenue 5,542.40 5,522.20 5,721.80 6,053.20 5,911.70 5,565.90
Cost of revenue, total 2,677.80 2,479.70 2,561.00 2,441.40 2,389.80 2,358.70
Gross profit 2,804.80 2,981.30 3,088.60 3,519.80 3,425.30 3,121.40
Total selling, general, and
admin. expenses
2,719.10 2,752.90 2,977.50 3,110.90 2,785.30 2,618.70
R&D
Depreciation/amortization 185.7 210.9 224.3 249.7 268.4 233.8
Unusual expense (Income) 2.2 5.1 341.9 1,504.40 1,304.90 0
Total operating expense 5,503.30 5,448.60 6,104.70 7,306.40 6,748.40 5,211.20
Operating Income 39.1 73.6 ?382.9 ?1,253.20 ?836.7 354.7
Interest Income (Expense),
net nonoperating
?82.2 ?91.7 ?94.6 ?34.5 ?30 ?45.4
Income before tax ?44.6 ?12.7 ?481.7 ?1,286.10 ?867.1 312.2
Income after tax ?74.2 63.7 ?544.1 ?1,248.80 ?973.6 205.1
Source: Blockbuster’s annual financial statements.
Exhibit 3.4 Summary of Blockbuster Total Access Movie Rental Plans
Plan Maximum rentals
per month
Price per month ($) Additional in-store
movie, or game
rentals per month
Mail only price (in-store
rental or return) ($)
4 DVDs at-a-time Unlimited 23.99 1 22.99
3 DVDs at-a-time Unlimited 17.99 1 16.99
2 DVDs at-a-time Unlimited 14.99 1 13.99
1 DVD at-a-time Unlimited 9.99 1 8.99
1 DVD at-a-time Limit 3 7.99 1 6.99
1 DVD at-a-time Limit 2 5.99 1 4.99
Source: Retrieved June 10, 2007 from, www.blockbuster.com.
388 Cases
Other Competitors
Many other smaller competitors sprang up once the DVD format had taken
hold. Some were forced to exit the market but a few remained, existing on the
fringe, trailing far behind giants Net?ix and Blockbuster. These included intel-
li?ix, DVD Overnight, DVD Barn, Rent My DVD, DVD Whiz, and Qwik?iks.
Blockbuster Total Access
In November of 2006, Blockbuster launched an updated version of Blockbuster
Online, called Blockbuster Total Access. In addition to offering movie rentals
requested over the Internet and delivered through the mail, as Net?ix and the
original Blockbuster Online had, Total Access sought to utilize Blockbuster’s
stores to offer additional bene?ts. Blockbuster Total Access’ customers could
return their movies rented through the mail through the mail service and have
their next title shipped to them. Alternatively, customers could return movies to
any Blockbuster location. When returning an online rental at a store, customers
received a free in-store rental in addition to having their next online rental
shipped.
26
Blockbuster promoted this advantage and the instant grati?cation it
provided using slogans such as “Never be without a movie.” Blockbuster Total
Access subscriptions also gave customers a coupon for one free in-store rental
each month. The coupon could be used for a movie or video game rental.
27
On June 12, 2007 Blockbuster added Blockbuster by Mail as an option for its
online service. Customers choosing this option would be permitted to return
movies to blockbuster stores, but they would not receive a free rental in
exchange. The return of their movie to the store would electronically stimulate
the next movie in their queue to be sent from the Blockbuster distribution
center. These users also would not receive a free rental coupon each month. In
return for giving up these privileges, subscription fees were $1 less per month
than the full Blockbuster Total Access plan. The addition of Blockbuster by
Mail provided a more direct comparison with Net?ix’s subscription plans and
drew attention to the added bene?t of in-store rentals. Blockbuster promoted its
plan as a way to save money for customers who did not live near a Blockbuster
location.
28
While the Blockbuster by Mail service was less expensive than
Net?ix, it did not offer the instant viewing option available from Net?ix.
Movie Downloads
In addition to threats from Blockbuster and other companies that potentially
could imitate the Net?ix model, there was also a rising trend in downloaded or
streaming movies, similar to the Net?ix Watch Now feature. These services
allowed customers to have a movie delivered to them through their cable televi-
sion connection directly to their television, or through the Internet to their
computer.
Comcast and other cable companies offered a range of on-demand enter-
tainment as part of their cable service. These services charged a fee for viewing
the most popular movie titles and had a limited selection. Exclusive rights to
digital distribution of many movies had already been sold for many years into
the future, typically to television stations. These deals excluded DVD rentals,
Netflix: Responding to Blockbuster, Again 389
but applied to movies delivered over cable or Internet. Online services such as
CinemaNow, iTunes, and Amazon Unbox started offering movie downloads for
rental and/or purchase. These companies offered downloads to computers that
must be burned to a disc or watched through the computer. Most potential
customers preferred to watch movies on their television rather than their com-
puter, and connecting one’s computer to the television was still a somewhat
cumbersome process. Much like the cable companies, these services also offered
a very limited selection compared to the Net?ix rental library. If the technology
issues could be solved so that movies were easier to watch on televisions and
if the selection improved, these companies could be serious competition for
Net?ix.
29, 30
There was also ZML.com, the pirate site that had a selection of
over 1,700 ?lms to burn to DVDs, or for download to personal computers or
handheld devices such as iPods.
31
Netflix’s Decision
Reed Hastings had several options for dealing with the threats posed by Block-
buster Total Access and competitors offering downloadable movies on demand.
First, if customers were not willing to pay for the added convenience of return-
ing movies to Blockbuster stores, Net?ix could push an aggressive price war to
try to eliminate Blockbuster from online rentals. Second, it could continue to
bring out innovations such as Net?ix Prize crowdsourcing idea and Net?ix
friends feature. Such innovations could help it fend off competitors. Third,
exclusive rights agreements currently prevented many titles from being released
through the Internet or by a cable provider, but as these agreements expired,
movies streamed over the Internet might become the disruptive technology that
displaced rental of physical DVDs. Current drawbacks to watching movies on a
computer rather than on a television might be displaced by technology similar
to AppleTV,
32
making streaming downloads more attractive. Net?ix had started
exploring this option with its Watch Now feature. The question was, how could
it insure that it was strategically positioned to take advantage of this technology
if its popularity increased?
Reed would have never thought that simply providing movie rentals would
be such a complex and technology driven business, but it was becoming obvious
that Net?ix must be a constantly improving and evolving business if it was
going to have a long future.
390 Cases
Threadless in Chicago
In 2000, Jake Nickell, a multimedia and design student at the Illinois Institute
of Art, and Jacob DeHart, an engineering student at Purdue University, entered
an online T-shirt design contest, which Jake won. However, both of them went
away with the idea that having someone else compete to design T-shirts for
them could lead to something interesting. They kept in touch and worked
together on a few projects before starting their own T-shirt company in 2001,
with $1,000.
1
Their company, Threadless, would make and sell T-shirts with
colorful graphics.
2
They were venturing into the colorful T-shirt—a so-called
hit-and-miss product. Traditionally, to be successful with such a product, a ?rm
needed to have the right distribution channels and its ?ngers on the pulse of
fast-changing trends.
3
A ?rm needed to have the right market research and
forecasting abilities to do well. The two founders added creative director Jeff
Kalmikoff later. They also took venture capital money from Insight Venture
Partners, not so much because they needed the money, but because they could,
well, obtain some insights from the venture capitalist ?rm.
The Community Designs and Markets
Threadless had a community of registered members that in 2004 was 70,000
strong and mushroomed to 700,000 by 2008. Anyone with a valid e-mail
address could join free. Each week, members of the community—largely art-
ists—uploaded hundreds of T-shirt designs to the community site. (In 2007, the
?rm received 150 submissions per day.) Visitors to the site then voted for their
favorite designs by scoring them on a scale of 0 to 5.
4
Each design remained
available for voting for seven days. From the scoring, the best six designs were
chosen from the hundreds of submissions. Creators of the winning designs were
awarded prizes. In 2007, these prizes were worth $2,000 per design: $1,500 in
cash, $300 in a gift certi?cate, and subscription to T-shirts.
5
By 2008, the prize
had climbed to $2,500. To many artists, there was something bigger than the
cash prize. “It was how cool it was to get your shirts printed,”
6
remarked Glen
Jones, a 2004 winner. The name of the designer (winner) was put on the label of
the T-shirt.
7
Threadless retained the rights to the design.
To help the artists with the design process, Threadless sent digital submission
kits—complete with HTML code and graphics—to each potential submitter.
With these kits, artists could create advertisements for their designs that looked
very professional. The artists not only spent weeks seeking advice from other
community members and perfecting their designs, they posted links to their
Case 4
submissions to their personal websites, any online design forums that they fre-
quented, MySpace pages, or blogs, asking their friends to vote for them and buy
if and when they won.
8
Effectively, the artists not only designed the shirts for
Threadless, they also premarketed them, adding to the brand. Some of the
members who participated in voting for designs saw the process as one of
exploring the latest in designs and learning. In effect, the ?rm committed ?nan-
cially only to T-shirt designs of which many of its customers approved.
Some Results
The company printed the winning designs and sold them to the very community
that had competed to create the designs and voted to decide the winning design.
By 2008, it had printed 1,000 designs
9
— all online. The T-shirts usually sold
out. It had no professional designers, used no fashion photographers or model-
ing agencies, had no sales force, did not advertise, and except for its retail store
in Chicago, it had no distributors.
10
Members of the community socialized,
blogged, and chatted about designs. It even had an of?cial fan site: http://
www.lovesthreadless.com/. In 2007, its shirts cost about $4 each to make and
sold for about $15.
11
The company sold 80–90,000 shirts a week.
12
Revenues
were growing at 500% a year; and the company was doing all this without the
help of big retailers such as Target, who had come knocking but been turned
down by Threadless.
A Retail Store?
Threadless opened its ?rst of?ine retail store in September of 2007, in Chi-
cago.
13
Why would an online company build an of?ine store when it could keep
its margins even higher by avoiding brick-and-mortar costs? Threadless
offered several reasons.
14
First, the ?rm wanted a building that re?ected the
Threadless culture in which design classes could be offered, galleries with
Threadless artists’ work hosted, and real-world group interaction and critics
facilitated. Second, the company’s products changed every week and most
retailers were not equipped to handle such changes. Third, there was a story
behind each of their T-shirts and the person who created it, how it was created,
scored and selected for print that needed to be told. Such a story would be lost
in a traditional retail outlet. With the retail store, they could tell the story their
own way. Of the 1,000 designs that had been created since its inception, about
300 of them were still in stock. The ?rm only displayed 20 designs for sale. The
rest could be obtained from its website. Designs were released in the of?ine
retail store before online.
Other Holdings
Threadless had a parent company called SkinnyCorp, also run by Nickell,
DeHart and Kraikoff. In June 2008, the other units under the SkinnyCorp
umbrella were Naked and Angry, Yay Hooray, and Extra Tasty.
392 Cases
Pixar Changes the Rules of the
Game*
On June 29, 2008, on the ?rst anniversary of the release of Ratatouille, a former
Pixar Animation shareholder wondered if Pixar had done the right thing selling
itself to Disney. Ratatouille had grossed more than $600 million worldwide
with an undisclosed amount from merchandising. What was even more amaz-
ing than the revenues was the fact that Ratatouille was the eighth straight hit for
Pixar, in an industry where every other movie risked crashing. Why had Pixar
been so successful? Would the success continue under Disney? Should Pixar
have stayed as a separate company in a continued alliance with Disney or
parted ways and found another partner? Eight straight hits with most of them
grossing more than half a billion dollars!
Pixar’s Digital Technology Roots
University of Utah Days
Pixar’s technical roots date back to 1970, when Ed Catmull joined the com-
puter science program at the University of Utah as a doctoral student.
1
Given
the program’s notoriety and leadership in computer graphics, several young
stars were attracted, among them John Warnock. He would later found Adobe
Systems and create a revolution in the publishing world with his PostScript page
description language. Jim Clark, another alumnus, would later start Silicon
Graphics and then lead Netscape Communications.
During the 1970s, the program made signi?cant headway into the develop-
ment of computer graphics. Catmull himself made a signi?cant advance in
computer graphics in his 1974 doctoral thesis, which focused on texture map-
ping, z-buffer and rendering curved surfaces. In 1974, interest in the work of
the Utah program came from an unexpected source, Alexander Schure, an
eccentric millionaire and founder of the New York Institute of Technology
(NYIT), who wanted to use the story from a children’s record album called
Tubby the Tuba to develop an animated ?lm. From the ranks at Utah, Dr
Catmull recruited a team of talented computer scientists and began experiment-
ing with computer-generated animation.
* This case was written by Catherine Crane, Will Johnson, Kitty Neumark, and Christopher
Perrigo under the supervision of Professor Allan Afuah as a basis for class discussion and is not
intended to illustrate either effective or ineffective handling of a business situation.
Case 5
The Lucasfilm Years: 1979–1986
While Catmull’s group struggled at NYIT, Hollywood was beginning to see the
bene?ts of computer graphics for production. One early Hollywood pioneer
was George Lucas, whose Star Wars had been a stunning special effects
achievement. With this blockbuster under his belt, Lucas became interested in
using computer graphics for image editing and producing special effects for his
next movie, The Empire Strikes Back. Lucas worked with an outside computer
graphics production house, Triple I, to create effects for Empire, but in the end
these were not used. However, the experience had proven that photorealistic
computer imagery was possible, and Lucas decided to assemble his own com-
puter graphics division within his special effects company, Lucas?lm.
In 1979, Lucas discovered Catmull’s group at NYIT. George Lucas extended
an offer to the team to come to Northern California to work as part of Lucas-
?lm; the team was more than happy to accept. Dr Catmull was named Vice
President and over the next six years, the new computer graphics division of
Lucas?lm would assemble one of the most talented teams of artists and pro-
grammers in the computer graphics industry.
Pixar Is Born (1984–Present): Creative Development
Enter the Story Man: John Lasseter
Like Ed Catmull, John Lasseter had long envisioned the future of computer
graphics animation. Lasseter had worked on Disney’s ?rst major foray into
computer-aided production—Tron (1981). Tron required nearly 30 minutes of
?lm quality computer graphics and was a daunting task for computer graphics
studios at the time. The computer-generated imagery of Tron was technologic-
ally dazzling, but the underlying story was an unappealing cyber-adventure.
Disney sank about $20 million into the picture, but it bombed at the box of?ce.
The resultant ?nancial loss alone served to all but kill Disney’s interest in the
computer graphics medium.
Despite the commercial failure of Tron, the ?lm was an epiphany for Lasseter.
Watching what fellow animators were doing with computer graphics imagery,
he started to see the possibilities of full-scale computer animation: “the minute I
saw the light-cycle sequence, which had such dimensionality and solidity,” Las-
seter recalls, “it was like a little door in my head opening to a whole new
world.”
2
Lasseter and fellow animator Glen Keane (who went on to make Beauty and
the Beast) tried to interest Disney in the medium by animating 30 seconds of
Maurice Sendak’s Where the Wild Things Are, using standard animation draw-
ings in computer-generated settings. However, Disney, which was struggling to
rejuvenate itself after years of lackluster box of?ce performance, was not inter-
ested in further experimentation with untried computer animation. In 1984, a
disappointed Lasseter left Disney. Ed Catmull, a friend of Lasseter, convinced
him to come to Lucas?lm to experiment for just a month. John Lasseter liked
what he found and never left.
394 Cases
Born in the “Next” Generation: Steve Jobs
While the computer graphics division of Lucas?lm was strengthened with the
addition of Lasseter in 1984, George Lucas’ interest in the project waned.
Although Catmull saw tremendous further potential in the technologies being
developed, Lucas viewed the project as complete and began looking for a buyer
of the computer division. An early potential buyer of the division was a partner-
ship between the behemoth General Motors’ Electronic Data Systems (EDS)
and a unit of the Dutch conglomerate Phillips NV. Much to Catmull’s relief, the
sale fell through.
Steve Jobs, then CEO of Apple Computer, heard about Lucas’ intended sale
of the computer division. Jobs thought the situation provided a strong acquisi-
tion opportunity for Apple, but unfortunately, Apple’s Board disagreed. When
Jobs left Apple in 1985, Pixar remained a division of Lucas?lm.
Ironically, it was the ousting of Jobs that ultimately permitted the sale of the
computer division. With a personal net worth of more than $100 million result-
ing from his sale of Apple stock, Jobs approached Lucas and reiterated his
interest in the division. In 1986, at a price of $10 million, Lucas sold the div-
ision to Jobs. Steve Jobs considered the idea of absorbing the group into his
other ?rm, NeXT Computer, but instead decided to incorporate Pixar as an
independent company, installing himself as Chief Executive Of?cer and Ed
Catmull as Chief Technical Of?cer.
Along with Catmull and Lasseter, Jobs viewed the ultimate goal of the com-
pany as producing computer-animated cartoons and full-length ?lms. However,
there were still several intermediate steps required to meet this objective. One of
the most important of these hurdles was developing and re?ning software tools
that would enable the creation of the ?lms the team envisioned.
“Innovate or Not to Innovate?”—That is NOT the
Question!
Pixar developed groundbreaking software systems—Marionette, Ringmaster
and RenderMan, and a laser recording system for ?lm—Pixarvision. Mario-
nette was an animation software system for modeling, animating, and lighting
simulation capabilities (see Exhibit 5.1 for an animation value chain).
3
Ring-
Master was a production management software system for scheduling,
coordinating, and tracking computer animation projects. Pixarvision was a
Exhibit 5.1 An Animation Movie Value Chain
Financing, purchasing, human resources, etc.
CREATIVE
DEVELOPMENT
Story and characters
development
? PRODUCTION
Modeling
Layout
Animation
Shading
Lighting
Rendering
Film recording
? POST-
PRODUCTION
Sound process
Picture process
Sound effects
Musical score
etc.
? MARKETING and
MERCHANDISING
? DISTRIBUTION
Pixar Changes the Rules of the Game 395
laser recording system for converting digital computer data into images on
motion picture ?lm stock with unprecedented quality. These three products
helped to provide a considerable competitive advantage to Pixar, as they were
critical to the production of high-quality three-dimensional graphics and com-
parable tools were simply not available on the market.
Unlike these software systems which remained proprietary to Pixar, Ren-
derMan software system was commercialized and quickly became a signi?cant
source of revenue, so that in 2001 approximately 10% of Pixar’s total revenue
came from software licensing. Released for commercial use in 1989, Render-
Man, a rendering software system for photorealistic image synthesis, enabled
computer graphics artists to apply textures and colors to surfaces of three-
dimensional images onscreen. Pixar licensed the tool to third parties and even-
tually sold upwards of 100,000 copies. RenderMan quickly became an industry
standard and was used extensively to augment live action ?lms. Over a 10-year
period, the software had been used to create eight out of the ten ?lms that won
Oscar for Best Visual Effects—The Matrix, What Dreams May Come, Titanic,
Forrest Gump, Jurassic Park, Death Becomes Her, Terminator 2, and The
Abyss. However, the true testimonial to RenderMan and people who created it
was in 2001 when the Academy of Motion Picture Art & Science Board of
Governors honored Ed Catmull, the President of Pixar, Loren Carpenter, Senior
Scientist, and Rob Cook, Vice President of Software Engineering, with an Acad-
emy Award of Merit (Oscar) “for signi?cant advancement to the ?eld of motion
picture rendering as exempli?ed in Pixar’s RenderMan.”
Developing the Creative Side of Pixar
In early 1990s Steve Jobs realized that sales of RenderMan and other tools
alone would not be able to fund Pixar’s technology research and internal pro-
jects, including ?lm development. “The problem was, for many years, the cost
of computers to make animation we could sell was tremendously high.”
4
Jobs
put Pixar technology to use in developing TV commercial campaigns for a
variety of clients. As the company evolved into a successful animation studio
producing TV ads for Listerine, Lifesavers, and others, John Lasseter, the dir-
ector of the ads, became Pixar’s big breadwinner. The company won a Gold
Medal Clio Award for its LifeSavers “Conga” commercial in 1993, and another
Gold Clio Award in 1994 for its Listerine “Arrows” commercial.
A second successful creative outlet for Pixar was short ?lm. In 1986, Pixar’s
?rst short movie, Luxo Jr., earned an Academy Award nomination for Best
Short Film (Animated). In 1988, another of Pixar’s short ?lms, Tin Toy, became
the ?rst computer-animated ?lm to win an Academy Award for Best Short Film
(Animated). John Lasseter, who had directed both ?lms, had established a well-
deserved reputation as one of the leading animators in the industry. Indeed, his
reputation set the creative foundation for Pixar. Meanwhile, Lasseter’s success
did not go unnoticed. Disney’s Michael Eisner and Jeffrey Katzenberg tried to
woo the director back, but Lasseter declined. “I was having too much fun,” he
said. “I felt I was on to something new—we were pioneers.”
5
396 Cases
A Tale of Four Animated Films
Teaming Up to Break New Frontiers: Disney and Pixar
In 1991, John Lasseter reviewed Pixar’s work in short ?lms and commercials,
and was con?dent enough in the company’s progress to propose the idea of
producing an hour-long animated TV special. He pitched the idea to his previ-
ous studio, Disney, with the hope that the two companies could collaborate on
the project. He was also hoping that Disney would be able to provide part of the
money necessary to fund the idea.
The timing was just right. Unlike his pitch for Toaster in 1984, Disney in
1991 was riding high on the phenomenal success of its animation department.
With smashes in The Little Mermaid (1989) and Beauty and the Beast (1991)—
both had utilized computer animation to some extent—Disney was ready to
invest in new technology. Although Disney CEO Michael Eisner and ?lm chief
Jeffrey Katzenberg rejected the TV project, they countered with a deal Lasseter
and Pixar could hardly have hoped for: Disney proposed a full length movie,
which it would fund and distribute.
In July 1991, Pixar signed a three-?lm deal. The deal stipulated that Disney
would fund the production and promotion costs and Pixar would earn a modest
percentage of box-of?ce and video sales gross revenues. Pixar’s share in the deal
was estimated to amount to approximately 10–15% of the ?lm’s pro?ts,
depending on the sales levels achieved. Pixar was required to pay a portion of
the costs over speci?ed budget levels, as well as provide the funding for the
development of any animation tools and technologies necessary to complete
the ?lms.
In return for taking the lower cut of box of?ce and video pro?ts, Pixar gained
access to Disney’s marketing and distribution network, as well as creative
advice from Disney’s veterans. However, a substantially higher share of rev-
enues was not the only price Disney extracted from the deal. In addition, Disney
retained all ownership to the characters appearing in the ?lms. Disney also
maintained sole licensing rights to the ?lms and characters, including very
lucrative ancillary merchandise such as toys and clothing. Pixar was only able
to retain the rights to any direct-to-video sequels, as well as the data ?les and
rendering technologies employed to develop the ?lms.
When asked about the agreement signed, Steve Jobs remarked that if the ?rst
movie was
a modest hit—say $75 million at the box of?ce—we’ll both break even. If it
gets $100 million, we’ll both make money. But if it’s a real blockbuster and
earns $200 million or so at the box of?ce, we’ll make good money, and
Disney will make a lot of money.
6
1995—Film 1: Toy Story
With the deal signed, Pixar now had to prove it could deliver on its technology
and creativity. In 1991 with a staff of only a few dozen people, Pixar had to
quickly gear up to begin design and production of the ?rst of the three ?lms. By
the end of 1992 all of the key ingredients were in place—screenplay was
Pixar Changes the Rules of the Game 397
approved by Disney, character voices, led by Tom Hanks as Woody and Tim
Allen as Buzz Lightyear, were signed, and the staff of animators was ready to
turn a tale about the rivalry between a toy cowboy, Woody, and a plastic
spaceman named Buzz Lightyear, to life.
Pixar completed Toy Story with a staff of 110, roughly one-sixth of the
number Disney and other studios typically use to make animated productions.
7
Of the staff, 27 were animators, compared to the 75 or more animators
required for previous animated Disney ?lms. With animators earning $100,000
or more each, the total cost savings amounted to more than $15,000,000 over a
three-year production for the movie.
Toy Story opened in US theaters over the Thanksgiving weekend of 1995
with great fanfare and extensive media publicity. During the ?ve-day Thanks-
giving weekend, Toy Story box of?ce receipts totaled $39.1 million, a record
debut for the weekend and by the end of 1995 it became the highest grossing
?lm of the year, making over $192 million in domestic box of?ce receipts and
$358 million worldwide.
1998—A New Contract and A Bug’s Life
In December 1997, riding high on the success of Toy Story, but making only
an estimated $45 million from the release of the ?lm, Pixar renegotiated its
contract with Disney. Pixar agreed to produce ?ve original computer-
animated feature-length theatrical motion pictures for distribution by Disney.
Pixar and Disney agreed to co?nance production, co-own, cobrand, and share
equally the pro?ts from each picture, including revenues from all related
merchandise.
The ?rst original picture released under the new agreement was A Bug’s Life,
which opened in theaters in November of 1998. The story, derived from the
fable “The Ant and the Grasshopper” revolved around an ant colony, led by a
rebel ant named Flick, and its quest to ?ght off the grasshoppers who stole the
ants’ food every winter. A Bug’s Life broke all previous US Thanksgiving week-
end box-of?ce records, becoming the highest grossing animated release in 1998
and making over $163 million domestically in box of?ce receipts and $362
million worldwide. After only one week of international release A Bug’s Life
captured the #1 spot in six international markets, including Thailand, Argen-
tina, and Australia.
Computer technology had advanced to a point where the computing power
used in A Bug’s Life was ten times the power used in Toy Story. The results
were images that were more real-life than ever before. Additionally, Pixar used
Pixarvision (its laser recording system) for the ?rst time, to convert digital
computer data into images on motion picture ?lm stock, achieving not only
faster recording time, but also higher quality color reproduction and sharper
images.
1999–2012: More Blockbuster Years
A Bug’s Life was followed by Toy Story 2, which was released on November 19,
1999, and became the ?rst ?lm in history to be entirely mastered and exhibited
digitally, and the ?rst animated sequel to gross more than its original. It won a
398 Cases
Golden Globe award for the Best Picture, Musical, or Comedy. This was
followed by Monsters, Inc., Finding Nemo, The Incredibles, Cars, and
Ratatouille—all of them blockbusters (Exhibit 5.2). Planned for release the
following years were WALL-E (2008), Up (2009), Toy Story 3 (2010), Newt
(2011), The Bear and the Bow (2011), and Cars 2 (2012).
Competitors
Pixar had competitors, chief among them, Disney, DreamWorks PDI/SKG, Fox
Studio, and Lucas?lm. In fact, two of the top ?ve spots on the all-time grossing
animation movies were occupied by PDI/DreamWorks, not Pixar (Exhibits 5.3
and 5.4).
Pondering Pixar’s Future—Where to Next?
In 2004, Steve Jobs and his team went to Disney for renegotiation of their
agreement, con?dent that their strong record of six blockbusters would be
enough to seal a new deal; but Ed Eisner, Disney’s CEO did not see eye-to-eye
with Steve Jobs and no deal was reached.
8
On October 1, 2005, however, Bob
Iger was appointed CEO of Disney to replace Eisner. Iger reopened talks with
Pixar. On January 24, 2006 Disney announced that it had agreed to purchase
Pixar for $7.4 billion in an all-stock deal.
9
The deal was completed on May 5,
2006, after approval by Pixar shareholders.
10
However, there were still some
Pixar shareholders and analysts who wondered if Pixar had done the right
thing. Should the ?rm have remained single?
Exhibit 5.2 Pixar Full-length Animation Movies
Movie Name Released 1st Weekend ($) US Gross ($) Worldwide
Gross ($)
Budget ($)
Toy Story 11/22/95 29,140,617 191,796,233 356,800,000 30,000,000
A Bug’s Life 11/20/98 291,121 162,798,565 358,000,000 45,000,000
Toy Story 2 11/19/99 300,163 245,852,179 485,828,782 90,000,000
Monsters, Inc. 11/2/01 62,577,067 255,870,172 525,370,172 115,000,000
Finding Nemo 5/30/03 70,251,710 339,714,978 864,614,978 94,000,000
The Incredibles 11/5/04 70,467,623 261,437,578 631,437,578 92,000,000
Cars 6/9/06 60,119,509 244,082,982 461,782,982 70,000,000
Ratatouille 6/29/07 47,027,395 206,445,654 617,245,654 150,000,000
Pixar Short Film
Collection—Volume 1
11/6/07
WALL-E 6/27/08 180,000,000
Up 5/29/09
Toy Story 3 6/18/10
Newt 8/31/11
The Bear and the Bow 12/31/11
Cars 2 8/31/12
Totals 1,907,998,341 4,301,080,146 866,000,000
Averages 238,499,793 537,635,018 96,222,220
Source: The Numbers. Retrieved June 21, 2008, from http://www.the numbers.com/movies/series/
DigitalAnimation.php.
Pixar Changes the Rules of the Game 399
Exhibit 5.3 Top 12 Grossing Animation Movies
Animation movie Release date Firm Worldwide gross ($)
Shrek 2 2004 PDI/DreamWorks 920,665,658
Finding Nemo 2003 Pixar 864,625,978
Shrek the Third 2007 PDI/DreamWorks 798,957,081
The Lion King** 1994 Walt Disney 783,841,776
Ice Age: The Meltdown 2006 Fox 647,330,621
The Incredibles 2004 Pixar 631,436,092
Ratatouille 2007 Pixar 617,245,650
Monsters Inc. 2001 Pixar 529,061,238
Madagascar 2005 PDI/DreamWorks 527,890,631
Aladdin 1992 Walt Disney 504,050,219
Toy Story 2 1999 Pixar 485,015,179
Shrek 2001 PDI 484,409,218
Cars 2006 Pixar 461,782,982
Source: The Numbers. Retrieved June 21, 2008, from http://www.the-numbers.com/movies/series/DigitalAnimation.php.
** The Lion King was also estimated to have brought in $1 billion in profits from merchandising, theme park
attractions, TV rights and videos.
Exhibit 5.4 Competing Animation Movies
Digital animated movie Date released Firm Worldwide gross ($)
Antz 1998 PDI 152,457,863
Shrek 2001 PDI 484,409,218
Shrek 2 2004 PDI/DreamWorks 920,665,658
Madagascar 2005 PDI/DreamWorks 527,890,631
Shrek the Third 2007 PDI/DreamWorks 798,957,081
Ice Age 2002 Blue Sky Studios/Fox 382,387,405
Robots 2005 Blue Sky Studios/Fox 260,700,012
Ice Age: The Meltdown 2006 Blue Sky Studios/Fox 647,330,621
Horton Hears a Whol 2008 Blue Sky Studios/Fox N/A
Source: The Numbers. Retrieved June 21, 2008, from http://www.the-numbers.com/movies/series/DigitalAnimation.php.
400 Cases
Lipitor: The World’s Best-selling
Drug
1
(2008)
Jeff Kindler, CEO of P?zer, pondered over sales of Lipitor. The drug had
brought in $12.7 billion in revenues in 2007.
2
This blockbuster belonged to a
group of drugs called statins that reduce the level of cholesterol in the body by
inhibiting the process by which the body produces cholesterol. What was it
about Lipitor and P?zer that had enabled the drug to do so well? Could P?zer or
any pharmaceutical company ever repeat such a feat?
Coronary Artery Disease
In 2008, it was believed that coronary artery disease was the leading cause of
death in the USA, where more than a million people suffered a heart attack
every year. A leading cause of coronary artery disease is the buildup of plaque in
the blood vessels, which can lead to blockage of these arteries, to heart attacks
and strokes. Frequently, this plaque buildup results from excessive cholesterol
levels, especially of the bad cholesterol called low-density lipoprotein (LDL).
High levels of triglycerides also have the same negative effect. However, high
levels of so-called good cholesterol—high-density lipoprotein (HDL)—have the
opposite effect as they return LDL to the liver for elimination, thereby reducing
harm to people. Cholesterol is a natural substance in the body that is used in the
formation of cell membranes, gastric juices, and some hormones; but like most
good things, too much of it is bad. The liver makes most of the cholesterol that
the body needs but cholesterol can also be ingested directly from food.
Role of Statins
Before statins, high levels of cholesterol were treated with drugs that break
down cholesterol or absorb it irrespective of whether it was naturally produced
by the body or from ingested food. These therapies were somewhat effective but
for many patients, the reductions in LDL levels were just not good enough.
Moreover, the therapies caused many side effects, including stomach pain and
nausea. All that changed when Merck introduced Mevacor, a statin, in 1987.
Statins work by inhibiting a key enzyme in the body from enabling the produc-
tion of cholesterol. Rather than wait for cholesterol to be produced by the body
and then try to eliminate it the way earlier drugs did, statins directly intervene in
the process that the body uses to produce cholesterol. Bristol Myers and Norva-
tis soon joined Merck in offering statin cholesterol drugs. The market shares for
the statins available just prior to the launch of Lipitor are shown in Exhibit 6.1.
Case 6
Lipitor Research and Development
The decision by Warner-Lambert to go on with the development of Lipitor was
not very popular because the drug was regarded as a me-too drug since it was
going to be the ?fth drug in the statin family. However, a Phase I study con-
ducted in 1992 showed that the drug reduced LDL levels much better than
existing statins (see Exhibit 6.2 for the different phases through which a drug
has to go before approval by the FDA). So Warner-Lambert decided to go ahead
with the development of Lipitor. To reduce the time that it takes to review the
data to approve or reject a new drug application (NDA) from the average of 12
months at the time, Warner-Lambert ran trials for a fatal hereditary condition
called familial hypercholesterolemia that results in exceptionally high choles-
terol levels. The idea was to take advantage of a law that encourages the FDA to
expedite new drug applications for any new drug that treats a serious or life-
threatening condition or addresses an unmet medical need. This worked as
Lipitor was approved by the FDA six months after receiving Warner Lambert’s
application for approval.
At the request of its marketing group, Warner-Lambert took the unusual step
of carrying out so-called head-to-head clinical trials in which clinical data are
collected on competing drugs and compared. Fortunately, the data showed
Lipitor to be superior to all the other statins. Lipitor reduced LDL levels by 40–
60% and reduced triglycerides by 19–40%. Zocor, the best of the other statins,
decreased LDL cholesterol by only about 40%.
3, 4, 5
After arriving at Warner-Lambert in 1988, Ron Cresswell, head of R&D, had
increased emphasis on biotechnology, integrated regulatory affairs, and clinical
research into the R&D unit, and sought to involve marketing earlier in the new
drug development process. He also sought to establish closer links to
manufacturing.
Warner-Lambert was granted FDA approval for Lipitor in December of
1996, one year ahead of most analysts’ expectations.
Bringing Lipitor to Market
To launch the drug, Warner-Lambert executives sought a partnership with a
company that had the marketing and sales resources. P?zer, which had a large
sales force but no cholesterol drug, was considered the best candidate. P?zer
liked the idea and promptly paid $205 million up front and future payments for
Exhibit 6.1 US Market Shares of Cholesterol-lowering Drugs, January 1997
Drug name Manufacturer Launch year Market share (%)
Mevacor Merck 1987 14
Pravachol Bristol-Myers Squibb 1991 21
Zocor Merck 1992 32
Lescol Novartis 1994 14
Source:
1
Seiden, C. (October 8, 1997). Pfizer, Inc. JP Morgan.
Note: Market shares are based on the entire cholesterol-lowering drug market (not only on statins).
402 Cases
the rights to sell Lipitor. Warner-Lambert positioned Lipitor as a therapeutically
superior drug but set its price lower than that of market leaders (Exhibit 6.3).
At the launch of Lipitor, the combined sales force from Warner-Lambert and
P?zer numbered more than 2,200 sales representatives that called on about
91,000 physicians made up of cardiologists, internists, and general and family
practitioners with a track record of prescribing cholesterol-lowering drugs.
Within one year of its launch in January 1997, Lipitor reached $1 billion in
domestic sales, beating estimates of $900 million in worldwide sales (see
Exhibit 6.4) for more estimates). On June 19, 2000, P?zer bought Warner
Exhibit 6.2 The Drug Development Process in the USA.
6
To insure the safety and efficacy of drugs sold in the USA, drugs have to go through Phases I, II, and III, and
the results of the testing scrutinized before the drug is approved by the Food and Drug Administration
(FDA) for marketing. Phase IV studies are undertaken after FDA approval to further understand the
long-term effects of a drug.
Preclinical Studies
As their name indicates, these are the studies that take place before a firm can start the actual clinical
trials on a drug. Preclinical studies are undertaken in vitro (that is, in test tube or laboratory), and in vivo
(in animal populations) to determine the effect that the drug in question has on living organisms. In these
studies, scientists monitor the drug’s efficacy, toxicity, and pharmacokinetics (how well the drug is
absorbed, distributed, metabolized, and excreted) to determine whether or not to proceed with the
clinical testing. Preclinical trials take 3–6 years.
Phase I
This is where the first testing on human beings starts. A small group of 20–80 healthy volunteers is
selected to participate in the studies. These studies are conducted to determine the basic characteristics
of a potential new drug in humans—in particular, to determine its safety, safe dosage range, and to
identify side effects. Emphasis here is to make sure that the drug is safe before it can be tried on patients
with the target disease.
Phase II
If the safety of the drug is confirmed in Phase I, Phase II trials are performed on larger groups (100–300)
of volunteers who have the target disease. The idea here is to establish that the drug is effective and to
further establish its safety. Thus, the testing tries to establish that the drug has a beneficial effect on the
disease that it targets, and to continue the proof of safety partially proven in Phase I. The drug fails Phase
II trials if it fails to work as expected or has toxic effects; that is, the drug fails when it does not
demonstrate efficacy and safety. Phase II studies take 6 months to a year to complete.
Phase III
These are multicenter, randomized controlled studies undertaken on large groups (1,000–3,000) of
patients that have the disease that the drug is supposed to treat. The idea here is to establish statistically
significant proof that the potential new drug is effective in treating the disease for which it is earmarked.
Patients are monitored at regular time intervals for progress in treatment and side effects. At the end of
Phase III trials, the pharmaceutical firm submits a New Drug Application (NDA) to the FDA for approval.
If the FDA is satisfied with the application, the drug is granted approval to launch and market the drug.
This approval is often referred to as conditional approval, since it can be withdrawn after Phase IV trials.
Phase IV
Also known as Post Marketing Surveillance Trial, Phase IV trials are designed to provide more data on
safety and to monitor technical support of a drug after its owner receives permission (through FDA
approval) to market and sell the drug. The studies offer more long-term data on the drug’s effects on
larger samples of patients, including the drug’s risks, benefits, and optimal use. The results of Phase IV
trials can result in the withdrawal of a drug from the market or its uses being restricted.
Sources: Understanding clinical trials. 2008. Retrieved July 22, 2008, from http://clinicaltrials.gov/ct2/info/understand.
Clinical trials. 2008. Retrieved July 22, 2008, from http:/en.wikipedia.org/wiki/Clinical_trial.
Lipitor: The World’s Best-selling Drug 403
Lambert. Direct-to-consumer (DTC) marketing of statins by all competitors
continued. In 2005 Bristol Myers Squibb conducted its own head-to-head test-
ing to compare its Pravachol against Lipitor. The tests showed that Lipitor, not
Bristol’s Pravachol, was better. Poor Bristol!
CEO Kindler wondered what would become of P?zer. Had he done the right
thing in closing down the R&D facility in which Lipitor had been developed?
What would he have to do to get another Lipitor? At an American Heart
Association scienti?c meeting in New Orleans in November 2008, it was
reported that Crestor, AstraZeneca’s statin, cut the risk of heart attacks not
only in patients with high cholesterol levels but also in those with low choles-
terol levels.
Exhibit 6.3 Statin Average Prescription Pricing Structure
Drug name 1997 average prescription price ($) 1999 average prescription price ($)
Lescol 52 50
Lipitor 84 91
Pravachol 93 105
Zocor 95 125
Mevacor 125 137
Source: IMS. (January–December 1997). National Prescription Audit. Price Probe Pricing History Report, 1992–9.
Exhibit 6.4 1997 Lipitor Worldwide Sales Projections
Year 1997 1998 1999 2000 2001 2002 2003
Revenues ($B) 0.9 2.2 3.4 4.6 5.6 6.7 7.7
Source: ING Baring Furman Selz, LLC, April 12, 1999.
404 Cases
New Belgium: Brewing a New
Game*
On June 11, 2008, InBev—a Belgium-based Brazilian-run, and world’s second
largest brewer—made a $46 billion bid for Anheuser-Busch (AB).
1
While some
AB managers wondered what would happen to them if their ?rm were bought,
many New Belgium Brewery (NBB) employees knew how they would vote if
such a large brewer with an unknown environmental sustainability record
wanted to buy them—No! Kim Jordan and her husband Jeff founded NBB in
1991 to turn their passion for good quality beer into a business they could work
at and with which they could feel good about themselves at the end of the day.
By 2008, it was not unusual for the ?rm to be mentioned as an example of a
?rm that did some socially responsible things that not only differentiated it but
also kept its costs low.
The US Beer Industry
In 2008, AB alone held more than 50% of the US beer market share.
2
The next
three ?rms held about 40%. The remaining 8% was held by many small
brewers, many of them so-called microbrewers. At 59%, input materials for
production and packaging, such as barley, hops, bottles, and cans, were a
brewer’s largest cost (Exhibit 7.1). Pro?t margins of 15% were not uncommon.
Exhibit 7.1 Average Cost of Goods Sold for United States Brewery
Item Cost (%)
Purchases 59.0
Wages 7.6
Depreciation 4.5
Utilities 1.5
Rent 0.4
Others 12.0
Profit 15.0
Source: IBS World.
* This case was written by Ali Dharamsey, Lei Duran, Claudia Joseph, Steve Krichbaum, and
Shama Zehra under the supervision of Professor Allan Afuah as a basis for class discussion and
is not intended to illustrate either effective or ineffective handling of a business situation.
Case 7
In many states in the USA, the sale of beer was restricted to certain areas, days,
and hours. The legal drinking age was 21. Brewers had to sell their beer to
distributors who, in turn, sold it to consumers. Distributors often maintained
exclusive contracts with one of the major breweries, carrying only beer from the
brewer.
Craft Beers
Craft beers were high-end premium beers that were distinguished from other
beers by their quality, price, and ingredients. In the early 2000s, Craft beers
were produced in small batches, allowing the brewers to produce what cus-
tomers perceived as better-tasting beer, relative to the beers produced in a larger
scale. Each brewer tried to market its beer as being distinct from the next, given
the uniqueness of its own small batch process. For instance Pete’s Brewing
(Pete’s Wicked Ale), one of the larger craft beer makers, sought to establish an
image of hard, bold ?avors for customers “with an edge.” This image was
highlighted throughout its packaging, ?avors, and website.
1991: Fort Collins, Denver
Jeff Jordan became passionate about brewing beer during their bicycle trips
through Europe. Back in Colorado, Jeff brewed some beer for their consump-
tion, and his friends liked it. Kim became interested in commercializing Jeff’s
home-brewed beer when she noticed that nothing that she tasted from outside
was as good as Jeff’s. After brainstorming, they agreed that the name of their
venture would be New Belgium, since Jeff’s brewing process had been heavily
in?uenced by the Belgian style of brewing. They called their ?rst commercial
beer “Fat Tire”.
Kim was the CEO. She and Jeff knew that above all else, they wanted to build
a company whose values and products supported their own personal core
values. After more brainstorming, they decided that their ?rm’s values would be
anchored on three main tenets: philanthropy, ownership, and sustainability.
She believed that these core values would attract new employees that shared
their goal of creating a business that left the world a better place. They could
then make products that would set them apart from other brewers in the eyes of
customers. She would later be quoted as saying “The beautiful part of it is we
believe in what we’re doing.”
3
Sustainability
New Belgium designed its headquarters in 1995 with an emphasis on ecof-
riendly practices. The headquarters housed two “Steinecker” brew houses, four
quality assurance labs, and a wastewater treatment facility that allowed them to
cleanse their process waters and create their own energy. Additionally, their
operations were also entirely wind powered, an option chosen in the wake of an
employee-owner vote (see Ownership section for more information). Kim and
Jeff constantly focused efforts on innovations that would help New Belgium
reduce its environmental footprint. New Belgium hired a sustainability director
Hillary Mizia who noted, “We’re closing energy loops. That’s the principal
behind everything we do.”
4
406 Cases
New Belgium was the ?rst brewery, among both major players and Craft,
within the US to become entirely wind-powered. In 2006, it was also still the
brewery with the largest wind consumption in the country.
5
This use of wind
power saved 3,000 tons of coal from being burned, thus reducing CO2 emis-
sions by some 5,700 tons. This, however, is one of the few energy initiatives that
failed to provide an economic return because of the premium of around 1 cent
per kilowatt (2006) that New Belgium paid for receiving wind-powered versus
standard power energy.
6
“Our ef?ciency projects have to make good business
sense,” said Hillary Mizia, New Belgium’s sustainability outreach coordinator.
“The social and environmental impacts are as important as the ?nancial impact,
but the ?nancial impact is what keeps us in business.”
7
New Belgium treated its windows with low-emission glaze that re?ected heat
rays from sunlight to reduce heat during the summer, thereby requiring less air
conditioning. The windows were retro?tted with light shelves that were made
of perforated metal and painted white, similar to a window sill. The windows
were retro?tted on the south-facing side to provide up to 50% additional day-
light into a space, thus reducing energy needs for lighting.
8
Lastly, additional
modi?cations were made to reduce energy costs further. This included windows
that opened automatically to cool rooms, and motion-sensor lights to ensure
that lights were on only when a room was in use. Through these actions, New
Belgium reduced its energy consumption by 40% (compared to the average
American brewer), per barrel of beer.
9
New Belgium’s attempt to build a green
roof to reduce energy expenditures further was not as successful; but that made
Kim even more determined. “It’s a gratifying way to use money, to try and push
the envelope and the practice of alternative energy,” she said. “It’s our goal to
completely close that loop, so all our energy use comes from our own waste
stream.”
10
The third initiative was the purchase of a $5 million system that collected
methane from brewing wastewater and used it to ?re a 290-kilowatt electric
generator (Exhibit 7.2). When the generator was running, for an average of 10–
15 hours a day, it created up to 60% of the brewery’s power. This amounted to
savings of $2,500–3,000 a month. New Belgium Brewery also conserved elec-
tricity by capturing the heat created by brewing tanks and piping it back to heat
water.
11
Renewable heating and cooling systems such as steam stack heat
exchangers were also utilized. By treating its own wastewater, the company was
able to reduce the load on the city’s facilities. By recovering energy in the form
of biogas and reusing water in nonbrewing processes, they were also able to
create processes that support holistic sustainability. In 2006, New Belgium used
4.75 liters of water for every liter of beer brewed (there are 119 liters per barrel,
which is the standard measure of beer sales).
12
These 4.75 liters were far less
than the industry standard of 20 liters. New Belgium’s goal was to reduce its
usage down to 3 liters. The combination of reduced water consumption and the
generator system created the largest savings by assisting New Belgium to avoid
steep fees that would be assessed by Fort Collins to treat the brewery’s nutrient
rich wastewater. It would have cost the ?rm $4.43 million to build a system that
would reprocess the used water before releasing it into the public water system,
as required by local laws.
New Belgium: Brewing a New Game 407
Ownership
New Belgium was a privately held company that allowed its employees to take
shares in the company and serve as employee-owners. The company had, on
average, an employee ownership of 32% and employees enjoyed equal voting
rights on all company issues.
13
The ?rm’s books were opened to employees, consistent with “trust and
mutual responsibility.”
14
Private ownership also enabled New Belgium to keep
its strategies, company data, performance ?gures, etc., from complete public
disclosure. In 2006, the ?rm had no public debt outstanding. The collective
employee culture extended beyond ownership with additional perks to increase
morale. Employees were provided with generous bene?ts including health, den-
tal, and retirement plans. Lunch was free to employees, every other week.
Employees were also entitled to a free massage (at a salon) every year. Kim and
Jeff encouraged employees to bring their children and even dogs to work. And
those employees that had been with the company for over ?ve years were given
an all expenses-paid trip to Belgium to understand “Beer Culture”. Employees
from all departments within the organization were also given roles on the Phil-
anthropy Committee which decided how to spend the company’s social and
charitable fund (see Philanthropy section for more information). Lastly, New
Belgium enjoyed a fairly decentralized management structure that enabled
employees to be readily involved. Employees were also encouraged to under-
stand, guide, and take responsibility for corporate decision-making.
Philanthropy
New Belgium gaves $1 of every barrel of beer sold to local causes such as care
for kids with learning and developmental disabilities.
15
From its inception to
2006, New Belgium Brewing had donated more than $1.6 million to local
Exhibit 7.2 Cost Implications of Generator Purchase
Cost of new water treatment facility $5,000,000
Estimated cost of discharge water treatment facility $4,430,000
Electricity costs
Energy use charge $0.0164 per kWh
Fixed demand charge $4.31 per kWh
Coincident peak demand charge $11.62 per kWh (plus other misc.)
Estimated electricity savings per month $2,500–3,000
Water costs
Cost of water per gallon—Denver, CO $0.001
Liters per gallon 3.79
Liters in a barrel of beer 119
New Belgium—liters of water per liter of beer produced 4.75
Industry average—liters of water used per barrel of beer
produced
20
New Belgium—estimated barrels of beer produced per year 330,000
408 Cases
charitable organizations in the communities where the company did business.
The donations were divided between States in proportion to their percentage of
overall sales.
16
Funding decisions were made by the Philanthropy Committee, made up of
owners, employee owners, area leaders, and production workers. New Belgium
targeted nonpro?t organizations that demonstrated creativity, diversity, and an
innovative approach to their mission and objectives. The Philanthropy commit-
tee also looked for groups that involved the community in reaching their goals.
Past recipients included Volunteers for Outdoor Colorado and The Larimer
County Search & Rescue team, as seen in these photos.
Marketing
Like most craft beer makers, New Belgium spent twice as much per barrel on
advertising as non-craft beer makers. The primary focus was to highlight
“experience” and awareness of taste and brand. With “Fat Tire” being the
?agship product and with a clear idea of the core values, Kim moved forward in
bringing the positioning to life with a statement that appeared on all New
Belgium product packaging:
“In this box is our labor of love. We feel incredibly lucky to be creating
something ?ne that enhances people’s lives. Know that we think about you
as we’re making it- enjoying Trippel by the ?re, splitting Fat Tire with a
friend, offering Abbey Ale as a present. Enjoy! And stop by to let us know
how it was. We’d love to see you!”
Kim’s success in bringing New Belgium’s character to life could be seen not
only through beer a?cionados’ avid enjoyment of the product, but more
importantly through the alignment of brand champions/evangelists/ambas-
sadors with the products and company.
17
As noted by just one set of evangelists
on numerous beer a?cionado targeted sites:
Ever since we tried this beer it has been THE favorite. (We even had it
kegged in for our wedding . . .) Keep bugging your local merchants to get it
in their stores, it really deserves more shelf space. And thank goodness
Coors lost.
18
(Shannon and Adam, October 10, 2005 [in reference to the Abby product])
The sentiments of these consumers highlighted their passion for New Belgium
and furthermore, an understanding of the competitive environment in which
their products competed. The call to action by other loyalists by rallying and
demanding for higher distribution showed the alignment Kim had sought to
achieve between her customers and New Belgium.
Future for New Belgium
Kim Jordan and Jeff Lebesch had grown their company into the third-largest
American craft beer maker in 2006 (after Sierra Nevada and Sam Adams). They
had grown their employee base to more than 260 employees.
19
Sales had grown
New Belgium: Brewing a New Game 409
to more than 330,000 barrels, and New Belgium was now the fastest-growing
craft brewer in the U.S. Annual revenues had exceeded $70 million—with
its corporate soul intact.
20
As Kim and Jeff looked to the future, they could
not help but wonder what more they could do for their community and New
Belgium, while still staying true to their core values.
410 Cases
Botox: How Long Would the Smile
Last?
The Allergan board member listened attentively to the words of a competitor to
Botox—the popular drug used to treat facial wrinkles and a lot more. This was
nothing to smile about. The drug had not had much competition in the USA
since FDA approval on April 15, 2002; but there appeared to be competition on
the horizon—enough to frown at. In 2008, Reloxin, another wrinkle remover
with similar chemical composition to Botox, was rumored to be near FDA
approval. Why had Botox done so well for Allergan all these years? Had it been
only because of its monopoly position in the USA? Could the advantage be
sustained?
Botox
Botulinum toxin A—Botox for short—is perhaps best known for its ability to
reduce wrinkles when injected in diluted form under wrinkled skin. It works by
stopping nerves from making muscles move for months at a time—it effectively
paralyzes the area into which it is injected. Because of this paralyzing ability,
Botox could be deadly if administered to the wrong muscles. The rise of Botox
to a popular drug is a textbook case of innovation through serendipity. Botuli-
num toxin A was ?rst used in humans by pioneer Doctor Alan Scott to treat
twitching and crossed eyes in 1977.
1
While she was using the toxin to treat eye
twitches, Dr Jean Carruthers, a Canadian ophthalmologist, noticed that those
of her patients to whom she had administered the drug looked more relaxed.
She and her dermatologist husband Dr Alastair Carruthers investigated this
potential new application some more and published their ?ndings on how to
use the toxin to treat face wrinkles in 1989.
2
As more and more dermatologists
used the drug to treat wrinkles, they found out that a large percentage of their
patients who had had migraines before stopped having the migraines after injec-
tion of the toxin. Different medical specialists and Allergan would go on to ?nd
more applications for the drug.
Botox was ?rst approved by the FDA in 1989 for use to treat eye-muscle
disorders (crossed eyes) and that approval expanded in December 2000 to treat
cervical dystonia, a neurological disorder that causes severe shoulder and neck
contractions.
3
It received FDA approval on April 15, 2002 for use to reduce or
eliminate frown lines or wrinkles between eyebrows. This approval meant that
Allergan could advertise Botox’s cosmetic bene?ts directly to consumers and
doctors in the USA. (In the USA, doctors could use a drug before it was
approved by the FDA, in so-called “off-label uses;” but ?rms could not market
Chapter 8
unapproved bene?ts. In fact, in 2000, two years before FDA approval, more
than one million faces had been smoothened with Botox.)
4
Used as a wrinkle ?ghter, Botox produced results within minutes, but wore
off after about six months. The procedure required no anesthesia and the
patient could return to work or other activity the same day. In some rare cases,
the patient had to go back to get a few areas ?lled out. Contrast this with
cosmetic surgery that required anesthesia, time to recover and see results, and
the risks associated with surgery.
As its name—Botulinum toxin A—reminds scientists, Botox is a biological
substance derived from the bacterium Clostridium botulinum, the bacterium
that can produce deadly botulism. If consumed in contaminated food the bac-
terial toxin can paralyze and kill.
5
Botulinum toxin A is but one of seven neuro-
toxins produced by the bacterium, and the process of growing and isolating
Botox is dif?cult and risky. Allergan could not patent the process but protected
it by keeping it proprietary.
6
Pharmaceutical ?rms often patented their chemical
compounds to protect them from competitors; but that also meant that when
the patent protection expired, generic versions of the drug could be produced by
competitors.
Marketing Botox
With FDA approval in 2002 for use in ?ghting frown lines, Allergan could now
market it as such. It launched a $50 million marketing campaign.
7
(US pharma-
ceutical ?rms spend twice as much on marketing as on R&D, on average.) In
2002, it was estimated that a vial of Botox cost Allergan $40 to make and it sold
it to doctors for $400.
8
Each vial contained 100 units, enough for 4–5 treat-
ments. In 2002, estimates of how much a doctor could charge patients for
administering the one vial ranged from $1,600 to $2,800.
9
Sales of Botox
increased steadily and in 2008, it was expected to fetch $1.38 billion in rev-
enues. Pyott, Allergan’s CEO, was quoted in 2006 as saying, “To sell $830
million of this stuff, you need less than one gram [of the active ingredient].”
10
Pyott attributed some of Botox’s success to the fact that vanity was “a global
need.”
11
Although Botox’s 2002 FDA approval was only for use in improving frown
lines between eyebrows, many doctors used it to smooth horizontal lines in the
forehead, shape the jaw and sides of the face, widen the eyes to produce a more
rounded look, lift the brow and shape eyebrows, treat crows feet, mouth frown,
dimple chins, lines on the neck, and other cosmetic areas.
12
The results of many
of these applications were enhanced when the procedures were complemented
by other procedures such as laser resurfacing. In addition to these cosmetic
applications, Botox had other nonvanity applications.
13
It was used by phys-
icians to treat back pain in some patients who did not respond well to trad-
itional pain medication, treat migraine and tension headaches, excessive sweat-
ing (hyperhirosis), and bladder problems (incontinence). In Canada, it was
approved for frown lines, crossed eyes, eye and facial spasm, wry neck, foot
deformity, spasticity, and excessive sweating.
412 Cases
Competitors
Botox faced two kinds of competition. First, it was taking on established com-
petitors in each of the different markets that Allergan hoped to invade. In the
face wrinkles market, it was wrestling away market share from those surgeons
that performed facelifts, eyelid surgery, and other face procedures.
14
Then there
were less invasive procedures such as chemical peel and laser skin resurfacing.
More menacing was the impending approval of another botulinum toxin type-
A compound, with trademark name Reloxin. Reloxin had been developed in
Canada by Ipsen, Inc., but in 2006 Medicis, a US specialist pharmaceutical ?rm,
had entered an agreement with Ipsen to develop, distribute, and commercialize
Reloxin in Canada, Japan, and the USA.
15
If and when the drug received FDA
approval, Medicis would pay Ipsen $25 million. By October 2007, Reloxin had
been approved in 21 countries for aesthetic use, but approval in Japan, Canada,
and the USA had not yet been received. On December 6, 2007, Ipsen and
Medicis announced that an application for FDA approval for aesthetic indica-
tion had been submitted.
Cosmetic Procedures Market
Cosmetic surgery used to be frowned upon but by the 2000s it had become so
popular that people used to have Botox parties to discuss their latest procedures
or the ones they intended to undertake soon. The average age of people who
wanted to look younger was dropping. In 2008, according to WebMD, the
most popular cosmetic procedures were liposuction, eyelid surgery, breast
implants, nose jobs, facelifts, and Botox injections.
16
Others included breast
lifts, tummy tucks, spider veins, and skin resurfacing. The fees for some of these
procedures are shown in Exhibit 8.1.
Exhibit 8.1 2008 Plastic Surgery Fees
Procedure Fees Average fees
Breast
augmentation
5,000–7,000 Surgeons fee: $3,050
Anesthesiologist: $700
Facility fee: $950
Implant fee: $1,300
Average total cost : $6,000
Breast lift 4,000–9,000 Surgeons fee: $3,500
Anesthesiologist: $700
Facility fee: $1000
Average total cost: $5,200
Breast
reduction
5,000–10,000 Surgeons fee: $3,500
Anesthesiologist: $700
Facility fee: $1000
Average total cost: $5,200
Eyelid surgery 1,500–7,000 Surgeons fee: $2,500
Anesthesiologist: $700
Facility fee: $800
Average total cost: Upper and lower lids $4,000
(Continued overleaf )
Botox: How Long Would the Smile Last? 413
Allergan
Although with a market capitalization of $16 billion on July 17, 2008, Allergan
was nothing compared to Silicon Valley’s behemoths such as Intel ($128 bil-
lion), Google ($167 billion), eBay ($31.6 billion), Cisco ($128.5 billion), and
Oracle ($108 billion), it was Orange County, California’s largest ?rm and the
pride of Southern California. In 2007, Allergan had net pro?ts of $499 million
on net product sales of $3.88 billion (Exhibit 8.2). Some $1.212 billion of the
sales came from Botox, which grew 23% over 2006.
17
The growth was faster
outside the USA where there was more competition. A third of its sales were
international. Allergan claimed to have an 85% cosmetic market share in ?ve
European countries where Reloxin was being marketed under the brand name
Dysport by Paris-based Ipsen.
18
As shown in Exhibit 8.2, Allergan had two
divisions: Specialty Pharmaceuticals, and Medical Devices. Selected products
from each of these divisions are shown in Exhibit 8.3. One of these products,
Exhibit 8.1 Continued
Procedure Fees Average fees
Facelift 6,000–12,000 Surgeons fee: $5,000
Anesthesiologist: $1,200
Facility fee: $1,700
Hospital fee: $600
Average total cost: $8,500
Lip
enhancement
300–5,000 Cost per procedure: collagen injection $333
Lip augmentation (other than injectable materials) $1,570
Surgeons fee: $1,600
Facility fee: $400
Average total cost: $2,000
Liposuction 2,000–10,000 Surgeons fee: $2,000
Anesthesiologist: $500
Facility fee: $700
Average total cost: (One Area) $3,500
Male breast
reduction
6,000–9,000 Surgeons fee: $2,500
Anesthesiologist: $700
Facility fee: $1000
Average total cost: $5,200
Rhinoplasty 3,000–12,000 Surgeons fee: $3,000
Anesthesiologist: $700
Facility fee: $800
Average total cost: $4,500
Tummy tuck 5,000–9,000 Surgeons fee: $4,200
Anesthesiologist: $500
Facility fee: $700
Average total cost: $6,400
Source: Plastic surgery research information. Retrieved July 19, 2008, from: http://www.cosmeticplasticsurgery
statistics.com/costs.html.
414 Cases
Exhibit 8.2 Allergan’s Product Areas
(In $ million) Year
Product area 2007 2006 2005 2004 2003
Specialty pharmaceuticals
Eye care pharmaceuticals $1,776.5 $1,530.6 $1,321.7 $1,137.1 $999.5
Botox/neuromodulator 1,211.8 982.2 830.9 705.1 563.9
Skin care 110.7 125.7 120.2 103.4 109.3
Urologics 6.0
Subtotal pharmaceuticals 3,105.0 2,638.5 2,272.8 1,945.6 1,672.7
Other (primary contract sales) 46.4 100.0 82.7
Total specialty pharmaceuticals 3,105.0 2,638.5 2,319.2 2,045.6 1,755.4
Medical devices
Breast aesthetics 298.4 177.2
Obesity intervention 270.1 142.3
Facial aesthetics 202.8 52.1
Core medical devices 771.3 371.6
Other 2.7
Total medical devices 774.0 371.6
Total product net sales $3,879.0 $3,010.1 $2,319.2 $2,045.6 $1,755.4
Source: Allergan Inc. 2007 Annual Financial Statement. Retrieved July 18, 2008, from http://files.shareholder.com/
downloads/AGN/362148606x0x184012/BB8ED2E7-30CF-443D-A2F7-0935FE134F78/2007AnnualReport.pdf.
Exhibit 8.3 Allergan’s Products in 2008
Specialty pharmaceuticals Medical devices
1. Eye care
a. Acular (allergic conjunctivitis)
b. Alocril (allergic conjunctivitis)
c. Alphagan (glaucoma)
d. Combigan (glaucoma, ocular hypertension)
e. Elestat (allergic conjunctivitis)
f. Exocin (ophthalmic anti-infective)
g. Ganfort (glaucoma)
h. Lumigan (glaucoma)
i. Ocuflox (ophthalmic anti-infective)
j. Oflox (ophthalmic anti-infective)
k. Pred Forte (opthalmic anti-inflammatory)
l. Restatis (chronic dry eye disease)
m. Zymar (bacterial conjunctivitis)
2. Neuromodulator
a. Botox (neuromuscular disorder treatment)
b. Botox cosmetic (wrinkle reduction)
1. Breast aesthetics
a. CUI (implants)
b. Inspira (implants)
c. McGhan (implants)
d. Natrelle (implants)
e. Tissue expanders
2. Obesity intervention
a. BIB System (stomach implant)
b. Lap-Band (stomach implant)
3. Facial aesthetics
a. CosmoDerm and CosmoPlast (dermal filler)
b. Juvederm (dermal fillers)
c. Zyderm and Zyplast (dermal fillers)
(Continued overleaf )
Botox: How Long Would the Smile Last? 415
dermal ?llers, was of particular interest when planning for Botox. Dermal ?llers
were injectible products that were designed to restore the youthful ?rmness to
tissue that had gradually broken down with age.
Looking Forward
The board member realized that he would need to do more research to under-
stand more about Allergan’s business model before the next board meeting.
19
The good old days when board members used to show up to board meetings
and rubberstamp everything that management wanted were gone. He could not
afford to look bad when asking questions at the next meeting. What should
Allergan’s next steps for Botox be?
Exhibit 8.3 Continued
Specialty pharmaceuticals Medical devices
3. Skin Care
a. Avage (skin wrinkles or discoloration)
b. Azelex (acne treatment)
c. Finacea (rosacea)
d. M.D. Forte (line of alpha hydroxy acid
products)
e. Prevage (skin lines or wrinkles and
protection)
f. Tazorac (treatment for acne and psoriasis)
g. Vivite (anti-aging)
4. Urologics
a. Sanctura (overactive bladder)
Source: Hoovers. Retrieved July 19, 2008, from http://0-premium.hoovers.com.lib.bus.umich.edu:80/subscribe/co/
ops.xhtml?ID=ffffrffhsrccksjcsk
416 Cases
IKEA Lands in the New World
Who was the richest European in 2008? Ingvar Kamprad, the Swedish founder
of IKEA.
1
In fact, according to the Swedish business magazine Veckans Affarer,
Ingvar Kamprad’s net worth in 2004 was $53 billion, making him the richest
person in the world, ahead of Bill Gates ($47 billion) and Warren Buffet
($43 billion).
2
Poor Bill! Poor Warren! In any case, a look at IKEA’s activities,
especially in the USA, can give us some idea why the ?rm made its founder one
of the richest people in the world.
In 2007, IKEA had revenues of 19.8 billion and 522 million customers
visited an IKEA store some time during the year (Exhibit 9.1).
3
The ?rm had net
margins of 10%, considered by analysts to be very good for a home furnishings
?rm. According to IKEA’s CEO, Anders Dahlvig in 2005, awareness of the
IKEA brand was “much bigger than the size of” IKEA.
4
Opening of a New Store
For many customers, the IKEA experience started with the activities that lead
up to the opening of an IKEA store. When the Edmonton store in north
London, UK’s largest IKEA store, opened its doors on February 10, 2005, the
Exhibit 9.1 IKEA Sales
By year
Year Sales ()
2007 19.8
2006 17.8
2005 14.8
By region in 2007
Region Share (%)
Asia and Australia 3
North America 15
Europe 82
Source: Retrieved June 24, 2008, from http://
www.ikea.com/ms/en_US/about_ikea_new/facts_figures/
index.html.
Case 9
discounts offered by the store and the pre-opening hype attracted 5,000–6,000
visitors. The rush to get into the store resulted in casualties and the store was
forced to close temporarily after only 30 minutes.
5
Over 2,000 IKEA fanatics
camped outside the new Atlanta, GA store seven days before the opening, some
hoping to win one of the prizes for the ?rst 100 people in line. The enthusiasm
shown in these two cases was typical of most IKEA store openings. The local
press and media picked up on the stories, arousing even more interest in IKEA.
Inside the Store
IKEA stores were located outside city centers where there was plenty of park-
ing. In 2006, it cost $66 million, on average, to open a new store.
6
Blue-and-
yellow Sweedish colors adorned the outside of each huge building—measuring
an average 300,000 square feet. A daycare center allowed shoppers to drop off
their kids and shop. The inside of the store was designed around a “one-way”
layout to make it easy for customers to see all the products and displays. This
layout contrasted with the layout of traditional US furniture stores where the
inside was laid out so that a customer could go straight to what he or she was
looking for. But IKEA’s line of products and displays were such that many
customers enjoyed the experience of going through the long one-way, picking
up a bargain every so often. Of course, there were shortcuts to the displays in
which one might be interested. The goal of the layout, furniture samples, dis-
plays, sample rooms, and atmosphere was to delight the customer with the
shopping environment, ideas, and the IKEA experience. Located at about the
center of most stores was a restaurant for shoppers to take a break from shop-
ping and enjoy some Scandinavian or local food, before continuing with shop-
ping. Customers who needed help with service could look for someone to help
them. Those who bought furniture took it home themselves and assembled it.
Product Design, Development, Distribution, and
Supply
“Designing beautiful-but-expensive products is easy. Designing beautiful prod-
ucts that are inexpensive and functional is a huge challenge,”
7
said Josephine
Rydberg-Dumont in 2005, president of IKEA of Sweden. In 2005, IKEA had 16
in-house designers from eight different countries, and 70 freelancers from all
over the world.
8
The job of these designers was not only to come up with
inspiring designs—contemporary or otherwise—but to work with in-house
production teams to identify the most suitable materials and lowest cost sup-
pliers. In 2008, IKEA had 1,350 suppliers in 50 countries from which to choose
(Exhibits 9.2).
9
The ?rm served these suppliers from its 45 trading service
of?ces in 31 countries. It pioneered ?at-pack designs so that furniture could be
packed and distributed to stores, or carried home with as little inconvenience as
possible. Shipping assembled furniture was regarded by IKEA as a big waste of
money since one was effectively paying to ship pockets of air. Using these ?at
packs, supplies were transported to its 31 distribution centers in 16 countries,
and distributed to its 232 stores in 24 countries.
10
Furniture was not designed to
be as durable as that available in high-end furniture stores.
418 Cases
Marketing
IKEA appeared to have made a connection with the global middle class, with
low budgets who were not quite sure about what furniture to buy before going
to IKEA for the ?rst time. IKEA’s layout and displays suggested what these not-
so-experienced furniture buyers could buy to ?t their emerging lifestyles at a
manageable budget. While it had developed a cult-like following, there were
still some people who were not as crazy about having to truck home furniture
and assemble it—themselves. IKEA appeared to have built a global brand and
following. In the USA, some of these followers could drive for as many as ten
hours to get to an IKEA store. They eye-shopped online or used IKEA’s catalog,
of which, there were plenty. In 2007, more than 191 million copies of the
catalog were printed in 56 editions and 27 languages, more than copies of the
bible. About a third of IKEA’s product line was replaced every year.
11
The top
?ve sales countries were Germany (16%), USA (10%), UK (9%), France (9%),
and Sweden (7%) (Exhibit 9.3).
Exhibit 9.2 Purchasing
By region in 2007
Region Share (%)
Asia and Australia 3
North America 33
Europe 64
By top purchasing countries in 2007
Country Share (%)
China 22
Poland 16
Italy 8
Sweden 6
Germany 6
Source: Retrieved June 24, 2008, from http://
www.ikea.com/ms/en_US/about_ikea_new/facts_figures/
index.html.
Exhibit 9.3 Top Sales Countries in 2007
Country Share (%)
Germany 16
USA 10
UK 9
France 9
Sweden 7
Source: http://www.ikea.com/ms/en_US/about_ikea_
new/facts_figures/index.html: Accessed: June 24, 2008.
IKEA Lands in the New World 419
IKEA Culture
Many of the values that underpinned the IKEA culture appeared to have come
from founder Kamprad’s thrifty, hard-working, value-for-the-buck mentality.
No one was too important for any job. For example, during the company’s
Antibureaucracy Week, CEO Dahvig would be “unloading trucks, and selling
beds and mattresses.”
12
Wastefulness was considered a sin. Flying ?rst class was
considered unusual.
US Furniture Market
The highly fragmented US furniture market could be divided into low-end and
high-end. The high-end market was exempli?ed by ?rms such as Ethan Allen
that had large selections of furniture, superior in-store service, high quality
furniture, classy environment, and ?nancing, but carried a high price tag to
match. These ?rms would customize your furniture for you, deliver your furni-
ture to your house, install it, and even take away old unwanted furniture. Sales
staff took the time to explain everything about the furniture from the fabric to
the origins of the wood, and how durable the furniture was guaranteed to last—
often longer than the customer’s marriage or lifetime. They did not carry the
many other products that IKEA carried, choosing to focus on furniture and few
other furnishings. The low-end was exempli?ed by Wal-Mart, where the cost
was lower than that at the high-end but with limited selection, quality, and
service to match. The shopping atmosphere was not as ?attering.
IKEA in the New World
In 2008, IKEA USA was doing very well; but things had not always been that
way. IKEA opened its ?rst US store in 1985, just outside Philadelphia. In the
years that followed, it would open more stores in the USA and make some
classic mistakes before correcting them. According to a former IKEA US
employee, “we got our clocks cleaned in the early 1990s because we really
didn’t listen to the consumer,”
13
IKEA managers did not do their homework
well and chose the wrong locations for many stores, their stores were too small,
and their prices too high. Their beds were measured in metric units rather than
the familiar American twin, queen, and king. Sofas were not deep enough, and
so on. IKEA learnt its lessons and corrected its mistakes.
IKEA’s Corporate Structure and Holdings: Where
the Money Goes
In 2008, each IKEA store was owned by a franchisee. The largest of these
franchisees was Ingka Holding, a Dutch-registered private company. In 2004,
Ingka Holding operated 207 of the 235 IKEA stores (Exhibit 9.4).
14
In the year
that ended in August of 2004, the Ingka Holding group had pro?ts of 1.4
billion on sales of 12.8 billion. The remaining 28 stores were owned by a
collection of other private franchisees (Exhibit 9.4). Each store paid a royalty of
3% of sales to Inter IKEA Systems, another Dutch-registered private company.
Finally, Ingka Holding was itself wholly owned by Stichting Ingka Foundation,
a Dutch-registered, tax-exempt, nonpro?t legal entity.
420 Cases
IKEA: A Global Leader?
In 2008, some academics enjoyed arguing about whether and why IKEA had
become a world darling, making its founder one of the richest people in the
world. Those who believed that the company was successful attributed the
success to some subset of the ?rm’s low cost offerings, designs-with-meaning,
brand, store experience, its world-wide sourcing network, company culture, or
growing worldwide community. Some were intrigued by what exactly Kam-
prad had done to become so rich selling one of the most ancient products—
furniture.
Study Questions
1 Why has IKEA been so successful and what have new games to do with it?
2 What type of strategy is IKEA pursuing: global adventurer, global generic,
global heavyweight, or global star?
3 What have new games had to do with Inkvar Kamprad being very rich?
4 What is new game about IKEA’s structure?
Exhibit 9.4 Where the Money Goes
IKEA Lands in the New World 421
Esperion: Drano for Your
Arteries?*
$1.3 billion. Dr Roger Newton sat in his car after leaving the of?ce for the day,
and paused before turning the ignition and heading home. It was late November
in 2003, and Esperion Therapeutics, the company Dr. Newton founded, had
just received an offer from P?zer to buy the company for $1.3 billion. He smiled
a little, remembering several years earlier when he was recognized by Warner–
Lambert (which was later purchased by P?zer) for developing the world’s most
successful drug—Lipitor. Along with the award, Dr Newton was provided with
a cash prize: $20,000. Times had certainly changed, and the award for guiding
Esperion through the development of several novel cardiovascular compounds
had obviously grown signi?cantly. Dr Newton and his team invested time,
money, and a great deal of thought and effort into Esperion, and while the
?nancial offer from P?zer was signi?cant, he worried whether now was the
right time to be acquired.
Esperion had just announced very positive clinical data for its lead candidate,
and its novel method of addressing high cholesterol was generating interest in
both the scienti?c and business communities. Was now the right time to sell, or
should Esperion push on and build itself into a fully-integrated biotech com-
pany? Was P?zer the right suitor, or was there another company which could
better help continue Esperion’s success? What would happen to Esperion if it
was acquired—to the people who had founded and built the company, and
developed the molecules so highly regarded today? Dr Newton turned his key
and pulled out of Esperion’s parking lot. He had several weeks to evaluate
P?zer’s offer, and would need the time to think fully through his options.
Cholesterol
Cholesterol is a natural substance used in the body for a variety of purposes
from cell membrane formation to the makeup of hormones. The liver makes
most of the cholesterol a person needs; however, it is also found in many foods
and is an inherent part of many diets. Cholesterol levels result from both genetic
and dietetic in?uences. While genetic in?uences are beyond an individual’s con-
trol, lifestyle choices that are marked by fatty foods and a lack of exercise serve
to increase cholesterol levels for many people.
* This case was written by Brian Levy, Melissa Vasilev, Jess Rosenbloom, Scott Peterson, and
Patrick Lyon under the supervision of Professor Allan Afuah as a basis for class discussion and
is not intended to illustrate either effective or ineffective handling of a business situation.
Case 10
Cholesterol is transported through the bloodstream when it is coupled with
special carriers called lipoproteins. Low-density lipoprotein (LDL), often
referred to as “bad” cholesterol, transports cholesterol from the liver to the
body’s cells for use. High-density lipoprotein (HDL), often referred to as
“good” cholesterol, removes cholesterol and other lipids (fats) from arterial
walls and other tissues, transporting them to the liver where they are eliminated
from the body.
Complications from Cholesterol
Excessive levels of LDL can lead to the build-up of cholesterol and other fats in
the walls of arteries, a condition known as atherosclerosis, causing a progres-
sive narrowing of arterial walls. If unchecked, these deposits can eventually
form a plaque. If a plaque ruptures and a clot forms, potentially blocking an
artery, a heart attack can result. A heart attack may also result if excessive
amounts of plaque form in the arteries that deliver blood to the heart, known as
coronary arteries, slowly starving the heart muscle of oxygen needed to func-
tion. This set of complications is also known collectively as coronary artery
disease and is the number one cause of death in the USA (Exhibit 10.1).
High LDL also increases the chances of stroke. Like dislodged plaque block-
ing a coronary artery of the heart, if a clot cuts blood ?ow to the brain, serious
nervous system damage or even death may occur. Further, increased blood pres-
sure from high LDL also poses the risk that sensitive arteries near the brain may
burst, resulting in nervous system damage or death.
Treatment Options
To treat high LDL levels and reduce the likelihood of the associated health
risks doctors had several options at their disposal. Base recommendations
always included diets that were low in saturated fat and an increase in physical
exercise. However, lifestyle changes alone were rarely enough to reduce more
elevated patient LDL levels. Physicians often chose from the following options
to reduce further the risks posed by cholesterol:
Pharmaceuticals (statins)—If LDL levels had not dropped enough after
6–12 months of lifestyle changes, physicians recommended a drug called a
Exhibit 10.1 Selected Disease Statistics—USA 2003
People who have one or more forms of cardiovascular disease (CVD) 71,300,000
High blood pressure 65,000,000
Coronary artery disease 13,200,000
Myocardial infarction (heart attack) 7,200,000
Angina pectoris (chest pain) 6,500,000
Stroke 5,500,000
Deaths from cardiovascular disease 910,614
Deaths from coronary artery disease 479,305
Deaths from cancer (all types) 554,642
Deaths from accidents 105,695
Source: Cardiovascular Disease Statistics, 2003—American Heart Association.
Esperion: Drano for Your Arteries? 423
statin that works to reduce LDL levels. Statins interfere with the liver’s
ability to produce cholesterol and, depending on the particular patient,
some statins may actually serve to increase HDL production slightly.
Angioplasty—For patients with more advanced and potentially acute
atherosclerosis, a doctor may have elected for an invasive solution to coun-
ter the effects of plaque in arteries. An angioplasty is a surgical procedure in
which a surgeon inserts a small tube or balloon at the spot of arterial block-
age. The balloon is in?ated, expanding the artery allowing for greater blood
?ow.
Stents—If an angioplasty was carried out on coronary arteries, standard
procedure included the placing of a stent. A stent is a small metal scaffold
that expands and supports the arterial wall to allow for greater blood ?ow.
Stents are left in the patient after the angioplasty procedure to ensure
greater long-term blood ?ow. Some stents, called drug-eluting stents, are
coated with specialized pharmaceutical compounds to prevent future
blockages, a condition known as restenosis.
The Cardiovascular Drug Market
The cholesterol drug market in 2003 was the world’s largest pharmaceutical
market, generating $17 billion annually and expected to grow at a 5% com-
pound annual growth rate (CAGR) through 2010.
1
While the market was com-
prised of three therapeutic classes—statins, resins, and ?brates—the statin class
dominated treatment, comprising 90% of dollar volume. Within the statin
market, an oligopoly competed ?ercely: P?zer, Bristol-Meyers Squibb, and
Merck promoted Lipitor, Pravachol, and Zocor against each other, generating
$8 billion, $2.2 billion, and $5.5 billion, respectively.
2
With each drug having a
similar ef?cacy and safety pro?le, companies utilized their signi?cant cardio-
vascular experience to apply large sales forces, high marketing spend, and
exhaustive post-approval clinical trial strategies to differentiate drugs to
cardiologists.
While heavy market development was helping to expand the hypolipemic
market, several additional characteristics were expected to contribute to the
market’s growth. Recent updates to treatment guidelines encouraged physicians
to pursue lower target lipid levels in their patients, causing upward titration in
statin dosage. Additionally, the ?rst combination product—Zetia—had
recently been launched, offering a complementary treatment to be added to
ongoing statin use to increase ef?cacy (raising the overall cost of treatment),
and additional combination treatments were expected. Lastly, patient demo-
graphics were expected to contribute to growing the incidence of cardiovascular
diseases worldwide: aging populations, and increasingly unhealthy eating
habits, in the USA and Europe were driving the overall number of possible
patients signi?cantly.
3
While patient populations and new therapeutic guidelines were expanding
the hypolipemic market, two issues did threaten the market’s growth. Zocor,
Pravachol, and Lipitor all faced patent expiry by 2010, and the entrance of
generic forms of these drugs (typically at 10–20% of branded patent prices)
would erode branded sales of these drugs signi?cantly. Additionally, patient
compliance with statin regimens was a continuing issue. Because statins were
424 Cases
prescribed as a preventative measure (prior to a heart attack or other major
health event), patients often did not recognize the importance these drugs
played in continuing their health—they often did not adhere to the
recommended treatment frequency that physicians recommended, adversely
affecting sales.
The Pharmaceutical Development Process
With several well-entrenched, well-performing statins already on the market in
2003, few statins were in trials or expected to be developed in the future.
4
Instead, new classes of drug were being developed either to complement or
improve upon the treatment success of the statins. New molecules in develop-
ment faced tremendous dif?culty reaching the market, however, due to signi?-
cant regulatory and ?nancial requirements (Exhibit 10.2).
Financial requirements for pharmaceutical research and development are
extremely high, with research costs for each new approved drug compound
reaching as high as $850 billion. Additionally, once the decision to pursue a
Exhibit 10.2 Drug Development Process
The Food and Drug Administration (FDA) regulates drug development and requires progression
through testing stages to ensure the safety and efficacy of potential drugs.
•
Drug Discovery is the first step in development, and is conducted in order to test a potential
molecule’s effect on a disease target ex vivo (not in a live subject). Once a basic understanding of a
disease is established, scientists will screen thousands of compounds in order to determine one
or several “lead” compounds which seem to have an effect on the disease mechanism and which
warrant testing in vivo (in a live subject).
•
Preclinical Studies are done in animals, to determine the effect of a new molecule on a living
organism. Scientists monitor the drug’s safety in the animal and also monitor its effect on the
target disease, attempting to understand whether the molecule has potential benefit in humans.
Preclinical studies typically take 3–6 years.
•
Phase I Studies typically involve 20–100 healthy volunteers, and are conducted in order to gauge
basic characteristics of a potential new drug in humans: how the drug is absorbed, distributed,
metabolized and excreted, as well as its pharmacokinetics (how long the drug is active in the
body). Phase I studies typically take six months to one year to complete.
•
Phase II Studies typically involve 100–500 volunteers who have the target disease. In this phase,
companies attempt to establish “proof of concept:” that the potential new drug actually has a
beneficial effect on its target disease. Scientists monitor the drug’s effect on the disease as well as
potential side effects, and attempt to determine the appropriate dose for the new drug. Phase II
studies typically take six months to one year to complete.
•
Phase III Studies typically involve 1,000–5,000 sick patients, and are conducted in order to provide
statistically significant proof that the potential new drug is effective against its target disease.
Physicians monitor patients at regular intervals and test for side effects. Phase III trials can take
from one to four years to complete. At the end of Phase III trials, companies will submit a NDA
(New Drug Application) to the FDA in order to gain approval to launch and market the drug
commercially.
•
Phase IV Studies are clinical trials required after the drug has been approved (in this case, drugs are
often said to have received “conditional approval”) in order to provide the FDA with further data
regarding the drug or more long-term evidence of its use. Companies are required to fulfill these
data requirements, but may do so after launching the drug commercially. Studies can range in both
years and expense.
Source: Clinical trials. Retrieved July 22, 2008, from http://en.wikipedia.org/wiki/Clinical_trial.
Esperion: Drano for Your Arteries? 425
drug target is made, the probability of passing through each trial and success-
fully reaching the market is very small. Of the compounds that are chosen to
exit preclinical trials, only 8% will be approved by the FDA (Exhibit 10.3).
The large expenses of drug development, and large risk associated at each
trial stage, represent signi?cant decision points for companies engaging in drug
development. Because of these factors, alliances between healthcare companies
are frequent: small companies with novel compounds often partnered with
larger sales and marketing-focused “big pharma” companies to help defray
development costs and provide a commercial outlet for drugs. In fact, in the
post-bubble year of 2002, biotech companies raised $10.5 billion in ?nancing
from venture capital, IPOs, and other ?nancing mechanisms. However, the bio-
tech sector pulled an additional $7.5 billion through 411 partnering revenues—
representing 42% of all funding for the year and yielding an average of about
$18 million per agreement.
Competition
In 2003, there were three major cholesterol drug makers: Merck which pion-
eered the statin drug category, P?zer, and Bristol-Myers Squibb. P?zer’s Lipitor
had a 46% share of the market, Merck’s Zocor had 32%, Bristol Myers
Squibb’s Pravachol had 13% and the remaining 9% was split among other
statin and nonstatin drugs.
5
The project market for cholesterol drugs for which
these ?rms were vying, a summary of their ?nancials, and their costs of capital
are shown in Exhibits 10.4, 10.5, and 10.6, respectively.
Pfizer
Founded in 1849, P?zer grew to become the world’s largest pharmaceutical
company. The ?rm, based in New York, focused on discovering, developing,
marketing, and delivering medications for both humans and animals. P?zer led
the statin market with Lipitor, the most popular drug in the world. In addition
Exhibit 10.3 Drug Trial Expenses per Approved Compound
R&D Animal Phase I Phase II Phase III TOTAL
Cost ($ billion) 358.0 12.5 42.9 117.8 325.8 857.0
Time (months) 21.6 38.0 56.5 116.1
Success rate 69% 38% 15% 8% (FDA approval)
Source: Joseph Dimasi, Ronald Hansen, and Henry Grabowski, The price of innovation: new estimates of drug
development costs, Journal of Health Economics, 2003. Bain and Co., 2003.
Exhibit 10.4 Total Hypolipemic Market Sales and Expectations
Year 2000 2001 2002 2003E 2004E 2005E 2006E 2007E 2008E 20009E
Revenues
($ million)
13,937 15,830 17,210 19,845 21,990 24,232 25,390 26,725 27,680 29,115
Source: CDC IXIS Securities, Cholesterol: the battle rages on, February 24, 2003
426 Cases
to Lipitor, P?zer’s internal development of a cholesterylester transfer protein
(CETP) inhibitor called Torcetrapib stood to strengthen the company’s hold on
the cardiology market. P?zer focused Phase III studies on the combination of
Lipitor and the new Torcetrapib, based on promising Phase II studies. The
planned Phase III trials would be the largest for any drug of any type. Torce-
trapib was not only one of the most promising drugs in P?zer’s pipeline, but
also within the entire spectrum of CETP-inhibitors.
6
P?zer backed Lipitor and
other drugs with the strongest sales and marketing spending in the industry.
Merck
Merck & Co., Inc. (Merck) was a global pharmaceutical company based in
New Jersey and founded in 1901. It had two statins on the market: Mevacor
and Zocor. Mevacor, launched in 1987, was one of the ?rst statins to be
launched. Mevacor experienced tremendous success, which built high expect-
ations for Merck’s second-generation statin, Zocor and by 2002, Zocor had
replaced sales of Mevacor.
7
Zocor’s popularity made it the top-selling drug for
Merck and the number two cholesterol medication in the world.
8
Historically,
Merck’s drug pipeline created numerous successes for the company across
several treatment categories, but by 2002, several Phase III setbacks called its
pipeline into question. Merck continued to develop promising arthritis and
diabetes drugs in its pipeline, but its cardiovascular pipeline was relatively
weak.
9
The most promising cardiovascular drug was based on a joint venture
between Merck and Schering Plough. They co-developed a combination Zocor–
Exhibit 10.5 2002 Select Pharmaceutical Company Financial Information ($000s)
Sales ($) BMS 18,119 Merck 51,790 Pfizer 32,373
Cogs ($) 6,388 33,054 4,045
Marketing, sales, and admin. ($) 5,218 6,187 10,846
R&D ($) 2,218 2,667 5,176
Other costs ($) 1,648 (331) 510
Total costs($) 15,472 41,577 20,577
Pre-tax income ($) 2,647 10,213 11,796
Taxes ($) 613 3,064 2,609
Net income ($) 2,034 7,149 9,187
Source: Firm 10-Ks.
Exhibit 10.6 Nominal and Real Cost-of-Capital (COC) for the Pharmaceutical Industry,
1985–2000
1985 1990 1994 2000
Nominal COC (%) 16.1 15.1 14.2 15.0
Inflation Rate (%) 5.4 4.5 3.1 3.1
Real COC (%) 10.8 10.6 11.1 11.9
Source: Dimasi, 2003, Tufts Center for the Study of Drug Development.
Esperion: Drano for Your Arteries? 427
Zetia drug that they thought might be more effective than Zocor alone through
attacking cholesterol from different approaches.
10
Bristol-Myers Squibb
Bristol-Myers Squibb (BMS), based in New York, was founded in 1914. In
2002, BMS generated $18.1 billion in revenue, 81% of which came from
pharmaceuticals.
11
BMS is responsible for the third most successful statin in the
world, Pravachol. Pravachol was expected to lose share over the next few years
as its patent expired in 2006.
12
Pravachol was expected to be BMS’s only chol-
esterol drug success, given the company’s poor drug development track record
in recent years. Two new products, Questran and Pravigard Pac, were launched
in 2003, although neither was projected to generate signi?cant revenue. A
cholestyramine, Questran targeted a nonstatin method of cholesterol reduction,
but its market was much smaller than the statins. Pravigard Pac was simply a
combination package of Pravachol and aspirin for patients requiring both
medications.
13
Other Competitors
London-based AstraZeneca launched a new statin in 2003, Crestor. On the
surface, Crestor appeared to face an already saturated market; however, Crestor
also demonstrated that it could be “unquestionably”
14
the most effective statin
on the market, including the wildly successful Lipitor. One analyst projected
that Crestor could own 30% of the cholesterol drug market within seven
years.
15
Such promising potential for Crestor could undermine the current statin
oligopoly and drive current players to seek out new cholesterol treatment
solutions.
In addition to large pharmaceutical companies, over 35 companies were
marketing or developing lipid therapeutics that were in some stage of clinical
trials. It is unknown how many additional companies were researching solu-
tions.
16
Most of the new drug development was centered on increasing the
amount of HDL through a variety of new avenues, rather than lowering LDL
with traditional statins.
Esperion Therapeutics
Company History
Esperion Therapeutics was founded in July 1998 with $16 million in capital
provided by four venture capital ?rms and several undisclosed investors.
17
Based in Ann Arbor, Michigan, the ?rm focused on conducting large molecule
research on cardiovascular drugs with a speci?c emphasis on cholesterol
medication.
The driving force behind Esperion was its President and CEO, Dr. Roger
Newton. At the time of Esperion’s founding, Newton was already a well-
established name in the cardiovascular pharmaceutical industry. Newton was
most famous for his work as a lead scientist at Warner-Lambert, where he was
instrumental in the development of Lipitor.
18
After his experience developing
428 Cases
Lipitor, Newton spurred the founding of Esperion to drive development further
in cholesterol drugs. He was considered one of the leading thinkers in choles-
terol therapy.
Esperion made its ?rst signi?cant move only a month after its founding by
licensing an HDL-raising drug from Pharmacia called ETC-216.
19
The research
behind ETC-216 ?rst appeared in a 30-year old study of a group of rural Italian
villagers with surprisingly long life spans. The research uncovered a genetic
anomaly in the villagers, forming the basis for ETC-216’s development.
20
Once
licensed from Pharmacia, the drug provided the cornerstone for Esperion’s
cholesterol research. The HDL-raising potential of ETC-216 offered a dramatic
departure from the statins that target lowering LDL. Backed by the promise of
ETC-216 and research on similar HDL-raising drugs (e.g. ETC-588 also
showed signi?cant promise), Esperion made an initial public offering in August
of 2000. The company raised $58 million despite never having generated a
single dollar of revenue.
21
Since its founding, Esperion managed to raise $200
million through venture capital and stock offerings.
22
Esperion used the money raised in its IPO to drive forward clinical trials of its
HDL drugs over the next several years. In June 2003, Esperion announced
signi?cant progress in the development of ETC-216. A Phase II clinical study
revealed that ETC-216 successfully reduced the heart plaque in study partici-
pants. Although the study contained only 47 patients, too few for a statistically
meaningful sample, the effectiveness and rapidity of the treatment created a
buzz across the pharmaceutical industry.
23
Furthermore, the reputation of
Newton in the cholesterol industry continued to grow with ETC-216’s success.
Esperion’s stock price reached a 52-week high after the June announcement.
24
Challenges
Despite excitement over ETC-216’s Phase II clinical trials, Esperion faced a
steep uphill battle. Many biopharmaceutical companies with promising early
stage clinical trials had faced serious setbacks in later stages.
25
Esperion would
not be immune to this statistic.
In addition, Esperion was a new biopharmaceutical ?rm and did not have the
capabilities of its larger competitors. It currently had no way of commercial-
izing its therapies, and therefore, had to rely heavily on the money earned from
its IPO as well as venture capital funding to support its clinical trial efforts. If
any of Esperion’s drugs were capable of making it through clinical trials and
earned FDA approval, Esperion did not have the infrastructure to commercial-
ize its product candidates. Esperion would again have to rely on third parties to
successfully bring its new drug to market.
Current Pipeline Portfolio
Esperion’s pipeline of products looked to replace both statin treatments as well
as surgical procedures. According to preliminary results for clinical trials, Espe-
rion’s product candidates were able to raise levels of HDL. This fostered the
removal of plaque from the artery walls as well as its movement to the liver for
expulsion from the body. In addition, there were also signs that the damaged
arteries were able to repair themselves. If Esperion could get one of the four
Esperion: Drano for Your Arteries? 429
products in its pipeline through clinical trials, it could revolutionize the way
doctors treated cardiovascular disease.
•
ETC-216 (AIM): ETC-216 was being developed as an infused treatment for
patients with acute coronary syndrome.
26
The properties of ETC-216
allowed it to mimic naturally-occurring HDL as well as improve HDL’s
function. Initial preclinical studies as well as Phase I and II clinical trials
illustrated positive results for ETC-216 and proved its capabilities. ETC-
216 was now poised for Phase III trials. Esperion hoped ETC-216 would be
a major success in the industry. As of 1999, there were already 47 drugs in
the market with greater than $500 million in US sales.
27
•
ETC-588 (LUV): ETC-588 was also being developed as an infused treat-
ment for acute coronary syndromes.
28
When introduced in the human
bloodstream, the biopharmaceutical served as a “sponge” for cholesterol.
Preclinical animal studies showed that ETC-588 did remove cholesterol
from the arteries and helped arteries regain their ?exibility and function.
ETC-588 was beginning Phase II trials.
•
ETC-642 (RLT Peptide): Esperion continued to develop RLT Peptide for
the treatment of acute coronary syndromes.
29
ETC-642 had similar bio-
logical properties to ETC-216 and ETC-588 in mimicking HDL, preventing
the accumulation of cholesterol on the artery walls. The completion of
Phase I trials in the ?rst half of 2002 indicated that RLT Peptide was safe
and well-tolerated and several different dose levels. The trials also illus-
trated evidence of rapid cholesterol mobilization and increased HDL-
cholesterol levels.
•
ETC-1001 (HDL Elevating/Lipid Regulating Agents): Esperion was “pur-
suing the discovery and development of oral small organic molecules that
could increase HDL-C levels and/or enhance the RLT pathway.”
30
Pre-
clinical studies not only showed an increase in HDL-C molecules in ani-
mals, but also suggested that these molecules might also have “anti-diabetic
and anti-obesity properties.” Esperion hoped to ?le an NDA for ETC-1001
and begin Phase I clinical trials in 2003.
Pfizer Inc. Company Background
Strategic Overview
P?zer fueled its growth in research and products in three primary ways: internal
R&D, mergers and acquisitions, and agreements and alliances. Given this struc-
ture, P?zer had hundreds of subsidiaries throughout the world. Despite pres-
sures to develop drugs at a faster rate than witnessed in recent years, the indus-
try had experienced a signi?cant reduction in M&A activity, from $23 billion in
the ?rst half of 2001 to just $3 billion in the second half of 2002. When con-
sidering transactions, buyers were becoming more cautious, and started relying
more heavily on licensing deals.
31
The actions of P?zer proved to be exceptions
to this rule, as the ?rm undertook two signi?cant mergers: Warner–Lambert in
2000 (the largest hostile takeover ever) and Pharmacia in 2003. Placing pres-
sure on competitive ?rms to consolidate, P?zer boasted the industry’s largest
pharmaceutical R&D organization with a library of more than 700 major
430 Cases
active collaborations and a 2003 R&D budget of $7.1 billion.
32
P?zer’s pipeline
acceleration strategy was expressed through the comments of Dr LaMattina,
president of P?zer Global Research and Development:
P?zer’s strength is its ability to maximize opportunities from our internal
programs and through partnerships. Our scale and R&D breadth are obvi-
ous advantages that we secure with very strict attention to our goals. Some
of our competitors believe the term ‘research management’ is an oxymoron,
but we don’t think so at P?zer. True, it’s hard to predict when discoveries
will occur. The process can be managed to maximize the chances of dis-
coveries happening . . . Before we closed the acquisition of Pharmacia, we
conducted extensive due diligence and understood the value of the pipeline,
and the way it complemented the R&D efforts under way at P?zer. There
were very few surprises and we have retained the great majority of
projects.
33
Proper management of acquisitions, combined with links to more than 250
partners in academia and industry, strengthened P?zer’s position on the cutting
edge of science by providing access to novel R&D tools and key data on emer-
ging trends.
Marketing
Capitalizing on the US Food and Drug Administration’s 1997 decision to
loosen restrictions on consumer advertising of prescription medications, P?zer
recruited a new senior media director in 1999 to establish P?zer’s ?rst consumer
media unit and form a company approach on how to use the ?edgling direct-to-
consumer (DTC) medium.
34
Two years later, P?zer was regarded as being in the
front tier in DTC brand building with hits such as Zyrtec and Viagra. By using
consumer ads to drive sales of prescription drugs, P?zer became a major player
in the annual TV upfront season. Over the ?rst six months of 2001, P?zer
became the second largest DTC spender with about $76 million.
35
Manufacturing and Distribution
For decades, the manufacturing component of the pharmaceutical industry had
been highly inef?cient with manufacturing expenses accounting for 36% of the
industry’s costs. The top 16 drug companies spent $90 billion on manufactur-
ing in 2001.
36
With inef?ciencies resulting in lower quality and product recalls,
the FDA updated its manufacturing regulations for the ?rst time in 25 years in
2003. In response, P?zer applied funding towards manufacturing research and
developed a fast and accurate new way to test drugs. This technology was being
tested in few of P?zer’s plants around the world.
P?zer had the distribution capability to launch a product simultaneously in
dozens of markets around the world. As of 2000, P?zer’s US sales force con-
sisted of 5,400 representatives in nine divisions. P?zer’s rigorous training and
ongoing education programs were unmatched in the industry, yielding best-in-
class sales representatives who consistently communicated advances in the
understanding and treatment of diseases to millions of health-care providers.
37
Esperion: Drano for Your Arteries? 431
In 2002, P?zer’s pharmaceutical sales organization was placed ?rst overall in a
survey of US physicians in nine core specialty groups for the seventh consecutive
year.
38
Pfizer and the Cholesterol Drug Market
P?zer obtained the rights to the blockbuster drug atorvastatin (Lipitor) after the
acquisition of Warner–Lambert in 2000. Prior to the acquisition, P?zer had
entered into a marketing agreement with Warner–Lambert to help successfully
launch the drug in 1996.
Warner–Lambert faced a number of setbacks in bringing Lipitor to market.
The ?rm had recently dealt with a series of drug recalls of some of its major
products. Furthermore, Warner-Lambert’s sales force was much smaller in size
relative to its competitors with established cholesterol drugs already in the mar-
ket. Given these circumstances, the ?rm signed a comarketing alliance with
P?zer. P?zer agreed to cover a signi?cant portion of the upfront expenses of
launching Lipitor as well as use its extensive networks of sales representatives to
bring the drug to market.
39
In exchange, P?zer would receive payments based
on Lipitor’s sales targets.
On November 5, 1999, American Home Products Corporation announced a
$70 billion dollar merger agreement with Warner-Lambert. Such a deal left a
great amount of uncertainty regarding the future status of marketing rights to
Lipitor and the alliance between P?zer and Warner-Lambert. Lipitor’s billions
in sales represented a large portion of P?zer’s drug sales portfolio. Therefore,
before the comarketing alliance came to an end, P?zer placed its own hostile bid
of $82.4 billion for Warner-Lambert. The two companies eventually merged in
2000, giving P?zer full rights to Lipitor.
40
With Lipitor secured as a P?zer prod-
uct and Torcetrapib entering Phase III trials, P?zer was poised to strengthen its
hold on the cholesterol drug market.
Pfizer’s Offer
In November 2003, Esperion published the of?cial results of its ETC-216 study
in the Journal of the American Medical Association. The article indicated that
its drug reduced build-up of fatty plaque in arteries by over 4% in patients who
were given weekly injections of the experimental medicine over a course of only
?ve weeks during the Phase II trial.
41
According to John LaMattina, director of
research at P?zer, ETC-216 would have to be tested on “hundreds, possibly
thousands (of people), and would have to be shown to signi?cantly reduce the
risk of a second heart attack” before the Food and Drug Administration would
approve it. This type of clinical trial would require a signi?cant investment.
42
After the trial results appeared in the Journal of the American Medical
Association, Newton publicly announced that the company would be looking
for a partner to develop and market the drug. P?zer acquired ?rst bidding rights
to co-develop and commercialize ETC-216 through its acquisition of
Pharmacia.
43
On December 21, 2003, P?zer announced its intent to purchase Esperion
Therapeutics for $1.3 billion. P?zer made an all-cash tender offer to acquire
shares of Esperion’s common stock at $35 per share.
44
This price represented a
432 Cases
54% premium over Esperion’s average closing share price over the 20 trading
days prior to the acquisition.
45
At the time of the offer, Newton owned 890,000
shares of Esperion stock.
The Decision
Newton had to decide if Esperion would bene?t from a buyout by a major
pharmaceutical company. Dr Newton knew that his company faced an uphill
battle with the continued development of ETC-216. Phase III trials would prove
incredibly expensive for Esperion and they would again have to look to venture
capital funding and potential stock offerings for additional cash. Dr Newton
knew that despite positive Phase II results, Phase III results could always be
negative and ETC-216 might never make it to FDA approval. If, however, the
ETC-216 Phase III trials proved successful, Esperion would have to look for a
partner to help launch and commercialize the product.
Dr Newton had a lot to consider. He had started Esperion so that he could
create an entrepreneurial environment for drug discovery, in which the scien-
tists received the rewards for their research. If he sold out to P?zer, would he be
giving up everything he had worked so hard to create? Would Esperion be able
to maintain the entrepreneurial identity that had brought about the discovery of
a new line of cardiovascular pharmaceuticals? Would Newton be giving up
control over the development of ETC-216 and the other promising drugs in
Esperion’s pipeline? In addition, how would his employees react to working for
a major pharmaceutical company?
Dr Newton had to decide whether Esperion’s future laid as an independent
biotech company, a wholly-owned subsidiary, or an integrated part of “big
pharma.”
Esperion: Drano for Your Arteries? 433
Xbox 360: Will the Second Time be
Better?*
In early 2006, Sony, Microsoft, and Nintendo were battling for supremacy in
the $30 billion videogames industry, with each ?rm claiming victory. Who was
right? Why?
Creation and Growth of the Home Video Game
Console Market (1968–1995)
1
Ralph Baer, the man who would come to be known as the father of the video
game, created a prototype home video game unit capable of playing 12 games in
1968. This prototype was inspired by a project Baer was working on for the US
military to design a system that could help improve soldier re?exes. The mili-
tary project eventually ?zzled but Baer continued development with an eye
towards the US consumer market. It wasn’t until 1972 that Magnavox intro-
duced Baer’s “Brown Box” as the ?rst home video game system—commercially
titled Magnavox Odyssey. Odyssey enjoyed mild commercial success, selling
200,000 units between 1972 and 1975.
Video game mania truly swept the USA in 1975 when an agreement between
Sears Roebuck & Co. and Atari led to production of a home version of Atari’s
wildly successful coin-operated arcade game “Pong.” This helped bring Atari to
the forefront of the newly-emerging home video game console industry. In
1977, Atari released Atari 2600, the ?rst programmable home console.
Incorporating an 8-bit Motorola 6507 microprocessor and 256 bytes of RAM,
the 2600 was on the market through 1990 and sold more than 25 million units.
Over 40 different manufacturers produced 200-plus game titles for the system,
and total sales volume reached 120 million cartridges.
In the mid-1980s, Nintendo quickly displaced Atari as the market leader
following the 1985 launch of its 8-bit Nintendo Entertainment System (NES).
The smash hit Super Mario Brothers and other game titles helped catapult
Nintendo to the top of the console industry by the end of the 1980s. In 1989
Sega introduced the ?rst 16-bit console, Sega Genesis. This was Nintendo’s ?rst
serious threat. The Genesis had improved graphics, faster processing speeds,
and the popular Sonic the Hedgehog video game was released on it in 1992. To
* This case was prepared by Katy Chai, Victor Colombo, Elizabeth Huntley, Ian Mackenzie,
Justin Manly, and Tatsuyoshi Matsuura under the supervision of Professor Allan Afuah as a
basis for class discussion and is not intended to illustrate either effective or ineffective handling
of a business situation.
Case 11
compete with Genesis, Nintendo launched its own 16-bit console, Super NES,
in 1992. Super NES was a huge success; over the course of its product life,
upwards of 46 million units were sold worldwide, re-establishing Nintendo as
the console market leader. Sega, following two failed attempts to introduce new
consoles (Saturn in 1995 and Dreamcast in 1999), exited the console industry in
2001 to focus strictly on video game development.
In June 1996, Nintendo released the Nintendo 64 (N64) in Japan to compete
with Sega’s Saturn and Sony’s PlayStation, both of which had been launched in
1995. However, N64 continued to use cartridge media, while its competitors
had moved to CD-based consoles. The largest N64 titles consisted of approxi-
mately 32 megabytes while PlayStation and Saturn games used 650–700 MB
CDs. This discrepancy put N64 at a signi?cant disadvantage because its games
were limited in terms of complexity and graphics, especially for role-playing
games which were becoming increasingly popular with consumers. Nintendo
attempted to attract users with extraordinary titles such as the Super Mario
Brothers series, but in 1997 Nintendo’s major software developer, Square Enix,
moved its legendary Final Fantasy franchise to PlayStation. The success of the
new Final Fantasy VII elevated PlayStation’s market position and helped pave
the way for Sony’s dominance of the video game industry.
A New Competitor Emerges—Sony’s PlayStation
During the 1970s and 1980s, Sony grew into one of the world’s most successful
and innovative consumer electronics companies. In the 1980s, Sony focused its
resources on developing game software for Nintendo but faced sluggish growth
in this area. Seeking additional opportunities in the video game business, Sony
entered into a development partnership with the then-market-leader Nintendo
to supply sound chips for Nintendo’s home video game console. However, this
represented a very limited opportunity for Sony in the rapidly-growing video
game industry.
In 1986, Nintendo and Sony worked together to develop a CD-ROM add-on
for Nintendo’s console to take advantage of the substantial data capacity of CD
media. The game cartridge had been the primary media for Nintendo’s game
systems, but the increasingly complex game content was beginning to drive up
cartridge manufacturing costs. In addition, NEC and Sega had both introduced
CD-ROM-based consoles to the market. Sony and Nintendo ultimately aban-
doned their joint CD peripheral which Sony had reportedly completed in proto-
type form.
2
Nintendo then announced a new partnership with Philips to
develop improved CD-ROM technology in June 1991. In response to this new
relationship with a Sony competitor, Sony discontinued supplying sound chips
to Nintendo and in 1993 began development of its own CD-ROM-based video
game console. Code named “PS-X,” the project was the origin of the ?rst gen-
eration Sony PlayStation. In the fall of 1993, the ownership of the project was
transferred to the Sony Computer Entertainment, Inc., a newly-formed division
within Sony comprised of approximately 60 members from Sony, Inc. and Sony
Music Entertainment, Inc.
Xbox 360: Will the Second Time be Better? 435
PlayStation (PS1) Launch
PlayStation was released in Japan at the suggested retail price of JPY39,800
(approximately $395) on December 3, 1994. This launch date (12/3) was
advertised extensively with the “1! 2! 3!” countdown promotional campaign.
Unique ads such as this helped Sony quickly sell out of the 100,000 consoles
that were initially shipped to stores. Sega had launched its Saturn a month
earlier, in November, but critics heralded PlayStation as the superior machine.
3
PlayStation was introduced in North America on September 5, 1995 at the
suggested retail price of $299, a full $100 less than analysts had expected.
4
Over
100,000 units were sold in the ?rst weekend and over a million units sold over
the ?rst six months. Sony released game titles in nearly every genre, including
Battle Arena Toshinden, Twisted Metal, Warhawk, Philosoma, Wipeout and
Ridge Racer. PlayStation quickly became the bestselling home video game con-
sole to-date, only to be surpassed by its successor, PlayStation 2.
PlayStation 2 (PS2) Launch
In September 1999, Sony announced the introduction of its PlayStation 2 and
associated pricing to the public. Most major software manufacturers decided
early on to develop games for PS2, resulting in mass media predictions of a
Sony-dominated game market. In February 2000, Sony began accepting preor-
ders for PS2 on PlayStation.com. Initial orders via the website set sales records
for the game industry and the site was quickly overwhelmed by heavy traf?c.
PS2 was released for sale on March 4, 2000 in Japan and on October 26, 2000
in North America. It sold well from the beginning (over 900,000 in Japan in the
?rst weekend alone), partly due to the strength of the PlayStation brand and its
backwards compatibility with PS1. This allowed Sony to tap in to the large
installed base of PS1 customers, games, and developers. In 2001, the launches
of Microsoft’s Xbox and Nintendo’s Game Cube increased competition in the
industry, but Sony’s release of several best-selling and critically-acclaimed game
titles helped PS2 to continue its market dominance. These titles included the
ever-popular Final Fantasy and Grand Theft Auto series. In several cases, Sony
struck exclusive deals with publishers to further strengthen its position.
Competition Heats Up
Microsoft of?cially announced the introduction of its Xbox on March 10, 2000
and released the console to consumers on November 15, 2001.
5
By late 2001,
the video game console industry had become highly competitive as Sony, Nin-
tendo, and Microsoft all offered extremely popular and attractive units.
Price Wars
One of the ways this competition manifested itself was through pricing. The
PS2 was launched in October 2000 at a retail price of $299. When the Xbox
was launched 13 months later, in November 2001, Microsoft matched the PS2’s
price despite the fact that this meant that the Xbox was estimated to be losing
$150 per unit. But Microsoft priced the Xbox below its production cost to gain
436 Cases
market share quickly. Sony responded by slashing PS2 prices by $100 six
months later, a move which Microsoft immediately followed for the Xbox.
Thus, Sony enjoyed 19 total months of selling PS2 at the original $299 retail
price while Microsoft was able to sell Xbox at this same price for only 6
months.
6
Price cuts in May became an annual event. In May 2003, both Sony and
Microsoft again cut their prices, this time by only $20 to bring their suggested
retail prices to $179. In May 2004, prices fell again, this time to $149. In
November of that year, Sony launched a thinner version of PS2 known as Slim,
then dropped the price one last time to $129 in May 2006, six months after the
release of Xbox 360, and six months prior to the release of PS2’s successor,
PlayStation 3. Xbox’s price remained at $149.
Game Franchises and Online Play
The wildly popular Halo franchise was launched simultaneously with the
Xbox, and was followed by such hits as Project Gotham Racing and Dead or
Alive. However, PS2, by virtue of its earlier launch date and preexisting fran-
chises from PS1, controlled a number of key game series, including premier
sporting titles from Electronic Arts such as Madden and NBA Live, as well as
Metal Gear Solid and Grand Theft Auto.
A defensive tactic that Sony employed just prior to the Xbox’s launch was to
negotiate a period of exclusivity with game developers, usually lasting 6–12
months, during which a new title would only be available on PS2. This, com-
bined with disappointing reviews of a few early Xbox-speci?c titles, served to
dampen the initial demand for Xbox.
Further complicating matters was the fact that, despite Xbox offering signi?-
cantly more processing power than PS2, many of the initial games developed for
Xbox did not take advantage of this capability. Thus, while Microsoft touted
the superior performance offered by their machine, this power was not readily
apparent to gamers.
The release of Xbox Live in late 2002 gave Microsoft a head start in the realm
of online gaming. This broadband service initially allowed gamers around the
world to compete head-to-head over the Internet just as if they were sitting
together playing on the same console. Xbox Live also included the ability to
download new games, hardware updates, and other content. Although the ser-
vice initially grew relatively slowly, within two years of launch Microsoft
reported having enrolled over one million subscribers. The service was seen as
especially compelling for many of Xbox’s hardcore gamers, and would become
a standard offering among the next generation of consoles. An Xbox Live Gold
subscription costs $50 a year.
7
The year 2004 saw Xbox hit a home run with the release of Halo 2, which set
a record by exceeding $125 million in sales on its ?rst day. The launch received
heavy national news coverage with stories of the thousands of loyal Xbox users
calling in sick on the release date to wait in line, purchase the game, and then
devote the entire day to mastering it.
8
Xbox 360: Will the Second Time be Better? 437
Xbox 360
Microsoft’s next-generation console, the Xbox 360, was released in November
2005, a year ahead of rivals. In that ?rst holiday season, signi?cant shortages of
the unit occurred. By its second holiday season in 2006, units were readily
available and the release of the new ?agship game Gears of War rejuvenated
demand. The company had yet to make money from video games since entering
the market in 2001 (Exhibit 11.1); but there was a lot of optimism about sales
of Xbox 360 (Exhibit 11.2).
The graphics of the Xbox 360 were signi?cantly better than that of second-
generation consoles and, at launch time, was touted as the most graphically-
advanced system on the market. Xbox 360 featured cutting-edge hardware,
including a 733 MHz Intel processor and a 233 MHz nVidia graphics processor
Exhibit 11.1 Microsoft’s Financials ($US millions, except where indicated)
Financial highlights (In millions) 2006 2005 2004 2003 2002
Fiscal year ended June 30
Revenue ($) 44,282 39,788 36,835 32,187 28,365
Operating income ($) 16,472 14,561 19,034 l9,545 8,272
Net income ($) 12,599 12,254 l8,168 l7,531 5,355
Cash and short-term
investments ($)
34,161 37,751 60,592 49,048 38,652
Total assets ($) 69,597 70,815 94,368 81,732 69,910
Long-term obligations ($) 7,051 5,823 4,574 2,846 2,722
Stockholders’ equity ($) 40,104 48,115 74,825 64,912 54,842
Home and entertainment division 2006 2005 2004 % %
(In millions, except percentages) Change 2006
versus 2005
Change 2005
versus 2004
Revenue $4,256 $3,140 $2,737 36% 15%
Operating loss $(1,262) $(3,485) $(1,337) ?160% 64%
Exhibit 11.2 Xbox 360 Sales Projections
2006 2007 2008 2009 2010
Console sales (millions) 1.5 8.5 10.0 10.0 5.0
Cumulative console sales (millions) 1.5 10.0 20.0 30.0 35.0
Console production cost ($) 525 323 323 323 323
Console MSRP ($) 399 399 399 399 399
Estimated wholesale price 279.3 279.3 279.3 279.3 279.3
Notes:
1 $4 million development costs, estimated at double that of previous generation system.
2 Console sale projections through 2007 are based on Microsoft projections. Sales growth beyond 2007 is estimated
using previous generation sales figures.
3 Second-year cost reductions estimated at 38%—the same level realized by Microsoft with the Xbox 360.
4 Changes in MSRP based on price change history of previous generation console.
5 Estimated at 70% of MSRP.
438 Cases
capable of producing even more realistic graphics than previous machines. Not
surprisingly, the system also incorporated a Windows-based operating system
which Microsoft claimed simpli?ed game development for developers.
Xbox 360 users (as well as users of the original Xbox) also had access to the
Xbox Live online gaming community. Over four million subscribers could
download games, compete and chat with friends, and buy maps and weapons.
In addition to subscriptions, the service generated revenues through advertising
and additional content sales. Microsoft expected Xbox Live members to exceed
six million worldwide by June 2007.
Microsoft planned to release a game development kit for amateur game
developers. The kit was expected to cost about $100 and allow developers to
create shorter, less graphically advanced games. These games would then be
made available on Xbox Live.
On the one-year anniversary of Xbox 360’s initial release, Microsoft
announced the additional capability of downloading movies and television
shows. Microsoft also added an HD-DVD unit to the list of accessories
available for Xbox 360. The average consumer could not yet take advantage of
Blu-Ray capabilities and was unable to discern differences in quality between
Blu-Ray and HD-DVD technologies. The HD-DVD addition was cheaper
than Blu-Ray. Xbox 360 could play music stored on an iPod or a Zune while
PS3 could only play music stored on the PlayStation Portable that was not
widely used in 2006.
Sony PlayStation 3 (PS3)
Sony launched its Play Station 3 (PS3) on Friday, November 17, 2006 in the
USA. With only 400,000 units available in the US and two million worldwide,
demand far exceeded supply. On opening day, it was reported that long lines of
customers got rowdy, with police having to disperse some crowds, a stampede
occurring at one store, and a shooting at another. Retail analysts suggested that
the actual number of units available to US consumers was only 150,000 on
launch day. Limited supply prompted many pro?teers to sell their units on
eBay. Analysts were optimistic about PS3 sales (Exhibit 11.3).
The PS3’s technology was proprietary. It was generally viewed as the most
advanced video game console on the market in terms of processing power as
well as graphics. PS3 came standard with the “Cell” processor, Blu-Ray DVD
player, and high-capacity hard drive. While the Blu-Ray DVD format could
store more data than Xbox 360’s HDD DVD, as of 2006, HDD DVD manu-
facturing costs were signi?cantly lower for both prerecorded as well as blank
Exhibit 11.3 Playstation 3 Sales Projections
2006 2007 2008 2009 2010
Console sales (millions) 2.0 11.3 13.3 13.3 6.7
Cumulative console sales (millions) 2.0 13.3 26.6 39.9 46.6
Console production cost ($) 806 496 496 496 496
Console MSRP ($) 499 399 399 399 299
Estimated wholesale price ($) 349.3 279.3 279.3 279.3 209.3
Xbox 360: Will the Second Time be Better? 439
recordable media. Blu-Ray was the format championed by Dell, while Toshiba,
NEC, and Intel all favored HDD DVD. Movie studios were also divided in their
support of the two technologies.
Like the Xbox 360, the PS3 could also serve as an entertainment delivery
system since users could watch HD movies, listen to music, view HD photos,
and search the Internet in addition to playing video games. PS3 allowed up to
seven wireless controllers and included a browser, built-in Wi-Fi, and supported
Bluetooth wireless earpieces. It also permitted additional operating systems to
be added, including Linux.
All of these advancements, however, delayed PS3’s launch by several months,
and resulted in a high price for consumers. Furthermore, the Blu-Ray DVD
player only bene?ted users with advanced television sets. These advancements
also increased the PS3’s complexity. Sony also added motion-sensitivity to the
PS3 controller in an effort to heighten the level of realism in play. Some obser-
vers wondered if Sony’s gaming division, once a cash cow for the company,
would start delivering again (Exhibit 11.4).
Nintendo Wii
Nintendo launched its latest game console, Wii, in November 2006. Retail
analysts predicted that 450,000 of those units would be available to US shop-
pers, more than double the quantity of PS3s available. Still, on November 19
when Wii debuted in US stores, it quickly sold out. Some customers camped
overnight to await the arrival of Wii.
Nintendo took a radically different approach to gaming than the visually
advanced, high-de?nition graphics of Xbox 360 and PS3. Nintendo was betting
that many consumers were not technologically savvy and therefore did not care
for the newest, fastest technology that PS3 offered. Additionally, with advances
in technology, games had become increasingly complex and time-consuming,
resulting in a small, albeit dedicated, customer base of avid gamers. Nintendo
Exhibit 11.4 Sony’s Summary Financials ($US millions, except where indicated)
Financial highlights 2006 2005 2004
Fiscal year ended March 31
Revenue ($) 163,541 66,584 71,216
Operating income ($) 1,626 1,059 940
Net income 1,051 1,524 841
Cash and short-term investments 10,541 11,539 10,722
Total assets 90,166 l88,342 86,361
Long-term obligations $ 35,731 35,520 35,439
Stockholders’ equity $ 27,233 26,694 22,591
Gaming division 2006 2005 2004 % %
(In millions, except percentages) Change 2006
versus 2005
Change 2005
versus 2004
Revenue ($) 8,125 6,185 6,569 31% ?6%
Operating income ($) 74 365 572 ?80% ?36%
440 Cases
believed that focusing only on these existing avid gamers limited growth
opportunities. Instead, with the Wii, Nintendo hoped to attract “gamers and
nongamers alike with intuitive game play.”
9
Additionally, games were simpler
and could be completed in less time. Nintendo expected this strategy to attract
new customers to the gaming market.
A key aspect of the Wii was its controller. Rather than the traditional compli-
cated controllers that required knowledge of each buttons’ purpose, Wii used a
wand-like controller that translated the movement of the player to the screen.
Gamers could, depending on the game, wave the controller around in the air,
using it as a tennis racket, golf club, steering wheel, gun, or sword.
The Wii lacked high-de?nition graphics and a DVD player. “Nintendo’s
stated goal is to hook people with the lure of the wireless controllers, low price
and a small, cute main unit that will ?t easily in most entertainment centers.”
10
The Wii could also display news and weather information from the Internet.
“Old games from Nintendo’s back catalogue could be downloaded to draw in
lapsed gamers.”
11
Of?cials of all three ?rms were optimistic about their chances. Who was right
to be optimistic and why? Exhibit 11.5 provides more information about
games.
Exhibit 11.5 Game Sales Information
Game sales
Percent of inhouse titles 50%
Inhouse title profit margin 70%
Third-party title profit margin 13%
Game attach rates
Playstation 3—launch 1.5
Xbox 360—launch 4.0
Xbox 360—one year 5.2
Wii—launch 3.0
Note: ongoing attach rates are typically one game per year after first year.
Source: GameStop Report, 11/2006. Deutsche Bank Game Sector Update,
August 18, 2005.
Xbox 360: Will the Second Time be Better? 441
Nintendo Wii: A Game-changing
Move
The Microsoft investor could not believe the news. Seven years after entering
the video game console business, Microsoft was still losing money in its video
game business. Its Xbox, launched in 2001, had lost billions, and the sophisti-
cated Xbox 360 did not appear to be making much money. Sony’s even more
sophisticated PS3 was also losing money. In contrast, demand for the Nintendo
Wii had been so strong during the 2007 Christmas season that Nintendo had
been forced to issue rain checks to customers. In fact, it was not unusual for
eager Wii customers to pay prices well above Nintendo’s suggested retail price
of $249 in live online auctions. Why had the Nintendo Wii performed so well?
Why had Microsoft done so poorly in video games? Why had Sony started
doing so poorly following its initial success in video games? The Microsoft
investor wondered if Microsoft had learned from the Nintendo Wii.
Competing for Gamers: The Early Years
Although the invention of the video game may date to as far back as 1947 with
the patenting of a “Cathode Ray Tube Amusement Device”
1
by Thomas T.
Goldsmith Jr and Estle Ray Mann, Atari is usually credited with introducing the
?rst successful video game to the home. In 1975 it offered a dedicated home
version of its popular arcade Pong called the Sears Tele-Game System and
150,000 units of it sold that Christmas.
2
Many other ?rms entered the home
video game console business but Atari reigned until Nintendo introduced its
Nintendo Entertainment System—a so-called third generation system—in
1985. Nintendo’s leadership position would be challenged by Sega when it
introduced its Sega Mega Drive (called the Sega Genesis in the USA) in 1989.
The Sega Genesis was a so-called fourth-generation console. Although Nin-
tendo fought back, Sega would emerge as the new leader until Sony’s entry.
The Market that Wii Would Face
The Products
Sony entered the home video game business by introducing the Playstation in
Japan in 1994 and in the USA in 1995. Sega and Nintendo fought back but
Sony emerged as the winner. Sony’s success would attract Microsoft, which
introduced the Xbox in 2001, one year after Sony introduced the Playstation 2.
The world’s number one software company was rumored to have spent $2
Case 12
billion to develop the Xbox and another $500 million to market it. In 2001
when the Xbox was introduced, Microsoft of?cials knew that they were going
to lose money on each console but hoped to make up for the losses with soft-
ware (game) sales. It was expected that each Xbox customer would buy three
games in his/her ?rst year of owning an Xbox console, and buy one game per
year thereafter. Exhibit 12.1 shows Xbox forecasted sales, costs, and prices
when it was launched. In November 2005, barely four years after introducing
the Xbox, Microsoft introduced the Xbox 360 in the US market. One year later,
Sony introduced the Playstation 3.
Riding the Technological Progress Envelope
The microchip technological revolution that put a cell phone in most hands, a
computer on many laps and desks, an ATM at most corners, etc., and that gave
us the iPod, iPhone, Blackberry, etc., was the same technology that drove the
video game industry. Microchip technology pushed the technology envelope
and video console makers exploited the frontier. Each new generation of con-
soles was driven by a new generation of faster microprocessors and graphic
processors with even more graphical detail. For example, the Xbox was
powered by an Intel microprocessor that ran at 733 megahertz and graphics
processor that delivered about 300 million polygons per second, more than
three times the graphics performance of the Playstation 2, the previous gener-
ation console that Microsoft hoped to displaced.
3
The Xbox 360, which Micro-
soft introduced four years after the Xbox, used a 3.2-gigahertz processor, an
order of magnitude faster than the Xbox while delivering 500 million polygons.
The PS3 also used a 3.2-gigahertz processor and the ?rm’s new much-touted
Blu-Ray DVD technology.
These advances in technological innovation also created more options for
software (game) developers to design games for each generation of consoles that
were even more lifelike and appealing to core gamers than those designed for
previous generations. However, in tracking the technology frontier, console
makers incurred very high console costs. Console makers had to develop cus-
tom chips dedicated to their consoles or use the fastest and best chips available
in the market. The result was that each console cost so much that its maker sold
it at a loss, and hoped to make money from the royalties collected on software
sales and from selling accessories.
Exhibit 12.1 Xbox 2001 Forecast Sales, Costs, and Prices
FY2002 FY2003 FY2004 FY2005 FY2006
Console forecasted sales (# of Xbox units) 4 10 11 12 13
Retail price per console ($) 299 249 249 249 199
Wholesale price ($) 209 174 174 174 139
Production cost 350 300 250 250 250
Retail price per game unit sold ($) 49 49 49 49 49
Production cost of each game unit ($) 36 36 36 36 36
Source: Microsoft forecasts and analysts estimates.
Nintendo Wii: A Game-changing Move 443
Effectively, each new generation of consoles delivered outstanding techno-
logical performance, images that were more lifelike than those from previous
generations, and appealed to core gamers. Each new generation was also more
complex than previous generations and many games took hours, if not days, to
play. Virtual violence also became more common with each generation. More-
over, playing many of these games required players to master complicated com-
binations of buttons on each console’s complex controls, and lots of gaming
know-how and expertise.
4
Each new generation of consoles rendered the previ-
ous generation technologically obsolete and out of style as far as core gamers
were concerned. Additionally, most games developed for new consoles often
rendered previous games obsolete. The product cycle time—the time from when
the ?rst product in a new generation was introduced to the time when the ?rst
product in the next generation was introduced—was also decreasing.
The Wii
Nintendo introduced its Wii video console in the Americas on November 19,
2006, only about a week after Sony had introduced its PS3 console on Novem-
ber 11, but one year after Microsoft had introduced its Xbox 360. The Wii had
a simpler design than the Xbox 360 and PS3 to appeal to the casual or lapsed
gamer, or noncore gamers who had neither the time (hours or days) to dedicate
to a game, nor the expertise to handle the complexity of existing console con-
trols and games.
5
It had easy-to-use controls and its games sought to offer real-
life, rather than escapist scenarios. According to Jeffrey M. O’Brien of Fortune,
the Wii differed from the Xbox 360 and PS3 in other ways:
Nintendo used off-the-shelf parts from numerous suppliers. Sony co-
developed the PS3’s screaming-fast 3.2-gigahertz “cell” chip and does the
manufacturing in its own facilities. Nintendo bought its 729-megahertz
chip at Kmart. (Not really. But it might as well have.) Its graphics are
marginally better than the PS2 and the original Xbox, but they pale next to
the PS3 and Xbox 360. Taking this route enabled the company to introduce
the Wii at $250 in the U.S. (vs. $599 for the PS3 and as much as $399 for
the 360) and still turn a pro?t on every unit.
6
The Wii also had no hard disk, no DVD, and no Dolby 5.1. Its video RAM was
24 MB compared to 256 MB for the PS3 and up to 512 MB for the Xbox 360.
However, the Wii had some innovative features that its high-tech competitors
did not.
7
It had a remote (motion) wand-like control that resembled a TV
remote control compared to the complex button-strewn controller carried by
the PS3 and Xbox 360.
8
The wand-like control enabled a gamer’s movements
and actions to be directly mapped into the video game. For example, to swing a
tennis racket or golf club, the player literally swung the remote controller as if it
were a racket or club. The swing would be remotely detected by the Wii proces-
sor and the player would get some exercise and more of a sense of playing tennis
or golf from the swing. Contrast this with having to be adept and knowledge-
able enough to hit the right complicated combination of buttons on the PS3 or
Xbox 360’s control at the right time. The other distinguishing feature was the
Mii. A Mii was a digital character that a player could create on the Wii. Once a
444 Cases
character had been so created, it could be used as participating characters in
subsequent games. It allowed players to capture different personalities and cari-
catures including their own. According to Saturo Iwata, president of Nintendo
when the Wii was introduced, the idea for the control and shorter simpler
games had been developed and tested on Nintendo’s handheld device called the
Nintendo DS. The Wii was also connectible to the DS so that the latter could be
used as the input to the former.
Beyond the remote control stick and the Mii, the Wii had other features such
as backward compatibility with all of?cial GameCube software, and the Wii-
Connect24 which enabled the Wii to receive information such as news and
weather over the Internet while in standby mode.
Despite the initial success of the Wii, some incumbents did not see it as much
of a threat to Sony and Microsoft. Remarks such as the following from Sony
Computer Entertainment of America’s Jack Tretton, were not uncommon:
9
You have to give Nintendo credit for what they’ve accomplished . . . But if
you look at the industry, any industry, it doesn’t typically go backwards
technologically. The controller is innovative, but the Wii is basically a
repurposed GameCube. If you’ve built your console on an innovative con-
troller, you have to ask yourself, Is that long term?
10
The Microsoft investor wondered how long the Wii would continue to do well.
Should he have invested in Nintendo instead of Microsoft? Why hadn’t Micro-
soft followed a Nintendo-type strategy when it entered the video game console
market in 2001? Was it too late to follow a Wii-type strategy?
The estimated costs, wholesale prices, and suggested retail prices for the Wii,
Xbox 360, and PS3 are shown in Exhibit 12.2, while the forecasted number of
units are shown in Exhibit 12.3. The exhibit is reproduced from Chapter 1.
Exhibit 12.2 Costs, Retail, and Wholesale Prices
First year After first year
Product Year
introduced
Cost ($) Suggested retail
price ($)
Wholesale
price ($)
Cost Suggested
retail price ($)
Wholesale
price ($)
Xbox 360 2005 525 399 280 323 399 280
Sony PS3 2006 806 499 349 496 399 280
Nintendo Wii Late 2006 158.30 249 199 126 200 150
Sources: Company reports. Various sources including: Ehrenberg, R. (2007). Game console Wars II: Nintendo shaves
off profits, leaving competition scruffy. Retrieved September 8, 2007, from http://seekingalpha.com/article/34357-
game-console-wars-ii-nintendo-shaves-off-profits-leaving-competition-scruff.
Nintendo Wii: A Game-changing Move 445
Exhibit 12.3 Forecasted Console and Games Sales
2005 2006 2007 2008 2009 2010
Console
Xbox 360 1.5 8.5 10 10 5
Sony PS3 2 11 13 13 7
Nintendo Wii 5.8 14.5 17.4 18.3
Games
Xbox 360 4.5 25.5 30 30 15
Sony PS3 6 33 39 39 21
Nintendo Wii 28.8 66.5 114.3 128.8
Sources: Company and analysts reports. HSBC Global Research. 2007. Nintendo Co., (7974). Telecom, Media &
Technology Software. Equity-Japan. July 5, 2007.
446 Cases
Notes
1 Introduction and Overview
1. Chafkin, M. (2008). The customer is the company. Inc. Magazine, June 2008.
http://www.inc.com/magazine/20080601/the-customer-is-the-company.html:
Accessed July 15, 2008.
2. Tischler, L. (2007). He struck gold on the net (really). Fast Company.com.
December 19, 2007. http://www.fastcompany.com/magazine/59/mcewen.html:
Accessed July 15, 2008.
3. Tapscott, D. & Williams, A.D. (2006). Wikinomics: How Mass Collaboration
Changes Everything. New York: Penguin Books.
4. Rivkin, J.W., & Porter, M.E. (1999). Matching Dell (Condensed). Harvard Busi-
ness School Case 704–440.
5. To the best of my knowledge, the phrase “New game strategies” was ?rst used
from Buaron, R. (1981). New-game strategies. McKinsey Quarterly, 17(1), 24–40.
He de?ned new game strategies as “innovative competitive moves” (p. 29); but my
de?nition is different from Buaron’s. For one thing, my de?nition sees new game
strategies as also involving cooperative moves and more. For the other, my
approach builds on and extends both the resource-based view (RBV) and the
product-market-position (PMP) view of strategic management as it pertains to
change. Throughout this book the words “appropriate” and “capture” are used
interchangeably.
6. I use the phrase “value chain” when I really mean “value chain, value network,
and value shop” only to make the de?nition of new game activity more precise and
easier to remember. For the relationship between value chain, value network, and
value shop, please see Stabell, C.B. & Fjeldstad, O.D. (1998). Con?guring value for
competitive advantage: On chains, shops, and networks. Strategic Management
Journal, 19(5), 413–37.
7. Ghemawat, P. (1991). Commitment: The Dynamics of Strategy. New York: Free
Press.
8. Porter, M.E. (1996). What is strategy? Harvard Business Review, 74(6), 61–78.
9. We will have a lot more to say about value creation and appropriation below and
in Chapter 4 of this book. Throughout the book, we will use products to mean
products and services. We will also use the words capture and appropriate
interchangeably.
10. See n.6.
11. Buaron, R. (1981). New-game strategies. McKinsey Quarterly, 17(1), 24–40. See
also, Bales, C.F., Chatterjee, P.C., Gluck, F.W., Gogel, D., & Puri, A. (2000). The
business system: A new tool for strategy formulation and cost analysis. Retrieved
November 13, 2007, from http://www.kellogg.northwestern.edu/faculty/vohra/ftp/
miin00.pdf
12. Porter, M.E. (1985). Competitive Advantage: Creating and Sustaining Superior
Performance. New York: Free Press.
13. Moon, Y. (2004). Ikea Invades America. HBS case #504-094. Boston, MA:
Harvard Business School Press.
14. Rivkin, J.W., & Siggelkow, N. (2003). Balancing search and stability: Inter-
dependencies among elements of organizational design. Management Science,
49(3), 290–311.
15. Given the critical role that intangible resources play in market value, many ?rms
are taking another look at their ?nancial statement reporting. See, for example,
Stewart, T.A. (1997). Intellectual Capital: The New Wealth of Organizations. New
York: Currency/Doubleday.
16. Barney, J., & Arikan, A.M. (2001). The resource-based view: Origins and implica-
tions. In M.A. Hitt, R.E. Freeman, & J.S. Harrison (eds), The Blackwell Handbook
of Strategic Management (124–88). Oxford: Blackwell.
17. We will have a lot more to say about ?rst-mover advantages and disadvantages in
Chapter 6 of this book. See also, Lieberman, M.B., & Montgomery, D.B. (1988).
First-mover (dis)advantages: Retrospective and link with the resource-based view.
Strategic Management Journal, 19(12), 1111–25.
18. This de?nition is closest to the one offered by The Economist. See Economics A–Z.
(2007). Retrieved July 26, 2007, from http://www.economist.com/research/
Economics/alphabetic.cfm?letter=G#globalisation
19. Deutsche Bank Game Sector update. August, 18, 2005.
20. Are big budget console games sustainable? (March 10, 2006). Retrieved April 20,
2006, from http://Biz.gamedaily.com/industry/advertorial/?id=12089
21. Playing a different game: Does Nintendo’s radical new strategy represent the future
of gaming? (2006, October 26). The Economist.
22. Ibid.
23. Porter, M.E. (1996). What is strategy? Harvard Business Review, 74(6), 61–78.
24. Barney, J., & Arikan, A.M. (2001). The resource-based view: Origins and implica-
tions. In M.A. Hitt, R.E. Freeman, & J.S. Harrison (eds), The Blackwell Handbook
of Strategic Management (124–188). Oxford: Blackwell. Peteraf, M.A. (1993). The
cornerstones of competitive advantage: A resource-based view. Strategic Manage-
ment Journal, 14(3), 179–91.
25. Professors Abernathy and Clark’s seminal paper also explored a similar classi?ca-
tion. However, their classi?cation was only about resources—technology and
market resources—and not about the resources and PMP of this book. See Aber-
nathy, W.J., & Clark, K.B. (1985). Mapping the winds of creative destruction.
Research Policy, 14(1), 3–22.
26. Global Gillette. (n.d.). Retrieved March 12, 2007, from http://en.wikipedia.org/
wiki/The_Gillette_Company.
27. Chandler, A. (1962). Strategy and Structure: Chapters in the History of the Ameri-
can Industrial Enterprise. Cambridge, MA: MIT Press.
28. Andrews, K. (1971). The Concept of Corporate Strategy. Homewood, IL: Irwin.
29. Porter, M.E. (1980). Competitive Strategy: Techniques for Analyzing Industries and
Competitors. New York: Free Press.
30. See, for example: Prahalad, C.K., & Hamel, G. (1990). The core competence of the
corporation. Harvard Business Review, 68(3), 79–91. For a comprehensive review
of the resource-based view of the ?rm, please see: Barney, J., & Arikan, A.M.
(2001). The resource-based view: Origins and implications. In M.A. Hitt, R.E.
Freeman, & J.S. Harrison (eds), The Blackwell Handbook of Strategic Management
(124–88). Oxford: Blackwell.
31. Porter, M.E. (1996). What is strategy? Harvard Business Review, 74(6), 61–78.
32. Oster, S. (1999). Modern Competitive Analysis. Oxford: Oxford University Press.
448 Notes
33. Grant, R.M. (2002). Contemporary Strategy Analysis: Concepts, Techniques,
Applications. (4th edn). Oxford: Blackwell.
34. Hitt, M.A., Ireland, R.D., & Hoskisson, R.E. (2007). Strategic Management: Com-
petitiveness and Globalization. Mason, OH: Thompson/Southwestern.
35. Mintzberg, H., Lampel, J., Quinn, J.B., & Ghoshal, S. (2003:4). The Strategy Pro-
cess: Concepts Contexts Cases. Upper Saddle River, NJ: Printice Hall.
36. Ibid.
37. Ibid.
38. Mintzberg, H. (2007). Are strategies real things? Retrieved June 10, 2007, from
http://www.phptr.com/articles/article.asp?p=378964&seqNum=5&rl=1.
39. Mintzberg, H., Lampel, J., Quinn, J.B., & Ghoshal, S. (2003: 9). The Strategy
Process: Concepts Contexts Cases. Upper Saddle River, NJ: Prentice Hall.
40. Hambrick, D.C., & Frederickson, J.W. (2005). Are you sure you have a strategy?
Academy of Management Executive, 19(4), 51–62.
2 Assessing the Profitability Potential of a Strategy
1. Afuah, A.N. (2003). Business Models: A Strategic Management Approach. New
York: McGraw-Hill/Irwin.
2. See, for example, Brealey, R.A., & Myers, S.C. (1995). Principles of Corporate
Finance. New York: McGraw-Hill.
3. This example is from: Afuah, A.N. (2003). Business Models: A Strategic Manage-
ment Approach. New York: McGraw-Hill/Irwin. Chapter 11.
4. Kaplan, R.S., & Norton, D.P. (1992). The balanced scorecard: Measures that
drive performance. Harvard Business Review, 70(1), 71–80.
5. Afuah, A.N. (2003). Business Models: A Strategic Management Approach. New
York: McGraw-Hill/Irwin.
6. Note that although no arrows are shown from Activities to Values, Appropri-
ability and Change, activities underpin the ?rst two and the ability of a ?rm to
exploit or cope with the last one. The arrows have been left out to make the dia-
gram more presentable. These relationships are explained in the text.
7. Afuah, A.N. (2003). Business Models: A Strategic Management Approach. New
York: McGraw-Hill/Irwin.
8. See Ryanair’s website: Ryanair.com Home. (n.d.). Retrieved August 27, 2007,
from http://www.ryanair.com/site/EN/.
9. Aviation: Snarling all the way to the bank. (2007, August 23). The Economist.
10. Investor Relations: Passenger Traffic 20023/2007. http://www.ryanair.com/site/
EN/about. php?page=Invest&sec=traf?c Roadshow Presentation. (2007).
Retrieved August 27, 2007, from http://www.ryanair.com/site/about/invest/docs/
present/quarter4_2007.pdf.
11. Rivkin, J.W. (1999). Dogfight over Europe: Ryanair (version C) (Harvard Business
School Case No. 9–700–117). Harvard Business School Press. See Ryanair’s ?nan-
cial statements, including the presentation on: http://www.ryanair.com/site/about/
invest/docs/present/quarter4_05.pdf, and Ryanair’s history on its website:
www.Ryanair.com. http://www.ryanair.com/site/about/invest/docs/Strategy.pdf
12. Capell, K. (June 2, 2003). Ryanair Rising: Ireland’s discount carrier is defying
gravity as the industry struggles. Business Week, 3835, 30.
13. Capell, K. (June 2, 2003). Ryanair Rising: Ireland’s discount carrier is defying
gravity as the industry struggles. Business Week, 3835, 30.
14. http://www.ryanair.com/site/about/invest/docs/Strategy.pdf
Notes 449
3 The Long Tail and New Games
1. Anderson, C. (2006). The Long Tail: Why the Future of Business is Selling the Less
of More. New York: Random House Business Books.
2. See similar arguments by Shirky, C. (February 8, 2003). Power laws, weblogs and
inequality. Retrieved July 9, 2008, from http://www.shirky.com/writings/
powerlaw_weblog.html.
3. Brynjolfsson, E., Hu, Y., & Simester, D. (2006). Goodbye pareto principle, hello
long tail: the effect of search costs on the concentration of product sales. Retrieved
July 9, 2008, from http://papers.ssrn.com/sol3/papers.cfm?abstract_id=953587 See
also, Brynjolfsson, E., Hu, Y., & Smith, M.D. (2003). Consumer surplus in the
digital economy: estimating the value of increased product variety at online book-
sellers. Management Science, 49(11), 1580–96.
4. Freeberg, D. (2005). Net?ix presents at Lehman Brothers Small Cap Conference.
Retrieved October 15, 2007, from http://thomashawk.com/2005/11/Rnet?ix-
presents-at-lehman-brothers.html.
5. Anderson, C. (2006). The Long Tail: Why the Future of Business is Selling the Less
of More. New York: Random House Business Books.
6. Agarwal A., Johnson M., Link T., Patel S., Stone, J., & Tsuchida, K. (2006).
Botox’s Makeover. Ann Arbor, MI: University of Michigan, Ross School of
Business.
7. Film history of the 1970s. (n.d.). Retrieved December 10, 2007, from http://
www.?lmsite.org/70sintro.html.
8. One million copies of iTunes for Windows software downloaded in three and a
half days. (2003). Retrieved September 15, 2007, from htt://www.apple.com/pr/
library/2003/oct/20itunes.html.
9. Taylor, C. (2003). The 99 cent solution. Retrieved December 7, 2007, from http://
www.time.com/time/2003/inventions/invmusic.html.
10. iTunes. Retrieved September 8, 2007, from http://en.wikipedia.org/wiki/Itunes.
11. Taylor, C. (2003). The 99 cent solution. Retrieved December 7, 2007, from http://
www.time.com/time/2003/inventions/invmusic.html.
4 Creating and Appropriating Value Using New Game Strategies
1. Apple iPhone to generate 50 percent margin, According to iSuppli’s Preliminary
Analysis. (January 18, 2007). Retrieved July 9, 2007 from http://www.isuppli.com/
news/default.asp?id=7308.
2. See similar de?nitions in Besanko, D., Dranove, D., & Shanley, M. (2000). Eco-
nomics of Strategy. (2nd edn). New York: John Wiley & Sons, Inc. Ghemawat, P.
(1991). Commitment: The Dynamics of Strategy. New York: Free Press. Saloner,
G., Shepard, A., & Podolny, J. (2001). Strategic Management. New York: John
Wiley.
3. Brandenburger, A. M., & Stuart, H. W. (2007). Biform games. Management
Science, 53(4), 537–49. MacDonald, G., & Ryall, M. (2004). How do value cre-
ation and competition determine whether a ?rm appropriates value. Management
Science, 50(10), 1319–33. Lipman, S., & Rumelt, R. (2003). A bargaining perspec-
tive on resource advantage. Strategic Management Journal, 24(11), 1069–86.
4. Laseter, T. M., Houston, P. W., Wright, J. L., & Park, J. Y. (2000). Amazon your
industry: Extracting value from the value chain. Strategy & Business, 18(1), 94–
105. Digman, L. A. (2006). Strategic Management: Competing in the Global
Information Age. New York: Thomson.
5. Ibid.
6. Laseter, T. M., Houston, P. W., Wright, J. L., & Park, J. Y. (2000). Amazon your
industry: Extracting value from the value chain. Strategy & Business, 18(1), 94–
450 Notes
105. Apple iPhone to generate 50 percent margin, according to iSuppli’s prelimin-
ary analysis. (January 18, 2007). Retrieved July 9, 2007 from http://www.isuppli.
com/news/default.asp?id=7308
7. Kanoh, Y. (July 6, 2007). Samsung Electronics Supplies Largest Share of iPhone
Components: iSuppli. Retrieved July 9, 2007, from http://techon.nikkeibp.co.jp/
english/NEWS_EN/20070706/135572/.
8. Wallace, J. (June 27, 2006). Boeing Dreamliner ‘coming to life.’ Retrieved July 8,
2007, from http://seattlepi.nwsource.com/business/275465_japan27.html.
9. Gates, D. (September 11, 2005). Boeing 787: Parts from around world will be
swiftly integrated. The Seattle Times.
10. Moon, Y. (2004). Ikea invades America. HBS case # 504–094. Harvard Business
School Press. Boston, MA.
11. Creager, E. (2002). Move over, Tupperware: Botox injections are the latest thing at
home parties. Retrieved September 14, 2007, from http://www.woai.com/guides/
beauty/story.aspx?content_id=16358daf-d7db-4ade-a757-9e8d7cf30212.
12. Dyer, J.H., & Singh, H. (1998). The relational view: Cooperative strategy and
sources of interorganizational competitive advantage. Academy of Management
Review, 23(4), 660–79.
13. Dyer, J.H., & Singh, H. (1998). The relational view: Cooperative strategy and
sources of interorganizational competitive advantage. Academy of Management
Review, 23(4), 660–79.
14. My thanks to Scott Peterson from whom I obtained the “grape versus watermelon”
comparison in a STRAT 675 MBA class at the Ross School in the Fall of
2007.
15. Tapscott, D. & Williams, A. D. (2006). Wikinomics: How Mass Collaboration
Changes Everything. New York: Penguin Books.
16. Tischler, L. (2007). He struck gold on the net (really). Fast Company.com. Decem-
ber 19, 2007. Retrieved June 19, 2008, from http://www.fastcompany.com/
magazine/59/mcewen.html.
17. Ibid.
18. Tapscott, D. & Williams, A. D. (2006:9). Wikinomics: How Mass Collaboration
Changes Everything. New York: Penguin Books, (p. 9).
19. Ibid.
20. Tischler, L. (2007). He struck gold on the net (really). Fast Company.com. Decem-
ber 19, 2007. Retrieved June 19, 2008, from http://www.fastcompany.com/
magazine/59/mcewen.html.
21. Ibid.
22. Howe, J. (2006). The rise of crowdsourcing. Wired, 14(6). Retrieved June 19, 2008,
from http://www.wired.com/wired/archive/14.06/crowds.html.
23. Tripsas, M. (1997). Unraveling the process of creative destruction: Complementary
assets and incumbent survival in the typesetter industry. Strategic Management
Journal, 18(6), 119–42.
24. Airbus A380: The giant on the runway. (2007, October 11). The Economist. Air-
bus: Gathering clouds. (2008, June 19). The Economist.
25. The Economist. 2008. Airbus: Gathering clouds. The Economist, June 19, 2008.
26. Linden, G., Kraemer, K.L., & Dedrick, J. (2007). Who captures value in a global
innovation system? The case of Apple’s iPod. Retrieved July 10, 2007, from http://
www.teardown.com/AllReports/product.aspx?reportid=8.
5 Resources and Capabilities in the Face of New Games
1. Grant, R.M. (2002). Contemporary Strategy Analysis: Concepts, Techniques,
Applications. Oxford, UK: Blackwell.
Notes 451
2. Given the critical role that intangible resources play in market value, many ?rms
are taking another look at their ?nancial statement reporting. See, for example,
Stewart, T.A. (1997). Intellectual Capital: The New Wealth of Organizations. New
York: Currency/Doubleday.
3. Hamel, G., & Prahalad, C.K. (1990). The core competence of the corporation.
Harvard Business Review, 68(3), 79–91.
4. Barney, J., & Arikan, A.M. (2001). The resource-based view: Origins and implica-
tions. In Hitt, M.A., Freeman, R.E., & Harrison, J.S. (eds), The Blackwell Hand-
book of Strategic Management (124–88). Oxford: Blackwell.
5. Hamel, G., & Prahalad, C.K. (1990). The core competence of the corporation.
Harvard Business Review, 68(3), 79–91.
6. Katz, M.L., & Shapiro, C. (1992). Product introduction with network external-
ities. Journal of Industrial Economics, 40(1), 55–84.
7. Katz, M.L., & Shapiro, C. (1985). Technology adoption in the presence of net-
work externalities. Journal of Political Economy, 94(4), 822–41.
8. See, for example, L. Downes & C. Mui, (1998). Unleashing the Killer App:
Digital Strategies for Market Dominance. Cambridge, MA: Harvard Business
School Press.
9. Afuah, A. N. (2007). How much does size matter? Working Paper, Stephen M.
Ross School of Business, University of Michigan.
10. Parker, G., & Van Alstyne, M. (2005). Two-sided network effects: A theory of
information product design. Management Science, 51(10), 1494–504. Rochet, J., &
Tirole, J. (2003). Platform competition in two-sided markets. Journal of the Euro-
pean Economic Association, 1(4), 990–1029.
11. Cusumano, M.A., Mylonadis, Y., & Rosenbloom, R.S. (1992). Strategic maneuver-
ing and mass-market dynamics: the triumph of VHS over Beta. Business History
Review, 66(1), 51–94.
12. Parker, G., & Van Alstyne, M. (2005). Two-sided network effects: A theory of
information product design. Management Science, 51(10), 1494–504.
13. Nair, H., Manchanda, P., & Bhatia, T. (2007). Social networks impact the drugs
physicians prescribe. Retrieved November 5, 2007, from http://www.gsb.stanford.
edu/news/research/mktg_nair_drugs.shtml.
14. Teece, D.J. (1986). Pro?ting from technological innovation: Implications for inte-
gration, collaboration, licensing and public policy. Research Policy, 15(6), 285–
306.
15. This model is derived from Professor David Teece’s seminal paper: Teece, D.J.
(1986). Pro?ting from technological innovation: Implications for integration, col-
laboration, licensing and public policy. Research Policy, 15(6), 285–306.
16. Afuah, A.N. (2003). Innovation Management: Strategies, Implementation and
Profits. (2nd edn). New York: Oxford University Press.
17. Burns, E. (March 23, 2007). U.S. search engine rankings, February 2007. Retrieved
May 28, 2007, from http://searchenginewatch.com/showPage.html?page=
3625336.
18. Know your subject: Topic-speci?c search-engines hope to challenge Google, at least
in some areas. (July 12, 2007). The Economist.
19. Bartlett, C.A., Cornebise, J., & McLean, A.N. (2002). Global wine wars: New
world challenges old. Harvard Business School Press, case # 9-303-056.
20. Yof?e, D. B., & Wang, Y. (2002). Apple Computer 2002. Harvard Business School
Press, case # 9-702-469.
21. Quittner, J. (2002). Apple’s latest fruit: exclusive: How Steve Jobs made a sleek
machine that could be the home-digital hub of the future. Retrieved August 23,
2007, from http://www.time.com/time/covers/1101020114/cover2.html.
22. Kanellos, M. (June 11, 2002). IDC ups 2001 PC-shipment estimate. Retrieved July
452 Notes
16, 2008, from http://news.cnet.com/IDC-ups-2001-PC-shipment-estimate/2100-
1001_3-935176.htm l.
23. Market share vs installed base: iPod vs Zune, Mac vs PC. (March 18, 2007).
Retrieved August 23, 2007, from http://www.roughlydrafted.com/RD/
RDM.Tech.Q1.07/9E601E8E-2ACC-4866-A91B-3371D1688E00.html.
24. One million copies of iTunes for windows software downloaded in three and a half
days. (October 20, 2003). Retrieved September 15, 2007, from http://www.apple.
com/pr/library/2003/oct/20itunes.html.
6 First-mover Advantages/Disadvantages and Competitors’ Handicaps
1. Many of the ?rst-mover advantages and disadvantages outlined here were laid out
in an award-winning paper by Professor Lieberman of UCLA and Professor Mont-
gomery of Northwestern University. Please see Lieberman, M.B., & Montgomery,
D.B. (1988). First-mover advantages. Strategic Management Journal, 9, 41–58.
Lieberman, M.B., & Montgomery, D.B. (1988). First-mover (dis)advantages:
Retrospective and link with the resource-based view. Strategic Management Jour-
nal, 19(12), 1111–25.
2. See, for example: Fishman, C. (2006). The Wal-Mart effect and a decent society:
Who knew shopping was so important? Academy of Management Perspectives,
20(3), 6–25.
3. Sheremata, W.A. (2004). Competing through innovation in network markets:
Strategies for challengers. Academy of Management Review, 29(3), 359–77.
4. Latif, U. (May 31, 2005). Google’s bid-for-placement patent settlement cover-up.
Retrieved July 16, 2008, from http://www.techuser.net/gcoverup.html. Olsen, S.
(July 18, 2003). Overture to a patent war? Retrieved July 16, 2008, from http://
news.com.com/Overture+to+a+ patent+war/2100-1024_3-1027084.html.
5. The settlement included another charge against Google that Yahoo had made in
connection with a warrant that Yahoo held in connection with a June 2000 services
agreement between the two ?rms.
6. Besanko, D., Dranove, D., & Shanley, M. (2000). Economics of Strategy. New
York: John Wiley.
7. Barney, J. (1986). Organizational culture: Can it be a source of sustained competi-
tive advantage? Academy of Management Review, 11(3), 656–65.
8. Teece, D.J. (1986). Pro?ting from technological innovation: Implications for inte-
gration, collaboration, licensing and public policy. Research Policy, 15(6), 285–
306.
9. Ghemawat, P. (1986). Wal-Mart Stores’ Discount Operations. Case 0-387-018.
Boston, MA: Harvard Business School Press.
10. Schmalensee, R. (1978). Entry deterrence in the ready-to-eat breakfast cereal indus-
try. Bell Journal of Economics, 9(2), 305–27.
11. Schmalensee, R. (1982). Product differentiation advantages of pioneering brands.
American Economic Review, 72(3), 349–65.
12. Carpenter, G.S., & Nakamoto, K. (1989). Consumer preference formation and
pioneering advantage. Journal of Marketing Research, 26(3), 285–98.
13. Fishburne, F. (1999, April 5). Hardware winner. Forbes (p. 59). Rivkin, J.W., &
Porter, M.E. (1999). Matching Dell. HBS Case 799–158.
14. Ghemawat, P. (1991). Commitment: The Dynamics of Strategy. New York: Free
Press.
15. Afuah, A.N. (2003). Innovation Management: Strategies, Implementation and
Profits. (2nd edn). New York: Oxford University Press.
16. Porter, M.E. (1996). What is strategy? Harvard Business Review, 74(6), 61–78.
17. Lieberman, M.B., & Montgomery, D.B. (1988). First-mover advantages. Strategic
Notes 453
Management Journal, 9, 41–58. Lieberman, M.B., & Montgomery, D.B. (1988).
First-mover (dis)advantages: Retrospective and link with the resource-based view.
Strategic Management Journal, 19(12), 1111–25.
18. Teece, D.J. (1986). Pro?ting from technological innovation: Implications for inte-
gration, collaboration, licensing and public policy. Research Policy, 15(6), 285–
306.
19. Hamel, G.M., & Prahalad, C.K. (1994). Competing for the Future. Boston, MA:
Harvard Business School Press (p. 49).
20. Bettis, R.A., & Prahalad, C.K. (1995). The dominant logic: Retrospective and
extension. Strategic Management Journal, 16(1), 5–14.
21. Besanko, D., Dranove, D., & Shanley, M. (2000). Economics of Strategy. New
York: John Wiley.
7 Implementing New Game Strategies
1. This section draws on Chapter 5 of A.N. Afuah, Innovation Management: Strat-
egies, Implementation, and Profits (New York: Oxford University Press, 2003).
2. Galbraith, J.R. (1982). Designing the innovating organization. Organizational
Dynamics, 10(3), 5–25.
3. This section draws heavily on, A.N. Afuah (2003). Business Models: A Strategic
Management Approach. New York: McGraw Hill/Irvin.
4. Lawrence, P.R., & Lorsch, J.W. (1967). Organization and Environments: Man-
aging Differentiation and Integration. Homewood, IL: Irwin.
5. Chandler, A.D. (1962). Strategy and Structure: Chapters in the History of the
Industrial Enterprise. Cambridge, MA: MIT Press.
6. Miles, R.E., Snow, C.C., Mathews, J.A., Miles, G., & Coleman, H. J., Jr (1997).
Organizing the knowledge age: Anticipating the cellular form. Academy of
Management Executive, 11(4), 7–24. Byrne, J.A., & Brandt, R. (February 8, 1993).
The virtual corporation. Business Week. Davidow, W.H., & Malone, M.S. (1992).
The Virtual Corporation. New York: Harper Collins.
7. Afuah, A.N. (2001). Dynamic boundaries of the ?rm: Are ?rms better off being
vertically integrated in the face of a technological change? Academy of Manage-
ment Journal, 44(6), 1211–28.
8. Hill, C.W.L., & Jones, G.R. (1995). Strategic Management: An Integrated
Approach. Boston, MA: Houghton Mif?in.
9. Christensen, C.M., & Overdorf, M. (2000). Meeting the challenge of disruptive
change. Harvard Business Review, 78(2), 66–77.
10. Afuah, A.N., & Tucci, C.L. (2003). Internet Business Models and Strategies: Text
and Cases. New York: McGraw-Hill. Afuah, A.N. (2003). Rede?ning ?rm bound-
aries in the face of the Internet: Are ?rms really shrinking? Academy of Manage-
ment Review, 28(1), 34–53.
11. Allen, T. (1984). Managing the flow of technology. Cambridge, MA: MIT Press.
12. Uttal, B., & Fierman, J. (October 17, 1983). The corporate culture vultures.
Fortune, (pp. 66–73).
13. Schein, E. (1985). Organizational Culture and Leadership. San Francisco, CA:
Jossey-Bass.
14. Barney, J. (1986). Organizational culture: Can it be a source of sustained competi-
tive advantage? Academy of Management Review, 11(3), 656–65.
15. Fuzzy maths: In a few short years, Google has turned from a simple and popular
company into a complicated and controversial one. (May 11, 2006). The
Economist.
16. Bettis, R.A., & Prahalad, C.K. (1995). The dominant logic: Retrospective and
extension. Strategic Management Journal, 16(1), 5–14.
454 Notes
17. Walsh, J.P. (1995). Managerial and organizational cognition: Notes from a trip
down memory lane. Organizational Science, 6(3), 280–321.
18. Hamel, G.M., & Prahalad, C.K. (1994). Competing for the Future. Boston, MA:
Harvard Business School Press.
19. The concept of champions was ?rst developed by Schön in his seminal article,
Schön, D.A. (1963). Champions for radical new inventions. Harvard Business
Review, 41(2), 77–86. See also, Howell, J.M., & Higgins, C.A. (1990). Champions
of technological innovation. Administrative Sciences Quarterly, 35(2), 317–41.
20. Roberts, E.B., & Fusfeld, A.R. (1981). Staf?ng the innovative technology-based
organization. Sloan Management Review, 22(3), 19–34.
21. Allen, T. (1984). Managing the flow of technology. Cambridge, MA: MIT Press.
22. Clark, K.B., & Fujimoto, T. (1991). Product Development Performance: Strategy,
Organization, and Management in the World Automobile Industry. Boston, MA:
Harvard Business School Press.
23. Ibid.
24. Ibid.
25. Uttal, B., & Fierman, J. (October 17, 1983). The corporate culture vultures. For-
tune, (pp. 66–73).
8 Disruptive Technologies as New Games
1. Foster, R. Innovation: The Attacker’s Advantage. (1986). New York: Summit
Books.
2. Foster, R. Innovation: The Attacker’s Advantage. (1986). New York: Summit
Books. Afuah, A.N., & Utterback, J.M. (1991). The emergence of a new super-
computer architecture. Technology Forecasting and Social Change, 40(4), 315–28.
See also, Constant, E.W. (1980). The Origins of the Turbojet Revolution. Balti-
more, MD: The Johns Hopkins University Press. Sahal, D. (1985). Technological
guideposts and innovation avenues. Research Policy, 14(2), 61–82. Foster, R.D.
(1985). Description of the S-Curve. Retrieved May 27, 2007, from http://
www.12manage.com/description_s-curve.html.
3. Christensen, C.M., & Bower, J.L. (1996). Customer power, strategic investment
and failure of leading ?rms. Strategic Management Journal, 17(3), 197–218. Chris-
tensen, C.M. (1997). The Innovator’s Dilemma. Boston, MA: Harvard Business
School Press. See also, Christensen, C.M., & Overdorf, M. (2000). Meeting the
challenge of disruptive change. Harvard Business Review, 78(2), 66–76. Chris-
tensen, C.M., & Raynor, M.E. (2003). The Innovator’s Solution. Boston, MA:
Harvard Business School Press. Christensen, C.M., Anthony, S.D., & Roth, E.A.
(2004). Seeing What’s Next. Boston, MA: Harvard Business School Press.
4. Christensen, C.M., & Overdorf, M. (2000). Meeting the challenge of disruptive
change. Harvard Business Review, 78(2), 68.
5. Christensen, C.M., & Overdorf, M. (2000). Meeting the challenge of disruptive
change. Harvard Business Review, 78(2), 69.
6. Bettis R.A., & Prahalad, C.K. (1995). The dominant logic: Retrospective and
extension. Strategic Management Journal, 16(1), 5–14.
7. Christensen, C.M., & Raynor, M.E. (2003). The Innovator’s Solution. Boston,
MA: Harvard Business School Press.
8. Von Hippel, E. (2005). Democratizing Innovation. Cambridge, MA: MIT Press.
Lilien, G.L., Morrison, P.D., Searls, K., Sonnack, M., & Von Hippel, E. (2002).
Performance assessment of the lead user idea-generation process for new product
development. Management Science, 48(8), 1042–59.
9. Professors Abernathy and Clark’s seminal paper also explored a similar classi?ca-
tion. However their classi?cation was only about resources—technological and
Notes 455
marketing resources—and not about product-market position and resources as
explored in this book. See Abernathy, W.J., & Clark, K.B. (1985). Mapping the
winds of creative destruction. Research Policy, 14(1), 3–22.
10. See n.9.
9 Globalization and New Games
1. Nigerian Bonny Light (Bonny Light crude oil spot prices in Europe went as high as
$80 in July. In France there was a tax of 0.5892 per liter of unleaded and a TVA of
19.6%.)
2. Energy Information Administration of the US Department of Energy. (2007).
Nigeria: Oil. Retrieved July 16, 2008, from http://www.eia.doe.gov/emeu/cabs/
Nigeria/Oil.html.
3. Energy Information Administration of the US Department of Energy (2006). Per-
formance pro?les of major energy producers 2006 (Form EIA-28). Retrieved July
31, 2007, from http://www.eia.doe.gov/emeu/perfpro/tab11.htm.
4. International Energy Agency (Agence Internationale de l’Energie). OECD/IEA.
(2007). End-user petroleum product prices and average crude oil import costs.
Retrieved August 9, 2007, from http://www.iea.org/Textbase/stats/surveys/
mps.pdf.
5. Energy information administration of the US Department of Energy. (2003).
Nigeria. Retrieved July 30, 2007, from http://www.eia.doe.gov/emeu/cabs/ngia-
_jv.html. Vernon, C. (2006). UK Petrol Prices. Retrieved July 30, 2007, from http://
europe.theoildrum.com/story/2006/5/3/17236/14255.
6. Pindyck, R.S., & Rubinfeld, D.L. (1992). Microeconomics (4th edn). Upper
Saddle River, NY: Prentice Hall.
7. Ibid.
8. Baxter, J. (May 19, 2003). Cotton subsidies squeeze Mali. Retrieved September
10, 2007, from http://news.bbc.co.uk/1/hi/world/africa/3027079.stm.
9. This de?nition is closest to the one offered by The Economist. See The Econo-
mist’s de?nition as retrieved July 26, 2007, from http://economist.com/research/
Economics/alphabetic.cfm?letter=G#globalisation.
10. IKEA. (2007). Retrieved August 10, 2007, from http://en.wikipedia.org/wiki/Ikea.
11. Happy meal: How a Frenchman is reviving McDonald’s in Europe. (January 25,
2007). The Economist.
12. Bove appeals over McDonalds rampage (February 15, 2001). Retrieved September
10, 2007, from http://news.bbc.co.uk/1/hi/world/europe/1171329.stm.
13. How not to block a takeover: Spain’s meddling government is the big loser in the
battle over Endesa. (2007, April 4). The Economist.
14. Vernon, C. (2006). UK petrol prices. Retrieved July 30, 2007, from http://europe.
theoildrum.com/story/2006/5/3/17236/14255.
15. AA fuel price report: Price rises hit plateau after overtaking 2006 levels (June 20,
2007). Retrieved July 31, 2007, from http://www.theaa.com/motoring_advice/
news/fuel-prices-june-2007.html.
16. Energy Information Administration of the US Department of Energy (2006). A
primer on gasoline prices (DOE/EIA-04). Retrieved July 31, 2007, from http://
www.eia.doe.gov/bookshelf/brochures/gasolinepricesprimer/printerversion.pdf.
10 New Game Environments and the Role of Governments
1. Innovation’s golden goose. (2002, December 12). The Economist.
2. Bayhing for blood or Doling out cash? (2005, December 20). The Economist.
456 Notes
3. Home truths: How much does housing wealth boost consumer spending? (Octo-
ber 12, 2006). The Economist.
4. Carroll, C.D., Otsuka, M., & Slacalek, J. (2006). How large is the housing wealth
effect? A new approach (NBER Working Paper No. W12746). Berlin, Germany:
German Institute for Economic Research.
5. Competitiveness clusters in France. (2006). Retrieved December 4, 2007, from
http://www.polesdecompetitivite.gouv.fr/IMG/pdf/poles_plaquette_en.pdf.
6. The fading lustre of clusters. (October 11, 2007). The Economist.
7. Farrell, C. et al. (1995). The boon in IPOs. Business Week, December 18, 1995,
(p. 64).
8. Please dare to fail (September 28, 1996). The Economist.
9. Porter, M.E. (1990). The Competitive Advantage of Nations. New York: The Free
Press.
10. The fading lustre of clusters. (October 11, 2007). The Economist.
11. This section draws heavily on Chapter 15 of A.N. Afuah (2003). Innovation Man-
agement: Strategies, Implementation and Profits. New York: Oxford University
Press.
12. Arrow, K.J. (1962). Economic welfare and the allocation of resources for invention.
In R. Nelson (ed.), The Rate and Direction of Inventive Activity (pp. 609–26).
Princeton, NJ: Princeton University Press.
13. Ibid.
14. For an excellent discussion of minimum ef?cient scale (MES), see S. Oster (1994).
Modern Competitive Analysis. New York: Oxford University Press.
15. Oster, S. (1994). Modern Competitive Analysis. New York: Oxford University Press
(p. 316).
16. This section also draws heavily from Chapter 15 of A.N. Afuah (2003). Innovation
Management: Strategies, Implementation and Profits. New York: Oxford Uni-
versity Press.
17. Von Hippel, E. (2005). Democratizing Innovation. Cambridge, MA: MIT Press.
18. Borrus, M. G. (1988). Competing for Control: America’s Stake in Microelectronics.
Cambridge, MA: Ballinger.
19. Rothwell, R. & Zegveld. W. (1981). Industrial Innovation and Public Policy.
London: Frances Pinter.
20. Porter, M.E. (1990). The Competitive Advantage of Nations. New York: The Free
Press.
21. Some of the data items from the ?gure are from PEST Analysis. Retrieved May 26,
2007, from http://www.valuebasedmanagement.net/methods_PEST_analysis.html,
and PEST Analysis. (2007). Retrieved June 1, 2007, from http://www.netmba.com/
strategy/pest/
11 Coopetition and Game Theory
1. Oster, S. (2002). Modern Competitive Analysis. Oxford: Oxford University Press.
Pindyck, R.S., & Rubinfeld, D.L. (1992). Microeconomics (4th edn). Upper Saddle
River, NY: Prentice Hall. Ghemawat, P. (1997). Games Businesses Play: Cases and
Models. Cambridge, MA: MIT Press. Kreps, D. M. (1990). Game Theory and
Economic Modelling. Oxford, England: Clarendon Press. Dixit, A. K., & Nalebuff,
B. J. (1991). Thinking Strategically. New York, New York: W. W. Norton and
Company.
2. Brandenburger, A. & Stuart, H. (2007). Biform games. Management Science
53(4), 537–49.
3. Brandenburger, A. (2002). Technical note on cooperative game theory: Character-
istic function, allocations, marginal contributions. Retrieved February 5, 2007 from
Notes 457
http://pages.stern.nyu.edu/~abranden/teachingmaterials/coop12502.pdf. Stuart, Jr,
H. W. Cooperative games and business strategy. In K. Chatterjee and W. Samuel-
son (eds), Game Theory and Business Applications, Kluwer Academic, 2001, 189–
211.
4. Brandenburger, A. (2002). Technical note on cooperative game theory: Character-
istic function, allocations, marginal contributions. Retrieved February 5, 2007 from
http://pages.stern.nyu.edu/~abranden/teachingmaterials/coop12502.pdf.
5. Pindyck, R. S., & D. L Rubinfeld. (1992). Microeconomics (4th edn). Upper Saddle
River, NY: Prentice Hall.
6. Note that this is still a simultaneous game because, although both ?rms have
talked about their plans to offer planes, they have not actually made the decision to
offer the planes. Neither ?rm has made any irreversible commitments to offer either
plane.
7. Ghemawat, P. (1991). Commitment: The Dynamics of Strategy. New York, NY:
Free Press, 1991.
8. Basdeo, D. K., Smith, K. G., Grimm, C. M., Rindova, V. P. & Derfus, P. J. (2006).
The impact of market actions on ?rm reputation, Strategic Management Journal,
27(12), 1205–19. Heil, O., & Robertson, T. S, (1991). Toward a theory of competi-
tive market signaling: A research agenda. Strategic Management Journal, 12(6),
403–18.
9. Huyghebaert, N., & Van de Gucht, L. M. (2004). Incumbent strategic behavior in
?nancial markets and the exit of entrepreneurial start-ups, Strategic Management
Journal, 25(6), 669–88.
10. Afuah, A. N. (1994). Strategic adoption of innovation: The case of RISC (reduced
instruction set computer) technology. Unpublished Ph.D. dissertation. Cambridge,
MA: Massachusetts Institute of Technology.
11. My thanks to Professor Valerie Suslow for these insights on tacit collusion.
12. Much of the pioneering management-oriented work in this area has been done by
Professors Adam Brandenburger, Barry Nalebuff, and Harthorne Stuart. See, for
example, Brandenburger, A. & Nalebuff, B. (1996). Co-opetition. New York, NY:
Doubleday. Brandenburger, A. M., & Stuart, H. W. (1996). Value-based business
strategy, Journal of Economics & Management Strategy, 5(1), 5–24. Branden-
burger, A. M. and Nalebuff, B. J. (1995). The right game: Use game theory to shape
strategy. Harvard Business Review. July–August, 1995.
13. See n.12.
14. The schematic that we use here is somewhat different from the Brandenburger and
Nalebuff rendition in Brandenburger, A. M. and Nalebuff, B. J. (1995). The right
game: Use game theory to shape strategy. Harvard Business Review. July–August,
1995. We chose to keep the suppliers and customers in the horizontal dimension as
is customary with the strategy literature. Brandenburger and Nalebuff have substi-
tutors and complementors in the horizontal dimension.
15. Brandenburger, A. M. and Nalebuff, B. J. (1995). The right game: Use game theory
to shape strategy. Harvard Business Review. July–August, 1995.
16. This example closely follows on in Stuart, Jr, H. W. (2001). Cooperative games and
business strategy. In K. Chatterjee, and W. Samuelson (eds), Game Theory and
Business Applications, Kluwer Academic, 2001, 189–211.
17. Brandenburger, A. and Nalebuff, A. (1997). The added value theory of business. In
Strategy & Business, published by Booz, Allen & Hamilton, fourth quarter, 1997.
18. Stuart, Jr, H. W. (2001). Cooperative games and business strategy. In K. Chatterjee,
and W. Samuelson (eds), Game Theory and Business Applications, Kluwer Aca-
demic, 2001, 189–211.
19. Ibid.
20. The Economist, January 24, 1998 (p. 63).
458 Notes
12 Entering a New Business Using New Games
1. Porter, M.E. (1987). From competitive advantage to corporate advantage. Harvard
Business Review, 65(3), 43–59.
2. Tirole, J. (1988). Theory of Industry Organization. Cambridge, MA: MIT Press.
McWilliams, A., & Smart, D.L. (1993). Ef?ciency v. structure-conduct-
performance: Implications for strategy research and practice. Journal of Manage-
ment, 19(1), 63–78.
3. This subsection draws heavily from Afuah, A.N. (2003). Business Models: A Stra-
tegic Management Approach. New York: McGrawHill/Irvin.
4. Kim, W.C., & Mauborgne, R. (2005). Blue Ocean Strategy: How to Create
Uncontested Market Space and Make Competition Irrelevant. Boston, MA:
Harvard Business School Press.
5. Moon, Y. (2004). Ikea Invades America (Harvard Business School case #9-504-
094).
13 Strategy Frameworks and Measures
1. Year in parenthesis indicates when the ?rst major publication that introduced the
framework was published.
2. Chandler, A. (1962). Strategy and Structure: Chapters in the History of the Ameri-
can Industrial Enterprise. Cambridge, MA: MIT Press.
3. Aguilar, F. (1967). Scanning the Business Environment. New York: Macmillan.
4. Allen, G.B., & Hammond. J.S. (1975). Note on the Boston Consulting Group
Concept of Competitive Analysis and Corporate Strategy (Harvard Business School
note 9-175-175). See also, Stern, C.W., & Deimler, M.S. (2006). The Boston
Consulting Group on Strategy: Classic Concepts and New Perspectives (2nd edn).
Boston, MA: BCG.
5. This example closely follows that from Afuah, A.N. (2003). Business Models: A
Strategic Management Approach, New York: McGraw-Hill/Irvin.
6. Porter, M.E. (1979). How competitive forces shape strategy. Harvard Business
Review, 57(2), 137–45. Porter, M.E. (1980). Competitive Strategy. New York: Free
Press.
7. Ibid.
8. Oster, S. (1999). Modern Competitive Analysis (3rd edn). Oxford: Oxford Uni-
versity Press.
9. Bales, C.F., Chatterjee, P.C., Gluck, F.W., Gogel, D., & Puri, A. (2000). The busi-
ness system: A new tool for strategy formulation and cost analysis. Retrieved
November 13, 2007, from http://www.kellogg.northwestern.edu/faculty/vohra/ftp/
miin00.pdf.
10. Gluck, F.W. (1980). Strategic choice and resource allocation. The McKinsey Quar-
terly, 1, 22–33.
11. Buaron, R. (1981). New-game strategies. McKinsey Quarterly, 17(1), 24–40.
12. Ibid. See also, Bales, C.F., Chatterjee, P.C., Gluck, F.W., Gogel, D., & Puri, A.
(2000). The business system: A new tool for strategy formulation and cost analysis.
Retrieved November 13, 2007, from http://www.kellogg.northwestern.edu/faculty/
vohra/ftp/miin00.pdf.
13. Bales, C.F., Chatterjee, P.C., Gluck, F.W., Gogel, D., & Puri, A. (2000). The business
system: A new tool for strategy formulation and cost analysis. Retrieved
November 13, 2007, from http://www.kellogg.northwestern.edu/faculty/vohra/ftp/
miin00.pdf.
14. Porter, M.E. (1985). Competitive Advantage: Creating and Sustaining Superior Per-
formance. New York: Free Press.
15. Stabell, C.B., & Fjeldstad, O.D. (1998). Con?guring value for competitive
Notes 459
advantage: On chains, shops, and networks. Strategic Management Journal, 19(5),
413–37.
16. Ibid.
17. Ibid.
18. Kaplan, R.S., & Norton, D.P. (1992). The balanced scorecard: Measures that drive
performance. Harvard Business Review, 70(1), 71–80.
19. Barney, J.B. (1999). How a ?rm’s capabilities affect boundary decisions. Sloan
Management Review, 40(3), 137–45. Barney, J., & Hesterly, W. (2007). Strategic
Management and Competitive Advantage: Concepts (2nd edn). New York: Prentice
Hall.
20. Henderson, R.M., & Clark, K.B. (1990). Architectural innovation: The recon?gur-
ation of existing product technologies and the failure of established ?rms. Adminis-
trative Science Quarterly, 35(1), 9–30.
21. Hamel, G., & Prahalad, C.K. (1990). The core competence of the corporation.
Harvard Business Review, 68(3), 79–91.
22. Afuah, A.N. (1998). Innovation Management: Strategies, Implementation, and
Profits. New York: Oxford University Press.
23. Hamel, G., & Prahalad, C.K. (1990). The core competence of the corporation.
Harvard Business Review, 68(3), 79–91.
24. Henderson, R.M., & Clark, K.B. (1990). Architectural innovation: The recon?gur-
ation of existing product technologies and the failure of established ?rms. Adminis-
trative Science Quarterly, 35(1), 9–30.
25. Kotler, P. (1998). Marketing Management: Analysis, Planning, Implementation,
and Control (9th edn). Upper Saddle River, NJ: Prentice Hall.
26. The 4Ps (Product, Pricing, Promotion and Placement) framework is a marketing
framework and does not belong to a strategy textbook. However, since students
often ask questions about it, I have decided to add a very short note on it. Those
readers who need details can refer to the references.
27. This section closely follows a section in the author’s previous book. See Afuah, A.N.
(2003). Business Models: A Strategic Management Approach. New York: McGraw-
Hill/Irvin.
28. Tully, S. (1993). EVA, the real key to creating wealth. Fortune 128 (September 20,
1993), 38–50. Stern, J., Stewart, B. & Chew, D. (1992). The EVA ?nancial
management system. Journal of Applied Corporate Finance, 8, 32–46.
Case 1 The New World Invades France’s Terroir
1. Genetically modi?ed wine: Unleash the war on terroir. (December 19, 2007). The
Economist.
2. Terroir and technology. Survey: Wine. (December 16, 1999). The Economist.
3. The brand’s the thing. Survey: Wine. (December 16, 1999). The Economist.
4. Viegas, J. (2007). Ancient Mashed Grapes Found in Greece. Retrieved June 16,
2008, from http://dsc.discovery.com/news.
5. Jefford, A. (July 13, 2007). Rise of the terrorists. Financial Times.
6. Médoc 1855 classi?cation. (n.d.). Retrieved June 16, 2008, from http://
www.thewinedoctor.com/regionalguides/bordeauxclassi?cations.shtml.
7. Bartlett, C.A. (2002). Global Wine Wars: New World Challenges Old (A) (HBS
case # 9–303–056). Harvard Business School Press.
8. Terroir and technology. Survey: Wine. (December 16, 1999). The Economist.
9. Rachman, G. (December 16, 1999). The globe in a glass. Survey: Wine. The
Economist.
10. The brand’s the thing. Survey: Wine. (1999, December 16). The Economist.
460 Notes
11. Rachman, G. (December 16, 1999). The globe in a glass. Survey: Wine. The
Economist.
12. France’s wine industry: Those vulgar markets. (January 20, 2005). The Economist.
13. Wine consumption: Sour grapes in France. (December 21, 2007). The Economist.
Johnson, J. (July 22, 2004). Europe: New World ferment crisis for French wine.
Financial Times.
14. France’s wine industry: Those vulgar markets. (January 20, 2005). The Economist.
15. Johnson, J. (July 22, 2004). Europe: New World ferment crisis for French wine.
Financial Times.
Case 2 Sephora Takes on America
1. Raper, S. (1993). Business & Company Resource Center: News/Magazines, Shop
8 and Sephora to merge. WWD, 166(21), 6.
2. Aktar, A. (1996). Business & Company Resource Center, Ross B-School, Kresge:
News/Magazines, Sephora’s superstore: Setting a faster pace for French cosmetics.
WWD, 172(94), 1.
3. Ibid.
4. Business & Company Resource Center, Ross B-School, Kresge: Source Citation:
“Sephora Holdings S.A.” International Directory of Company Histories, Vol. 82.
St James Press, 2007.
5. IBISWorld Industry Report. (March, 2008). Beauty, cosmetics & fragrance stores
in the US (p. 38).
6. Ibid.
7. Ibid.
8. IBISWorld Industry Report. (March, 2008). Beauty, cosmetics & fragrance stores
in the US (p. 11).
9. IBISWorld Industry Report. (March 2008). Beauty, cosmetics & fragrance stores
in the US (p. 9).
10. Maestri, N. (February 14, 2007). J.C. Penney kicks off brand campaign. Reuters
UK.
11. Business & Company Resource Center. Ulta Salon, Cosmetic & Fragrance, Inc.
Company History.
12. Ibid.
13. Ibid.
14. Annual Report. (April 2008). Ulta Salon, Cosmetic & Fragrance, Inc. 2007 (p. 26).
15. Hoover’s Online. Ulta Salon, Cosmetic & Fragrance, Inc. Company Pro?le.
16. Sephora ?les suit against federated department stores. (August, 1999). Business
Wire.
17. Injunction granted: Sephora wins round in federated battle. (February, 2000).
Women’s Wear Daily.
18. IBISWorld Industry Report. (March, 2008). Beauty, Cosmetics & Fragrance Stores
in the US (p. 22).
19. Hoover’s Online. Bath & Body Works, Inc. Company Pro?le.
20. IBISWorld Industry Report. (March, 2008). Beauty, Cosmetics & Fragrance Stores
in the US (p. 24).
Case 3 Netflix: Responding to Blockbuster, Again
1. Spielvogel, C. (2007). Blockbuster’s total access gains subs. Retrieved May 2,
2007, from http://www.videobusiness.com/article/CA6438581.html.
2. Business 2.0 Magazine Staff. (2006). 10 people who don’t matter. Retrieved July
Notes 461
21, 2008, from http://money.cnn.com/2006/06/21/technology/10dontmatter.biz2/
index.htm.
3. A history of home video. (2005). Retrieved July 21, 2008, from http://
www.idealink.org/Resource.phx/vsda/pressroom/history-of-industry.htx.
4. Ibid.
5. Ault, S. (2007). Rental stores stock more niche titles. Retrieved July 21, 2008,
from http://www.videobusiness.com/article/CA6446483.html?q=Rental+Stores+
Stock+More+Niche+Titles.
6. Datamonitor. (June 2006). Global recorded DVD & video industry pro?le.
7. Blockbuster annual report, 1999.
8. IbisWorld. (May 8, 2007). IbisWorld industry report: Video tape and disc rental in
the U.S.
9. O’Brien, J.M. (2002). The Net?ix effect. Retrieved July 21, 2008, from http://
www.wired.com/wired/archive/10.12/net?ix.html.
10. Andrews, P. (2003). Videos without late fees, Reed Hastings, digital entrepreneur.
Retrieved July 21, 2008, from http://www.usnews.com/usnews/culture/articles/
031229/29hastings. htm.
11. Net?ix consumer press kit. (2007). Retrieved July 21, 2008, from http://www.net?ix.
com/MediaCenter?id=5379.
12. Leohardt, D. (June 7, 2006). What Net?ix could teach Hollywood. New York
Times.
13. Dornhelm, R. (2006). Net?ix expands indie ?lm biz. Retrieved July 21, 2008, from
http://marketplace.publicradio.org/shows/2006/12/08/AM200612081.html.
14. Netflix Prize. (2006). Retrieved June 10, 2007, from www.net?ixprize.com.
15. Netflix website. (2007). Retrieved June 10, 2007, from www.net?ix.com.
16. Netherby, J. (October 21, 2002). Three’s company in online rental. Video Business.
17. Ibid.
18. Lieberman, D. (April 20, 2005). Movie rental battle rages. USA Today.
19. Kipnis, J. (September 4, 2004). On the video beat. Billboard.
20. Daikoku, G., & Brancheau, J. (August 12, 2004). Blockbuster moves to capture
online DVD rental business. Gartner G2 Analysis.
21. Wasserman, T. (December 19, 2005). Category wars: Blockbuster to hit replay on
ads for online service; Service still trails rival Net?ix by 3 million subscribers.
Brandweek.
22. Sweeting, P. (February 28, 2005). Blue turns to distributors for online product.
Video Business.
23. Oestricher, D. (May 5, 2005). Blockbuster’s new initiatives produce mixed results
in 1Q. Dow Jones Newswires.
24. Wasserman, T. (December 19, 2005). Category wars: Blockbuster to hit replay on
ads for online service; Service still trails rival Net?ix by 3 million subscribers.
BrandWeek.
25. Ibid.
26. Blockbuster (video store). (2007). Retrieved June 10, 2007, from http://en.wikipedia.
org/w/index.php?title=Blockbuster_%28video_store%29&oldid=137206813.
27.Blockbuster Online. (2007). Retrieved June 10, 2007, from www.blockbuster.
com.
28. Blockbuster announces new lower prices subscription plans for online subscribers.
(2007). Retrieved June 12, 2007, from http://www.b2i.us/pro?les/investor/
ResLibraryView.asp? BzID=553&ResLibraryID=20305&Category=1027.
29. Gonzalez, N. (2006). Movie downloads: iTunes v. the rest. Retrieved July 21, 2008,
from http://www.techcrunch.com/2006/10/15/itunes-movies-v-the-rest/.
30. Leohardt, D. (June 7, 2006). What Net?ix could teach Hollywood. New York
Times.
462 Notes
31. Hollywood and the Internet: Coming soon. (February 21, 2008). The Economist.
32. Apple TV. (2007). Retrieved June 10, 2007, from www.apple.com/appletv.
Case 4 Threadless in Chicago
1. Brabham, D.C. (2008). Outsourcing as a model for problem solving: An introduc-
tion and cases. Convergence: The International Journal of Research Into New
Media Technologies, 14(1), 75–90. Gilmour, M. (November 26, 2007). Threadless:
From clicks to bricks. Business Week.
2. Ogawa, S., & Piller, F.T. (2006). Reducing the risk of new product development.
MIT Sloan Management Review, 47(2), 65–71.
3. Ibid.
4. Weingarten, M. (June 18, 2007). “Project runway” for the T-shirt crowd. Business
2.0 Magazine.
5. Kawasaki, G. (2007). Ten questions with Jeffrey Kalmikoff, Chief Creative Of?cer
of skinnyCorp/Threadless. Retrieved June 17, 2008, from blog.guykawasaki.com/
2007/06/ten_ questions_w.html.
6. Chafkin, M. (2008, June). The customer is the company. Inc. Magazine. Retrieved
July 21, 2008, from http://www.inc.com/magazine/20080601/the-customer-is-the-
company.html.
7. Boutin, P. (2006). Crowdsourcing: Consumers as creators. Retrieved June 26,
2008, from http://www.businessweek.com/innovate/content/jul2006/
id20060713_755844.htm.
8. Chafkin, M. (June, 2008). The customer is the company. Inc. Magazine. Retrieved
July 21, 2008, from http://www.inc.com/magazine/20080601/the-customer-is-the-
company.html.
9. Threadless Chicago. (2008). Retrieved June 17, 2008, from http://www.threadless.
com/retail.
10. Chafkin, M. (2008, June). The customer is the company. Inc. Magazine. Retrieved
July 21, 2008, from http://www.inc.com/magazine/20080601/the-customer-is-the-
company.html.
11. Weingarten, M. (June 18, 2007). “Project runway” for the T-shirt crowd. Business
2.0 Magazine.
12. Kawasaki, G. (2007). Ten questions with Jeffrey Kalmikoff, Chief Creative Of?cer
of skinnyCorp/Threadless. Retrieved June 17, 2008, from blog.guykawasaki.com/
2007/06/ten_ questions_w.html.
13. Threadless Chicago. (2008). Retrieved June 17, 2008, from http://www.threadless.
com/retail.
14. Ibid.
Case 5 Pixar Changes the Rules of the Game
1. Hormby, T. (2007). The Pixar Story: Dick Shoup, Alex Schure, George Lucas,
Steve Jobs, and Disney. Retrieved June 21, 2008, from http://www.the-numbers.
com/movies/series/Pixar.php.
2. Toy’ wonder. (1995). Retrieved June 29, 2008, from www.ew.com/ew/article/
0,,299897,00.html.
3. From “Toy Story” to “Chicken Little.” (2005, December 8). The Economist.
4. Schlender, B., & Furth, J. (1995). Steve Jobs’ amazing movie adventure. Disney is
betting on Computerdom’s ex-boy wonder to deliver this year’s animated Christ-
mas blockbuster. Can he do for Hollywood what he did for Silicon Valley?
Retrieved June 21, 2008, from http://money.cnn.com/magazines/fortune/for-
tune_archive/1995/09/18/206099/index.htm.
Notes 463
5. Toy’ Wonder. (1995). Retrieved June 29, 2008, from www.ew.com/ew/article/
0,,299897,00.html.
6. Schlender, B., & Furth, J. (1995). Steve Jobs’ amazing movie adventure. Disney is
betting on Computerdom’s ex-boy wonder to deliver this year’s animated Christ-
mas blockbuster. Can he do for Hollywood what he did for Silicon Valley?
Retrieved June 21, 2008, from http://money.cnn.com/magazines/fortune/fortune_
archive/1995/09/18/206099/index.htm.
7. Hormby, T. (2007). The Pixar Story: Dick Shoup, Alex Schure, George Lucas,
Steve Jobs, and Disney. Retrieved June 21, 2008, from http://www.the-numbers.
com/movies/series/Pixar.php.
8. Face value: Finding another Nemo. (February 5, 2004). The Economist.
9. Disney: Magic restored. (April 17, 2008). The Economist.
10. Kafka, P. (January 23, 2006). Mickey’s big move. Forbes.
Case 6 Lipitor: World’s Best-selling Drug (2008)
1. This minicase draws heavily on the case of Leafstedt, M., Marta, A., Marwaha, J.,
Schallwig, P., & Shinkle, R. (2003) Lipitor: At the heart of Warner-Lambert. In A.
Afuah, Business Models: A Strategic Management Approach (356–70).
2. Loftus, P. (2008). P?zer to protect Lipitor sales until November 2011, Retrieved
June 20, 2008, from http://www.smartmoney.com/news/ON/index.cfm?story=
ON–20080618–000684–1151.
3. Grom, T. (May, 1999). Reaching the goal. PharmaBusiness.
4. Mincieli, G. (June, 1997). Make room for Lipitor. Med Ad News.
5. Lipitor. (March, 1997). R&D Directions.
6. Understanding clinical trials. (2008). Retrieved July 22, 2008, from http://clinical-
trials.gov/ct2/info/understand.
Case 7 New Belgium: Brewing a New Game
1. A bid for Bud. (June 19, 2008). The Economist.
2. Ibid.
3. Inc. staff. (2006). Bringing fundamental change to everyday life. And, for that
matter, death. Retrieved July 22, 2008, from http://www.inc.com/magazine/
20061101/green 50_integrators.html.
4. Kessenides, D. (June 2005). Green is the new black. Inc Magazine, 27(6), 65–6.
5. The brewery with the big green footprint. (2003). In Business, 25(1), 16.
6. Raabe, S. (2005, June 1). Brewery supplements pro?ts with energy savings. Knight
Ridder Tribune Business News, (p. 1).
7. http://fcgov.com/utilities/wind-power.php.
8. Kessenides, D. (June, 2005). Green is the new black. Inc Magazine, 27(6), 65–6.
9. Raabe, S. (June 1, 2005). Brewery supplements pro?ts with energy savings. Knight
Ridder Tribune Business News, (p. 1).
10. Cohn, D. (2006). This green beer’s the real deal. Retrieved July 22, 2008, from
http://www.wired.com/news/technology/0,70361-0.html.
11. Kessenides, D. (June 2005). Green is the new black. Inc Magazine, 27(6), 65–6.
12. http://www.paulnoll.com/Oregon/Canning/number-liters.html.
13. “Liquid—metric to non-metric. (n.d.). Retrieved July 22, 2008, from http://
www.paulnoll.com/Oregon/Canning/number-liters.html.
14. Brewing up fun in the workplace. (n.d.). Retrieved July 22, 2008, from http://
www.e-businessethics.com/NewBelgiumCases/NBB-BreweryFun.pdf.
15. Armstrong, D. (November 28, 2006). Philanthropy gets serious for some com-
464 Notes
panies: Growing number are making donations from revenue, not from pro?t.
Inc.com.
16. www.newbelgiumbrewery.com/philanthropy.
17. Brand evangelists/ambassadors/champions are consumers that feel so strongly con-
nected with the brand that they spread the word of the brand and attempt to help
the brand succeed.
18. http://www.mylifeisbeer.com/beer/bottles/bottledetail/293/.
19. Inc. staff. (2006). Bringing fundamental change to everyday life. And, for that
matter, death. Retrieved July 23, 2008, from http://www.inc.com/magazine/
20061101/ green50_ integrators.html.
20. Ibid.
Case 8 Botox: How Long Would the Smile Last?
1. Weise, E. (2003). The little neurotoxin that could. Retrieved February 16, 2008,
from http:/www.usatoday.com/news/health/2003-04-20-botox_x.htm.
2. Ibid.
3. Fletcher, A. (2002). Boon for Botox injections expected with FDA’s approval.
Retrieved July 18, 2008, from http://www.bizjournals.com/denver/stories/2002/04/
22/newscolumn2.html.
4. Smooth face, big Botox: A poison turned cosmetic treatment that might be the
next blockbuster. (2002, February 14). The Economist.
5. Vangelova, L. (1995). Botulinum Toxin: A poison that can heal. Retrieved July 17,
2008, from http://www.fda.gov/fdac/features/095_bot.html.
6. Brush, M. (2003). Company Focus: 3 body-beautiful stocks for bountiful returns.
Retrieved July 17, 2008, from http://moneycentral.msn.com/content/P65606.asp.
7. Weisul, K. (2002, May 6). Botox: Now it’s a guy thing. BusinessWeek Online.
8. Creager, E. (2002). Move over, Tupperware: Botox injections are the latest thing at
home parties. Retrieved February 16, 2008, from http://www.woai.com/guides/
beauty/story.aspx?content_id=16358daf-d7db-4ade-a757-9e8d7cf30212.
9. Smooth face, big Botox: A poison turned cosmetic treatment that might be the
next blockbuster. (2002, February 14). The Economist. Creager, E. (2002). Move
over, Tupperware: Botox injections are the latest thing at home parties. Retrieved
February 16, 2008, from http://www.woai.com/guides/beauty/story.aspx?
content_id=16358daf-d7db-4ade-a757-9e8 d7cf30212.
10. Smith, A. (2006). Plenty of smooth sailing ahead for Botox. Retrieved July 17,
2008, from http://money.cnn.com/2006/04/03/news/companies/allergan_botox/
index.htm.
11. Ibid.
12. Emerging uses of Botox. (2005). Retrieved July 18, 2008, from http://
www.botoxfacts.ca/uses.html.
13. Ibid.
14. Facelift information. (2008). Retrieved February 17, 2008, from http://
www.cosmeticplasticsurgerystatistics.com/facelifts.html#INFO.
15. Reloxin, botulinum toxin type A: Treatment for Aesthetics. (2007). Retrieved July
17, 2008, from http://www.drugs.com/nda/reloxin_071206.html.
16. The most popular cosmetic procedures: popular cosmetic surgery. (n.d.). Retrieved
July 17, 2008, from http://women.webmd.com/features/most-popular-cosmetic-
procedures.
17. Realizing opportunities: Annual Report 2007. (2008). Retrieved July 18, 2008,
from http://?les.shareholder.com/downloads/AGN/362148606x0x184012/
BB8ED2E7-30CF-443D-A2F7-0935FE134F78/2007AnnualReport.pdf.
18. Rundle, R.L. (2007). Botox faces worry lines in smooth skin game. Retrieved July
Notes 465
18, 2008, from http://medicalnewstouse.blogspot.com/2007/12/botox-may-face-
competition.html.
19. I would like to thank Adeesh Agarwal, Michael Johnson, Tyler Link, Samir Patel,
Jonathan Stone, and Kevin Tsuchida for drawing my attention to Botox when they
wrote a case on Botox in the class New Game Business Model at the Stephen M.
Ross School of Business at the University of Michigan.
Case 9 IKEA Lands in the New World
1. List of the 100 wealthiest people. (2008). Retrieved June 24, 2008, from http://
en.wikipedia. org/wiki/List_of_billionaires.
2. Tycoons: Bill v Ingvar. (April 7, 2004). The Economist.
3. Facts & ?gures. (2008). Retrieved June 24, 2008, from http://www.ikea.com/ms/
en_US/about_ikea_new/facts_?gures/index.html.
4. Ibid.
5. Crush chaos at Ikea store opening. (2005). Retrieved June 27, 2008, from http://
news.bbc.co.uk/2/hi/uk_news/england/london/4252421.stm.
6. Capell, K., Sains, A., Lindblad, C., Palmer, A.T., Bush, J., Roberts, D., & Hall, K.
(2005). Ikea: How the Swedish retailer became a global cult brand. Retrieved June
27, 2008, from http://www.businessweek.com/magazine/content/05_46/
b3959001.htm.
7. Ibid.
8. Chang, J. (2005). How IKEA, MoMA connect with design talent. Retrieved June
27, 2008, from http://www.metropolismag.com/cda/story.php?artid=1391.
9. Facts & ?gures. (2008). Retrieved June 24, 2008, from http://www.ikea.com/ms/
en_US/about_ikea_new/facts_?gures/index.html.
10. Ibid.
11. Capell, K., Sains, A., Lindblad, C., Palmer, A.T., Bush, J., Roberts, D., & Hall, K.
(2005). Ikea: How the Swedish retailer became a global cult brand. Retrieved June
27, 2008, from http://www.businessweek.com/magazine/content/05_46/
b3959001.htm.
12. Ibid.
13. Ibid.
14. IKEA: Flat-pack accounting. (2006, May 11). The Economist.
Case 10 Esperion: Drano for Your Arteries?
1. CDC IXIS Securities. (February 24, 2003). Cholesterol: The Battle Rages On.
2. Ibid.
3. Ibid.
4. Two drugs are notable exceptions. Crestor (AstraZeneca) was expected to be
launched in 2003 with a better safety and ef?cacy pro?le than any currently mar-
keted statin. Additionally, Novartis/Sankyo’s Pitavastin was a statin currently in
Phase IIb trials in Europe expected to be launched in 2007.
5. CDC IXIS Securities. (February 24, 2003). Cholesterol: The Battle Rages On.
6. Deutsche Bank Securities. (December 22, 2003). Pfizer Inc.: Building Cardio
Dominance.
7. How far we’ve come. (August 1, 2006). Pharmaceutical Executive.
8. CDC IXIS Securities. (February 24, 2003). Cholesterol: The Battle Rages On.
9. UBS Investment Research. (November 21, 2003). Merck & Co.
10. Harper, M. (2003). Merck’s troubles, Schering’s solution. Retrieved December 6,
2006, from http://www.forbes.com/2003/11/21/cx_mh_1121mrk.html.
11. Bristol-Myers Squibb Co. (2002). 10-K.
466 Notes
12. Bristol-Myers Squibb Co. (November 19, 2003). Where’s the Growth?
Oppenheimer Equity Research
13. Ibid.
14. CDC IXIS Securities. (February 24, 2003). Cholesterol: The Battle Rages On.
15. Ibid.
16. Frost & Sullivan. (November 10, 2005). U.S. Lipid Therapeutics Market. (Section
2.6.1).
17. Thomson Financial Venture Economics. (September 27, 2006). Esperion Thera-
peutics, Inc Company Report (VentureXpert).
18. Rozhon, T. (December 22, 2003). P?zer to buy maker of promising cholesterol
drug. New York Times.
19. Datamonitor Company Pro?les. (January 24, 2004). Esperion Therapeutics—–
history.
20. Winslow, R. (November 5, 2003). New HDL drug shows promise in heart study.
The Wall Street Journal.
21. PR Newswire. (October 31, 2000). Esperion Therapeutics, Inc. announce results
for third quarter 2000.
22. Rozhon, T. (December 22, 2003). P?zer to buy maker of promising cholesterol
Drug. New York Times.
23. Winslow, R. (November 5, 2003). New HDL drug shows promise in heart study.
The Wall Street Journal.
24. Braunschweiger, A. (June 26, 2003). Esperion shares surge on study of heart-plaque
treatment. Dow Jones Business News.
25. Esperion. (2002). 10-K.
26. Ibid.
27. Dimasi, J., Hansen, R., & Grabowski, H. (2003). The price of innovation: New
estimates of drug development costs. Journal of Health Economics, 22(2), 151–85.
28. Esperion. (2002). 10-K.
29. Ibid.
30. Ibid.
31. Young, P. (September 18, 2002). Troubling times for Pharma. Chemical Week.
32. P?zer.com. (March 2004). Press Release.
33. Ibid.
34. Goetzl, D. (October 1, 2001). Media mavens: Donna Campanella. Advertising Age.
35. Ibid.
36. Abboud, L., & Hensley, S. (September 3, 2003). Factory shift: New prescriptions
for drug makers; update the plants—after years of neglect, industry focuses on
manufacturing; FDA acts as a catalyst; The three story blender. Wall Street Journal.
37. Physician survey ranks P?zer sales force ?rst in industry for ?fth consecutive year.
(January 20, 2000). PR Newswire.
38. P?zer sales force most esteemed by US doctors. (February 18, 2002). Marketletter.
39. Mintz, S.L. (2000). What is a merger worth? Retrieved October 12, 2006, from
http://www.cfo.com/article.cfm/2988576
40. Morrow, D.J., & Holson, L.M. (November 5, 1999). Warner—Lambert gets P?zer
offer for $82.4 billion. New York Times.
41. P?zer to buy maker of promising cholesterol drug. (December 22, 2003). New York
Times.
42. Ibid.
43. Ibid.
44. P?zer to acquire Esperion Therapeutics to extend its research commitment in car-
diovascular disease. (December 21, 2003). Pfizer press release.
45. Pfizer to buy Esperion for $1.3bn. (2003). Retrieved October 10, 2006, from http://
www. cnn.com/2003/BUSINESS/12/21/us.p?zer.reut/.
Notes 467
Case 11 Xbox 360: Will the Second Time be Better?
1. PONG-story: Introduction. (2008). Retrieved July 15, 2008, from http://
www.pong-story.com/intro.htm. Atari Museum home page. (n.d.). Retrieved July
15, 2008, from http://www.atarimuseum.com/mainmenu/mainmenu.html.
2. Herman, L., Horwitz, J., Kent, S., & Miller, S. (2002). The history of video games.
Retrieved July 15, 2008, from http://www.gamespot.com/gamespot/features/video/
hov/index.html.
3. Ibid.
4. Ibid.
5. Vogelstein, F. (n.d.). Rebuilding Microsoft. Retrieved December 20, 2006, from
http://www.wired.com/wired/archive/14.10/microsoft_pr.html.
6. Wii price is high by historical standards. (2006). Retrieved July 15, 2008,
from http://diggy.wordpress.com/2006/10/17/wii-price-is-high-by-historical-
standards/.
7. Xbox live. (n.d.). Retrieved July 15, 2008, from http://en.wikipedia.org/wiki/
Xbox_Live.
8. Becker, D. (2004). “Halo 2” clears record $125 million in ?rst day. Retrieved July
15, 2008, from http://news.com.com/Halo+2+clears+record+125+million+in+?rst+
day/2100– 1043_3–5447379.html.
9. Gamers wipe out supply of Nintendo’s new Wii. (2006). Retrieved July 15, 2008,
from http://www.pcmaczone.co.uk/modules.php?name=News&?le=article&sid=
386.
10. Ibid.
11. Playing a different game. (October 26, 2006). The Economist.
Case 12 Nintendo Wii: A Game-changing Move
1. Video game. (2007). Retrieved December 25, 2007, from http://en.wikipedia.org/
wiki/Video_games.
2. Afuah, A.N., & Grimaldi, R. (2003). Architectural innovation and the attacker’s
advantage from complementary assets: The case of the video game console
industry. Working Paper, Stephen M. Ross School of Business at the University of
Michigan, Ann Arbor, MI.
3. Megahertz is a crude measure of the speed or power of a processor. The higher the
Megahertz, the faster the processor is supposed to be. The “number of polygons” is
a measure of the graphical detail in the resulting images.
4. Playing a different game: Does Nintendo’s radical new strategy represent the
future of gaming? (October 26, 2006). The Economist. Gapper, J. (July 13, 2007).
Video games have rediscovered fun. Financial Times.
5. Ibid.
6. O’Brien, J.M. (2007). Wii will rock you. Retrieved December 27, 2007, from
http://www.mutualofamerica.com/articles/Fortune/June%202007/fortune2.asp.
7. Turott, P. (2007). Xbox 360 vs. PlayStation 3 vs. Wii: A technical comparison.
Retrieved December 27, 2007, from http://www.winsupersite.com/showcase/Xbox
360_ps3_wii.asp.
8. Gapper, J. (July 13, 2007). Video games have rediscovered fun. Financial Times.
9. Bird D., Bosco N., Nainwal S., & Park E. (2007). The Nintendo Wii. Working
Case, Stephen M. Ross School of Business at the University of Michigan, Ann
Arbor, MI.
10. O’Brien, J.M. (2007). Wii will rock you. Retrieved January 2, 2008, from http://
money. cnn.com/magazines/fortune/fortune_archive/2007/06/11/100083454/
index.htm.
468 Notes
Author Index
Abboud, L. 467
Abernathy, W.J. 448, 455, 456
Afuah, A.N. 449, 452, 453, 454, 455,
457, 458, 459, 460, 464, 468
Agarwal, A. 450, 466
Aguilar, F. 328, 459
Aktar, A. 461
Allen, G.B. 459
Allen, T. 454, 455
Anderson, C. 67, 72, 87, 450
Andrews, K. 28, 448
Andrews, P. 462
Anthony, S.D. 455
Arikan, A.M. 448, 452
Armstrong, D. 464
Arrow, K.J. 457
Ault, S. 462
Bales, C.F. 343, 447, 459
Barney, J.B. 353, 448, 452, 453, 454,
460
Bartlett, C.A. 452, 460
Basdeo, D.K. 458
Baxter, J. 456
Becker, D. 468
Besanko, D. 450, 453, 454
Bettis, R.A. 454, 455
Bhatia, T. 452
Bird, D. 468
Borrus, M.G. 457
Bosco, N. 468
Boutin, P. 463
Bower, J.L. 455
Brabham, D.C. 463
Brancheau, J. 462
Brandenburger, A.M. 290, 450, 457, 458
Brandt, R. 454
Braunschweiger, A. 467
Brealey, R.A. 449
Brush, M. 465
Brynjolfsson, E. 450
Buaron, R. 447, 459
Burns, E. 452
Bush, J. 466
Byrne, J.A. 454
Capell, K. 449, 466
Carpenter, G.S. 453
Carroll, C.D. 457
Chafkin, M. 447, 463
Chai, K. 434
Chandler, A.D. 28, 448, 454, 459
Chang, J. 466
Chatterjee, P.C. 343, 447, 459
Chew, D. 460
Chock, C. 383
Christensen, C.M. 202, 204–5, 207–8,
209, 212, 214, 216, 220, 454, 455
Clark, K.B. 190, 448, 455, 456, 460
Cohn, D. 464
Coleman, Jr, H.J. 454
Colombo, V. 434
Constant, E.W. 455
Cornebise, J. 452
Crane, C. 393
Creager, E. 451, 465
Cusumano, M.A. 452
Daikoku, G. 462
Davidow, W.H. 454
Dedrick, J. 116, 451
Deimler, M.S. 459
Derfus, P.J. 458
Dharamsey, A. 405
Digman, L.A. 450
Dimasi, J. 426, 427, 467
Dixit, A.K. 457
Dornhelm, R. 462
Downes, L. 452
Dranove, D. 450, 453, 454
Duran, L. 405
Dyer, J.H. 451
Farrell, C. 457
Fierman, J. 184, 454, 455
Fishburne, F. 453
Fishman, C. 453
Fjeldstad, O.D. 348, 447, 459
Fletcher, A. 465
Foster, R.D. 201, 455
Frederickson, J.W. 29, 449
Freeberg, D. 450
Fujimoto, T. 190, 455
Furth, J. 463, 464
Fusfeld, A.R. 455
Galbraith, J.R. 454
Ganguly, T. 383
Gapper, J. 468
Gates, D. 451
Ghemawat, P. 447, 450, 453, 457,
458
Ghoshal, S. 449
Gilmour, M. 463
Gluck, F.W. 343, 447, 459
Goetzl, D. 467
Gogel, D. 343, 447, 459
Gonzalez, N. 462
Grabowski, H. 426, 467
Grant, R.M. 28, 449, 451
Greeno, C. 383
Grimaldi, R. 468
Grimm, C.M. 458
Grom, T. 464
Hall, K. 466
Hambrick, D.C. 29, 449
Hamel, G. xvi, 28, 119, 355, 448, 452,
454, 455, 460
Hammond, J.S. 459
Hansen, R. 426, 467
Harper, M. 466
Heil, O. 458
Henderson, R.M. 460
Hensley, S. 467
Herman, L. 468
Higgins, C.A. 455
Hill, C.W.L. 454
Hitt, M.A. 29, 449
Holson, L.M. 467
Hormby, T. 463, 464
Horwitz, J. 468
Hoskisson, R.E. 29, 449
Houston, P.W. 450
Howe, J. 107, 451
Howell, J.M. 455
Hu, Y. 450
Huntley, E. 434
Huyghebaert, N. 458
Ireland, R.D. 29, 449
Jefford, A. 460
Johnson, J. 461
Johnson, M. 450, 466
Johnson, W. 393
Jones, G.R. 454
Joseph, C. 405
Kafka, P. 464
Kanellos, M. 452
Kanoh, Y. 451
Kaplan, R.S. 350, 449, 460
Katz, M.L. 452
Kawasaki, G. 463
Kent, S. 468
Kessenides, D. 464
Kim, W.C. 459
Kipnis, J. 462
Knakal, J. 383
Knakal, T. 383
Kotler, P. 460
Kraemer, K.L. 116, 451
Kreps, D.M. 457
Krichbaum, S. 405
Lampel, J. 449
Laseter, T.M. 450
Latif, U. 453
Lawrence, P.R. 454
Leafstedt, M. 464
Leohardt, D. 462
Levy, B. 422
Lieberman, D. 462
Lieberman, M.B. 448, 453,
454
Lilien, G.L. 455
Lindblad, C. 466
Linden, G. 116, 451
Link, T. 450, 466
Lipman, S. 450
Loftus, P. 464
Lorsch, J.W. 454
Lyon, P. 422
470 Author Index
MacDonald, G. 450
McLean, A.N. 452
Mackenzie, I. 434
McWilliams, A. 459
Maestri, N. 461
Malone, M.S. 454
Manchanda, P. 452
Manly, J. 434
Marta, A. 464
Marwaha, J. 464
Mathews, J.A. 454
Matsuura, T. 434
Mauborgne, R. 459
Miles, G. 454
Miles, R.E. 454
Miller, S. 468
Mincieli, G. 464
Mintz, S.L. 467
Mintzberg, H. 29, 449
Montgomery, D.B. 448, 453,
454
Moon, Y. 448, 451, 459
Morrison, K. 377
Morrison, P.D. 455
Morrow, D.J. 467
Mui, C. 452
Myers, S.C. 449
Mylonadis, Y. 452
Nainwal, S. 468
Nair, H. 452
Nakamoto, K. 453
Nalebuff, B.J. 290, 457, 458
Netherby, J. 462
Neumark, K. 393
Norton, D.P. 350, 449, 460
O’Brien, J.M. 444, 462,
468
Oestricher, D. 462
Ogawa, S. 463
Olsen, S. 453
Oster, S. 28, 448, 457, 459
Otsuka, M. 457
Overdorf, M. 454, 455
Palmer, A.T. 466
Paradowski, J. 377
Park, E. 468
Park, J.Y. 450
Parker, G. 452
Patel, S. 450, 466
Perrigo, C. 393
Peteraf, M.A. 448
Peterson, S. 422
Piller, F.T. 463
Pindyck, R.S. 456, 457, 458
Podolny, J. 450
Porter, M.E. 28, 268–9, 337, 345, 447,
448, 453, 457, 459
Pototschnik, S. 377
Prahalad, C.K. 28, 119, 255, 355, 448,
452, 454, 455, 460
Puri, A. 344, 447, 459
Quinn, J.B. 449
Quittner, J. 452
Raabe, S. 464
Rachman, G. 460, 461
Raper, S. 461
Raynor, M.E. 455
Rindova, V.P. 458
Rivkin, J.W. 447, 448, 449, 453
Roberts, D. 466
Roberts, E.B. 455
Robertson, T.S 458
Rochet, J. 452
Rosenbloom, J. 422
Rosenbloom, R.S. 452
Roth, E.A. 455
Rothwell, R. 266, 457
Rozhon, T. 467
Rubinfeld, D.L. 456, 457, 458
Rumelt, R. 450
Rundle, R.L. 465
Ryall, M. 450
Sahal, D. 455
Sains, A. 466
Saloner, G. 450
Schallwig, P. 464
Schein, E. 184, 454
Schlender, B. 463, 464
Schmalensee, R. 453
Schön, D.A. 455
Searls, K. 455
Shanley, M. 450, 453, 454
Shapiro, C. 452
Shepard, A. 450
Sheremata, W.A. 453
Shinkle, R. 464
Shirky, C. 450
Siggelkow, N. 448
Simester, D. 450
Singh, H. 451
Author Index 471
Slacalek, J. 457
Smart, D.L. 459
Smith, A. 465
Smith, K.G. 458
Smith, M.D. 450
Smucker, M. 377
Snow, C.C. 454
Sonnack, M. 455
Spielvogel, C. 461
Stabell, C.B. 348, 447, 459
Stern, C.W. 459
Stern, J. 460
Stewart, B. 460
Stewart, T.A. 448, 452
Stone, J. 450, 466
Stuart, Jr, H.W. 299, 450, 457,
458
Sweeting, P. 462
Tapscott, D. 106, 447, 451
Taylor, C. 450
Teece, D.J. 124, 452, 453, 454
Tirole, J. 452, 459
Tischler, L. 106, 447, 451
Tripsas, M. 451
Tsuchida, K. 450, 466
Tucci, C.L. 454
Tully, S. 460
Turott, P. 468
Uttal, B. 184, 454, 455
Utterback, J.M. 455
Vamvaka, S. 377
Van Alstyne, M. 452
Vangelova, L. 465
Van de Gucht, L.M. 458
Vasilev, M. 422
Vernon, C. 456
Viegas, J. 460
Vogelstein, F. 468
Von Hippel, E. 75, 266, 455, 457
Wallace, J. 451
Walsh, J.P. 455
Wang, Y. 452
Wasserman, T. 462
Weingarten, M. 463
Weise, E. 465
Weisul, K. 465
Williams, A.D. 106, 447, 451
Winslow, R. 467
Wright, J.L. 450
Yof?e, D.B. 452
Young, P. 467
Zegveld, W. 266, 457
Zehra, S. 405
472 Author Index
Subject Index
4Ps: advantages 360; applications
357–61; disadvantages 360; elements
358–9; new games 360–1
7Cs framework: pro?tability 39
activities: activities to pro?ts 9–10;
activities, value, appropriability and
change see AVAC; components 39,
40–4, 56–60, 79–82; comprehensive
42, 44, 60, 113–14, 216, 297, 310,
324–5; coopetitors 43, 59; customer
value 45; differentiation 43, 57–8,
110–11; ?nancial support 257–8; ?rst
to establish a system of activities
154–5, 157; industry value drivers 42,
44, 59–60, 112; key takeaways 64;
long tail 81–2; low cost 43, 57–8;
new game activities see new game
activities; parsimonious 42, 44, 60,
113–14, 216, 297, 310, 324–5;
performance 40–4; primary 345–6,
349; resources/capabilities 44, 60;
Ryanair 56–60; support 346–7; value
chain 92, 345–7
adverse selection 263
aggregators: long tail 72
Amazon: long tail 68
Apple: intangibles 141; iPhone 6, 84,
91–2, 99–100, 210, 443; long tail
80–7
appropriability: activities, value,
appropriability and change see AVAC;
component 45–8, 61–2, 83–4;
coopetitors 45–7, 61; Google 133–4;
imitability 47–8, 61; key takeaways
64–5; resources 130; Ryanair 61–2;
substitutes/complements 48, 62; value
see value appropriation
assets: intangibles 118
attractiveness test: entry 306–8
AVAC: activities 39, 40–4, 56–60,
79–83, 361–3; advantages 364;
analysis 52–3, 79–87; applications
361–4; appropriability 45–8, 61–2,
83–4, 363; case example 79–87;
change 48–52, 62–4, 84–5, 363–4;
components 40, 362; data
organization 53; drivers 41; elements
361–4; framework 39–52; key
takeaways 64–6; logic 39–40; long
tail investigation 79; new game
strategies 17–19; outcomes compared
53; pro?tability assessment 35–66;
record labels/musicians 87; strategic
consequences 86; strategic planning
53; strategy execution 79; timing 53;
value 40, 82–3, 130, 363; worked
example 54–6
Balanced Scorecard: advantages 353;
applications 350–3; customers 352;
disadvantages 353; elements 351–2;
?nancial perspective 352; internal
business perspective 352; learning and
growth perspective 352; pro?tability
38
bargaining leverage 340–1
BCG’s Growth/Share Matrix:
advantages 333–4; application 330–4;
cash cows 331; disadvantages 334;
dogs 331–2; elements 330–2; question
marks 332; relative market share 332;
stars 331
better-off/alternatives test 308–12
Blockbuster Inc 76–7, 387–9
blockbusters: long tail 68, 72
books: value system 97–8
Botox 73, 77, 411–16
boundary spanners 189–90
breakeven 313–15, 367
business systems: strategy frameworks
343–5
buyers: bargaining power 340–1
capabilities: activities 44, 60;
competition 129; customers 118–19;
disruptive technologies 215–16; entry
304, 310; ?rst-mover disadvantages
162; game theory 297; globalization
237–8, 239–40; intangibles 118; key
takeaways 142–4; new games 13,
117–44; pro?tability 128–39; strategic
consequences 135
case studies: Botox 411–16; business
performances 3–4; Dell 4; Esperion
422–33; Goldcorp 4; Google 3; IKEA
417–21; Lipitor 3, 401–4; Net?ix
383–90; New Belgium 405–10;
Nintendo Wii 3, 442–6; P?zer 3,
401–4; Pixar 393–400; Ryanair 4;
Sephora 377–82; Threadless 4,
391–2; Xbox 434–41
cash ?ow 315–16, 367
CAT scans 124, 125
champions 189
change: activities, value, appropriability
and change see AVAC; components
48–52, 62–4, 84–5; coopetitors 51, 64;
?rst-mover advantages (FMAs) 50–2,
63; ?rst-mover disadvantages 50–2,
63, 159–60; Google 134; handicaps
49; key takeaways 66; new game
factors 48–52, 62–4; new games
11–13, 84–5; questions 49; resources
50, 62, 130; Ryanair 62–4; strengths
49; technology 159–60; value creation
50, 62
characteristic function 288
Cisco Systems: market value 36–8
commitments: ?rst-mover advantages
(FMAs) 155, 284–5; ?rst-mover
disadvantages 161; game theory
284–5; irreversible commitments 155,
284; relationships 161; sunk costs
161–2
Compaq: competition 15
competences: core competences 119
competition: appropriation 6; better
positioning 10; capabilities 129;
entry 307, 319; ?rst-mover advantages
(FMAs) 18, 145–77; ?rst-mover
disadvantages 145–77; globalization
238–42; government policies 260;
handicaps 15, 50–2, 160, 298;
incentives 108; innovation 206–7;
latent links 105; meeting the
competition 287; missed
opportunities 105; new games 17–19;
players 165; position-building new
games 26–7; product-market position
(PMP) 23; reactions 14–15; regular
new games 24–5; resource-based view
(RBV) 23; resource-building new
games 25; resources 129, 130;
strategic action 131; strategy
consequences 18–19
complementary assets: classi?cation
135; exploitation strategies 126;
identi?cation 135–6; imitability
124–6; investment 261; location 152;
preemption 151–2; public goods
261–2, 267; rank ordering 136; role
124–6; scarcity 169–70; strategic
consequences 126–7; teaming up
126–7; Teece Model 124–8; value
appropriation 94
complements: appropriability 48, 62;
boosting complements 122; Five
Forces Framework 343
components: activities 40–4, 56–60,
79–83; appropriability 45–8, 61–2,
83–4; change 48–52, 62–4, 84–5; new
game strategies 17–19; value 40, 82–3
comprehensive activities 42, 44, 60,
113–14, 216, 297, 310, 324–5
concentration of buyers 340
consumers: direct-to-consumer
marketing (DTC) 103; globalization
235; perceptual space 154; tastes/
needs 235; see also customers
contribution: contribution margin 322;
coopetitors 6; marginal contribution
289; political contributions 74
cooperation: latent links 105; missed
opportunities 105; value creation 6
cooperative games 276–7, 287–8
coopetitors: activities 43, 59;
appropriability 45–7, 61; change 51,
64; contribution 6; disruptive
technologies 214–15; entry 310;
environment 258–9; ?rst-mover
advantages (FMAs) 149; Five Forces
Framework 343; game theory
275–300; globalization 245; key
takeaways 32–3; long tail 71; players
165; position-building new games
474 Subject Index
26–7; positioning xvi, 4, 10, 24–9, 43,
112, 296–7, 310; reactions 17;
relationships 95; Ryanair 57, 61, 63;
value appropriation 94–5; value
creation 97–100
cosmetic surgery 73
costs: breakeven analysis 313–15; capital
asset pricing model (CAPM) 315–16;
cash ?ow method 315–16;
contribution margin 313; discount
rate 315; drivers 312–13; entry
312–19; estimation 313–16; ?xed
costs 341; high cost channels 69; low
see low cost; new game activities
316–19; opportunity cost 313; sunk
cost-related commitments 161–2;
switching see switching costs;
systematic risk 315; transaction costs
reduced 305–6; under globalization
237
crowdsourcing: cheaper/faster 108;
competitor incentives 108;
disadvantages 108; existing solutions
107; Internet 106–9; outsourcing 107;
public 107; signaling 108; talent 108
culture: failure tolerated 258, 260;
?nancial rewards 259–60; ?rst-mover
advantages (FMAs) 151;
organizational culture 151; people
184; sociocultural environment 255
customer value: activities 45; Google
131–3; products 9; resources 130
customers: Balanced Scorecard 352;
buyer choice under uncertainty 154;
capabilities 118–19; changing needs
159–60; cognitive limitations 69;
disruptive technologies 214; ?rst-at-
customers 153–4, 157; heterogeneity
69; most-favored customer clauses
287; new game activities 110–11;
reservation price 95; switching costs
149, 153
data: AVAC 53; Five Forces Framework
342; strategy frameworks 325; value
chain 347
debt capital 368–9
de?nitions 4–7
Dell: case studies 4; competition 15;
environment 15; ?rst-mover
advantages (FMAs) 154–5; ?rst-mover
disadvantages 159; new game
strategies 5, 16
demand: innovation 269; price elasticity
228–9
deterrence: game theory 283–4
developing countries: cell phones 74;
micro?nancing 75; regulation 238
differentiation: activities 43, 57–8,
110–11; inputs 340; products 340;
VIDE 356
discount retailing: rural areas 74
disruptive technologies: capabilities
215–16; characteristics 202;
coopetitors 214–15; customers 214;
disrupted/disruptors 205;
disruptiveness 218–20; handicaps
210–13; incumbents 206–8, 216–17;
industry value drivers 215; innovation
206–7; key takeaways 220–2; limited
coverage 209; new entrants 218; new
game strategies 210–16; new games
199–222; phenomenon 202–10;
potential 207–8; pro?tability 210–18;
rationale 203–5; resources 215–16;
shortcomings of model 209–10;
strategy focus 209–10; strengths
210–13; unique value 215–16;
usefulness 206–8; value appropriation
206–8; value chain 213–16; value
creation 206–8
distribution: high cost channels 69;
identi?cation 78; long tail 69, 71, 78
domestic corporations 234
drivers: costs 312–13
earnings: ?rst-mover advantages (FMAs)
155–7, 169; historical earnings 36;
stabilization 237
earnings per share 367
EBIDT 36
economic value added (EVA) 368–9
economies of scale: entry 304, 338;
?rst-mover advantages (FMAs) 147;
globalization 237–8
entry: attractiveness test 306–8;
better-off/alternatives test 308–12;
capabilities 304, 310; competition
307, 319; coopetitors 310; costs
312–19; economies of scale 304, 338;
encouragement 285; environment
307, 319; evaluation 306–16; ?rst-
mover advantages (FMAs) 318–19;
frameworks of analysis 308; game
theory 283, 285; growth 303;
industry value drivers 310;
Subject Index 475
international ?nancial market 304–5;
key players 308; key takeaways
321–2; market position 311; new
business 303–22; new games 316–21;
new value 317–18; opportunity cost
313; position-building new games
321; product lines 311; pro?tability
309–12; reasons 303–5; regular new
games 320–1; resource-building new
games 320; resources 304, 310, 318;
revolutionary new games 321;
Structure-Conduct-Performance (SCP)
308; transaction costs reduced 305–6;
value creation 317–18; vertical
integration 311–12
entry barriers: Five Forces Framework
338–40; game theory 283
environment: coopetitors 259;
demographic 255; economic 255;
entry 307, 319; factor conditions
258–9; failure tolerated 259; ?rst-
mover advantages (FMAs) 170;
globalization 246–7; government
policies 259–68; key takeaways
272–4; macroenvironments 246–7,
253–300, 343; natural environment
255–6; new games 252–74;
opportunities 15–16, 51, 64, 246–7,
253–6, 299, 319; PESTN analysis 15,
16, 216–17, 270–4; political-legal
254; procreative destruction 259; S
3
PE
framework 185–6; sociocultural 255;
technology 253–4; threats 15–16, 51,
64, 246–7, 253–6, 299, 319; value
appropriation 256–61; value creation
256–61
equity capital 368
Esperion 422–33
extendability 356
factor conditions: environment 258–9;
?rst-mover advantages (FMAs) 152;
innovation 268–9
factors: industry see industry factors; new
game see new game factors; SWOT
325–7
?nance: ?nancial rewards 259–60;
?nancial support 260–1; international
?nancial market 304–5;
micro?nancing 75
?nancial measures: 7Cs framework 38;
Balanced Scorecard 38; beneath the
numbers 38; Five Forces Framework
38; historical earnings 36; market
value 36–8; strategy 36–8, 367–9
?nancial support: activities 257–8;
micro?nancing 75; new games
259–61
?nancier 265–6
?rm-speci?c factors: Five Forces
Framework 342; long tail 73
?rms: globalization 236–8; long tail 73;
S
2
P 190–3; strategy/structure/rivalry
269–70
?rst-mover advantages (FMAs): brand
mindshare 154; buyer choice under
uncertainty 154; change 50–2, 63;
commitments 155, 284–5;
competition 18, 145–77; conclusions
169–74; coopetitors 149; earnings
155–7, 169; economic rents 148;
economies of scale 147; entry 318–19;
environment 170; equity 148;
exploitation 169, 172–4; factor
conditions 152; ?rst to establish a
system of activities 154–5, 157;
?rst-at-customers 153–4, 157; game
theory 298; globalization 244–5;
intellectual property 150; key
takeaways 174–7; leadership 149–51;
learning 151; managers 172;
mechanisms 146; numerical example
172–4; organizational culture 151;
plant and equipment 152; potential
13–14; preemption of scarce resources
151–3, 156–7; pursuit 157–8; rank
order 158; scope 145–55; size effects
147; switching costs 153; technology
and innovation 156; total available
market preemption 146–51, 156
?rst-mover disadvantages:
cannibalization 162; capabilities 162;
change 50–2, 63, 159–60;
competition 145–77; dominant logic
160; ?rst-mover inertia 159–60;
free-riding 159; game theory 298;
irreversible investments 161;
minimization/exploitation 170; prior
commitments 161–2; relationship-
related commitments 161; research &
development (R&D) 159, 170;
resources 162; scope 159–62;
strategic ?t 159–61; sunk cost-related
commitments 161–2; technological/
marketing uncertainty 159
Five Forces Framework: advantages 341;
476 Subject Index
applications 337–43; complementors
343; coopetitors 343; data
organization 342; disadvantages
342–3; elements 338–41; entry
barriers 338–40; ?rm-speci?c factors
342; industry attractiveness 341;
industry factors 342; narrowing down
343; opportunities 342; pro?tability
38; threats 342
followers: advantages 159; conclusions
169–74; strategy 161
Foster’s S-curve 201–2
France: wine 373–6
game theory: accommodate/merge/exit
287–8; advertising 280; capabilities
297; changing the game 290–3;
changing players 290–1; characteristic
function 288; commitments 284–5;
cooperative games 276–7, 287–8;
coopetitors 275–300; deterrence
283–4; dominant strategy 278–9, 280;
entry barriers 283; entry encouraged
285; ?rst-mover advantages (FMAs)
298; ?rst-mover disadvantages 298;
future anticipated 294; industry value
drivers 297; innovation 276;
insights/possibilities/consequences
294; limit pricing 283–4; limitations
294–5; lower price 277; Nash
equilibrium 279–80; new game
activities 295; new game factors 298;
noncooperative games 276–87;
payoffs 277, 280; predatory activities
285–6; prisoners’ dilemma 280,
281–2; raise price 277; repeated
simultaneous games 281–2;
reputation 285; research &
development (R&D) 297; resources
297; revenue sources 296; rules
fought/changed 285–6; sequential
games 282–4; signaling 285;
simultaneous games 278–82; strategic
questions 294; tacit collusion 287;
usefulness 293–9; value appropriation
293–9; value chain 295–9; value
creation 293–9
gatekeepers 189–90
GE/McKinsey Matrix: advantages 336;
applications 334–6; Business Strength/
Competitive Position 335;
disadvantages 336; elements 334–5;
industry attractiveness 334–5
globalization: capabilities 238, 239–40;
competition 238–42; consumers 235;
coopetitors 245; drivers 234–6;
earnings stabilization 237; economies
of scale 237–8; environment 246–7;
?rms 236–8; ?rst-mover advantages
(FMAs) 245–5; following buyer 237;
global adventurers 240–1; global
generic 242; global heavyweights
241–2; global multinationals 234;
global stars 241; government policies
236; growth 237; handicaps 242–3;
innovation 234–6; key takeaways
247–9; learning 238; markets 238;
meaning 232–3; multinational
corporations (MNCs) 233–4; new
games 223–51; offensive move 237;
opportunities 16, 246–7; product-
market position (PMP) 238–9;
production costs 237; regulation 238;
resources 239–40, 244; strategies
238–42; strengths 242–3; value
appropriation 224–30
Goldcorp Inc: case studies 4;
crowdsourcing 106–7; new game
strategies 4
Google: activities 131; appropriability
133–4; capabilities 131–6; case
studies 3; change 134; customer value
131–3; long tail 68, 70; new game
strategies 5, 16; research &
development (R&D) 6, 132
government policies: competition 261;
education 268; environment 259–68;
globalization 236; lead user 266;
macroeconomic fundamentals 268;
new games 265–8; rationale for role
261–4; regulation 267–8; value chain
228–30
growth: entry 303; globalization 236
handicaps: change 49; competition 15,
50–2, 160, 298; disruptive
technologies 210–13; globalization
242–3; new game strategies 109; new
games 136–9
historical earnings: pro?tability 36
Honda: core competences 119
IKEA 417–21
imitability: appropriability 47–8, 61;
complementary assets 124–7; value
appropriation 96; VIDE 356
Subject Index 477
industry: minimum ef?cient scale (MES)
264
industry attractiveness: Five Forces
Framework 341; GE/McKinsey
Matrix 334–5
industry factors: Five Forces Framework
342; long tail 71–3
industry value drivers: activities 41, 44,
59–60, 112; disruptive technologies
215; entry 310; game theory 297
information technology: innovation 70;
see also Internet
innovation: competition 206–7; demand
269; disruptive technologies 206–7;
factor conditions 268–9; ?rm strategy/
structure/rivalry 269–70; ?rst-mover
advantages (FMAs) 156; game theory
276; globalization 234–6; information
technology 70; long tail 77–9; people
188–90; Porter’s Diamond 268–9;
related/supporting industries 269;
S
2
P 188–90; strategic see strategic
innovation; user innovation 75
innovations see inventions
intangibles: assets 118; assigning
numbers 139–40; leveraging effect
140–2; numerical example 140–2;
valuation 139–42
intellectual property: ?rst-mover
advantages (FMAs) 150; political-legal
environment 254
Internet: crowdsourcing 106–9; in?nite
shelf space 68; long tail 70; political
contributions 74; user innovation 74;
value creation 106–9; VOIP
technology 199, 206–7, 212; see also
networks
inventions: block strategy 127–8;
dynamics 127–8; imitability 124–7;
invention resources 123; run strategy
127–8; see also innovation
investment: complementary assets 261;
irreversible investments 161; return on
investment (ROI) 368
iPhone 6, 84, 91–2, 99–100, 210,
443
iTunes Music Store (iTMS): AVAC 80–7
knowledge: paradoxical/public/leaky
nature 262; public knowledge 261
learning: ?rst-mover advantages (FMAs)
151; globalization 238
Lipitor: case studies 3, 401–4;
?rst-mover advantages (FMAs) 172–4;
new game strategies 5
logic: AVAC 39–40; dominant
managerial logic 160, 188–9
long tail: aggregators 71; blockbusters
68, 72; case studies 73–7; coopetitors
71; distribution channels/shelf space
69; ?rm-speci?c factors 73;
implications for managers 77–87;
industry factors 71–3; key takeaways
87–8; long tail distribution 68, 71, 78;
new game ideas/innovations 77–9;
new games 67–88; organic foods 75;
phenomenon 69–70; producers 72;
pro?tability 71–3; rationale 69–70;
suppliers 72; value appropriation 73;
value creation 73
low cost: activities 43, 57–8; new game
activities 110–11; Ryanair 56–8
managers: dominant logic 160, 188–9;
entry reasons 305; ?rst-mover
advantages (FMAs) 172; long tail and
new games 77–87; project managers
190; top management team 188–9
market value: discount rate 37;
pro?tability 36–8; worked example
37–8
markets: direct-to-consumer marketing
(DTC) 103; globalization 238;
international ?nancial market 304–5;
market growth rate 332; market
position 311; market power 305;
marketing uncertainty 159; PMP see
product-market position; relative
market share 332; total available
market preemption 146–51, 156
mass collaboration 107–9
Microsoft: pro?tability 21
minimum ef?cient scale (MES) 264, 338
moral hazard 263
multigames 162
multinational corporations (MNCs):
globalization 233–4; strategy 236;
types 233–4
Nash equilibrium 279–80
natural monopoly 264
Net?ix 383–90
networks: boosting complements 121–3;
de?nition and role of size 120; early
lead 121; exploiting externalities
478 Subject Index
121–2; nature 121; negative/positive
externalities 264–5; network
externalities 119–23, 148–9, 264–5;
pricing strategy 121–2; social
networks 122–3; structure 120, 182;
two-sided networks 120; value
network 102, 146, 210, 348–50
New Belgium 405–10
new game activities: costs 316–19;
customers 110–11; game theory 295;
industry value drivers 112; low cost
110–11; new games 7; pricing 110;
revenue sources 110–11; unique value
113; value 102–4; value
appropriation 103–4; value creation
102–3; see also activities
new game factors: change 48–52, 62–4;
game theory 298–9; new game
strategies 109; value chain 109–14
new game strategies: AVAC 17–19;
competitive consequences 18–19;
components 17–19; de?nitions 4–6,
28–9; different countries 166–8;
disruptive technologies 210–16;
handicaps 109; history 168;
implementation 178–95, 216; key
takeaways 114–15, 193–5; new game
factors 109; product strategies 166;
pro?tability 109–14; strengths 109;
technology 7; value appropriation
91–116; value chain 109; value
estimation 20–1; value systems and
options 7–9; video consoles 20–1
new games: 4Ps 360–1; business system
and options 8; change element 11–13,
84–5; characteristics 10–16, 243–7;
classi?cation 23; competition 17–19;
disruptive technologies 199–222;
entry 316–21; environment 252–74;
?nancial rewards 256; ?nancial
support 259–61; globalization
223–51; government policies 265–8;
handicaps 136–9; long tail 67–88;
new game activities 7; new value
captured 243–4, 298; position-
building see position-building new
games; product position 23; regular
see regular new games; resource-
building see resource-building new
games; resources/capabilities 13,
117–44; revolutionary see
revolutionary new games; role of
resources 123–8; S
3
PE framework
186–93; strengths 136–9; types 21–7,
192–3, 319–21
Nigeria: oil industry 224–8
Nintendo Wii: case studies 3, 442–6;
new game strategies 5, 20–1;
pro?tability 21; reverse positioning
103
noncooperative games 276–87
nonrivalrous goods 261–2
Obama, Barack 74
opportunities: environment 15–16, 51,
64, 246–7, 253–6, 299, 319; Five
Forces Framework 342; globalization
16, 246–7; missed opportunities 105;
strategic innovation 199–300; SWOT
327
Pareto Principle 67
parsimonious activities 42, 44, 60,
113–14, 216, 297, 310, 324–5
people: boundary spanners 190;
champions 189; culture 184;
gatekeepers 189–90; heterogeneity/
self-interest/cognitive limitation 264;
innovation 189–90; project managers
189–90; S
3
PE framework 184–6;
sponsors 189; top management team
189; types 185–6
PEST 328–30
PESTN analysis: advantages/
disadvantages 272; economic 271;
environment 15, 16, 216–17, 270–4;
natural 272; political 270; social 271;
technology 272
P?zer: case studies 3, 401–4; direct-to-
consumer marketing (DTC) 102; new
game strategies 5
pharmaceuticals: skimming 111
Pixar 393–400
placement 359–60
players: applications of framework
165–8; business strategy 171;
changing players 290–1; competition
165; coopetitors 165; exploiters
164–5, 171; explorers 163–4, 171;
framework 163–8; key players 308;
me-too 165, 171; new game product
strategies 166; superstars 164, 171;
types 163–8, 171; value added 291–2
Porter’s Diamond: innovation 268–9
Porter’s Five Forces see Five Forces
Framework
Subject Index 479
position multinationals 234
position-building new games:
competition 26; entry 321; new
products 26–7; S
2
P 188
predatory activities 285–6
price elasticity of demand 228–9
price sensitivity 340–1
pricing: 4Ps 359; cooperative 287–8;
new game activities 110; price
leadership 287; pricing limited 283–4;
relative price-performance 341;
reservation price 95
pricing strategy: networks 121–2; value
appropriation 95
printing 76
prisoners’ dilemma 280, 281–2
producers: long tail 72
product position: competition 23; new
games 24
product-market position (PMP):
competition 23; globalization 238–9;
revolutionary new games 27;
uniqueness 238–9
products: 4Ps 358; customer value 9;
differentiation 340; long tail rationale
69–70; new game strategies 166; new
products 24–5, 26–7
pro?tability: 7Cs framework 38;
activities to pro?ts 9–10; assessment
35–66; Balanced Scorecard 38;
capabilities 128–39; conducive
environments 256–61; disruptive
technologies 210–18; drivers 310;
entry 309–12; Five Forces Framework
38; gross pro?t margin 367; historical
earnings 36; long tail 71–3; market
value 36–8; new game strategies
109–14; potential 129–30; resources
128–39; strategy 22, 35–66
promotion 360
regular new games: competition 24–5;
entry 320–1; new products 24–5; S
2
P
186–7; types of game 21–5
regulation: globalization 238;
government policies 267–8
relationships: commitments 161;
coopetitors 95
repeated simultaneous games
281–2
research & development (R&D):
?nancier 265–6; ?rst-mover
disadvantages 158–9, 170; free-riding
159; game theory 297; Google 5;
options 8–9; public knowledge
261
resource multinationals 234
resource-based view (RBV): competition
23
resource-building new games:
competition 25; entry 320; new
products 26; S
2
P 188
resources: activities 44, 60;
appropriability 130; change 50, 62,
130; competition 129, 130; customer
value 130; disruptive technologies
215–16; entry 212, 304, 310; ?rst-
mover disadvantages 162; game
theory 297; globalization 239–40,
244; intangibles 118, 139–42;
invention resources 123; key
takeaways 142–4; new games 13,
117–44; organizational 118;
preemption 151–3, 156–7;
pro?tability 128–39; role 123–8;
tangible 118; value 130
return on investment (ROI) 368
revenue sources: game theory 296;
new game activities 110–11; value
appropriation 95
reverse positioning: attributes 103;
value creation 12
revolutionary new games: entry 321;
product-market position (PMP) 27;
S
2
P 187–8
rivalry: determinants 341; innovation
269–70; nonrivalrous goods 261–2
rural areas: discount retailing 74
Ryanair: activities 56–60;
appropriability 61–2; AVAC 54–64;
case studies 4; change 62–4;
coopetitors 57, 61, 63; ?rst-mover
advantages (FMAs) 63; imitability 61;
industry value drivers 59–60; low cost
56–8; new game strategies 5;
opportunities 15; revenue sources 96;
value creation 11–12, 60
S
2
P: ?rms 190–3; impact 186–93;
innovation 188–90; people 188–90;
position-building new games 188;
previous game components 191–2;
regular new games 186–7;
resource-building new games 188;
revolutionary new games 187–8;
types of new game 192–3
480 Subject Index
S
3
PE framework: advantages 357;
disadvantages 357; elements 357,
358; environment 185–6; impact
186–8; implementation 179–93;
new games 186–93; people 184–6;
strategy 180; structure 180–2;
systems 183
scarcity: complementary assets 169–70;
preemption of scarce resources 151–3,
156–7; shelf space 69
Sephora 377–82
sequential games 282–4
shelf space: Internet 68; scarcity 69
short head 67
signaling: crowdsourcing 108; game
theory 285
simultaneous games 278–82
size: de?nition and role 120; effects
147–8
skimming: pharmaceuticals 111
social networks 122–3
Sony: pro?tability 21
sponsors 189
stock price 367
strategic consequences: AVAC 86;
capabilities 135; complementary
assets 126–7
strategic innovation: dawn xv–xvi; key
takeaways 32–3; questions xvii–xviii;
weaknesses 89–195
strategies: globalization 238–42
strategy: block strategy 127–8; business
strategy 171; competition
consequences 18–19; ?nancial
measures 36–8, 367–9; followers 161;
inventions 127–8; multinational
corporations (MNCs) 236; networks/
pricing 121–2; new games see new
game strategies; pro?tability 22,
35–66; run strategy 127–8; strategic
?t 159–61
strategy frameworks: advantages 324–5;
AVAC see AVAC; BCG’s Growth/Share
Matrix 330–4; business systems
343–5; common language/platform
324; data collection 325;
disadvantages 325; GE/McKinsey
Matrix 334–6; marketing-mix
357–61; measures 323–69; PEST
328–30; Porter’s Five Forces see Five
Forces Framework; S
3
PE see S
3
PE
framework; scorecard see Balanced
Scorecard; simplicity 324;
summarised 364–7; SWOT see SWOT;
value chain analysis 345–8; value
con?gurations 348–50; VIDE 355–7;
VRIO framework 353–5
strengths: change 49; disruptive
technologies 210–13; globalization
242–3; new game strategies 109; new
games 136–9; strategic innovation
89–195; SWOT 326
structure: M-form 181; coordination
180; functional structure 180; matrix
structure 181–2; multidivisional
structure 181; networks 120, 182;
S
3
PE framework 180–2; virtual
structure 182
substitutes: appropriability 48, 62;
threats 341; value appropriation 96
suppliers: bargaining power 340; long
tail 72
sustaining technology 206
switching costs: customers 149, 153;
?rst-mover advantages (FMAs) 153;
suppliers 340
SWOT: advantages 327; applications
325–8; context dependence of
elements 327; disadvantages 328;
external factors 325–7; internal
factors 325–6; key elements 325–7;
opportunities 327; strengths 326;
threats 327; weaknesses 326
systems: book value system 97–8;
business system and options 8;
?rst to establish a system of
activities 154–5, 157; information
systems 183–4; organizational
systems 183; processes 183–4;
S
3
PE framework 183; value systems
and options 7–9
technology: change 159–60; disruptive
see disruptive technologies;
environment 253–4; ?rst-mover
advantages (FMAs) 156; ?rst-mover
disadvantages 158–9; Foster’s S-curve
201–2; new game strategies 7; PESTN
analysis 271; potentially displaceable
established technology 203; sustaining
technology 206; today/ancestral 200;
uncertainty 159
Threadless 4, 391–2
threats: environment 15–16, 51, 64,
246–7, 253–6, 299, 319; Five Forces
Framework 342; strategic innovation
Subject Index 481
199–300; substitutes 341; SWOT
327
Toyota: activities 42
uncertainty: buyer choice under
uncertainty 154; ?rst-mover
disadvantages 158–9; marketing 159;
technology 159; value appropriation
263; value creation 263
unique value: disruptive technologies
215–16; new game activities 113
United Kingdom: oil industry 249–51
United States: political contributions
74
value: activities, value, appropriability
and change see AVAC; components 40,
82–3; concepts 92–102;
con?gurations 348–50; customer see
customer value; drivers see industry
value drivers; economic value added
(EVA) 368–9; estimation 20–1; key
takeaways 65; networks 102, 146,
210, 348–50; new game activities
102–4; new value captured 243–4,
298, 317–18; options 7–9;
resources 130; unique see unique
value; value added 100, 289, 291–2;
value captured 93, 100; value net 290,
291; value systems 7–9, 347; VIDE
355
value appropriation: appropriators
classi?ed 231–2; book value system
97–8; competition 6; complementary
assets 94; complexity 263; concept
94–6; coopetitors 95; de?nition 6;
disruptive technologies 206–8;
environment 256–61; examples
97–100; export subsidies 230; game
theory 293–9; generation 11–13;
globalization 224–30; imitability 96;
import duties/taxation 228–9;
international element 101–2; iPhone
99–100; locus shifts 104; long tail 73;
new game activities 103–4; new game
strategies 91–116; oil industry 224–8,
249–51; pricing strategy 95; revenue
sources 95; substitutability 96;
uncertainty 263; valuable customers
96
value chain: activities 92, 345; analysis
345–8; bears 232; beavers/ants 232;
bees 231–2; data organization 347;
disruptive technologies 213–16; ?rm-
speci?c effects 347; foxes 232; game
theory 295–9; generic value chain
analysis 348; government insertion
228–30; members 231–2; new game
factors 109–14; new game strategies
109; primary activities 345–6; support
activities 346–7; value systems 347
value creation: bene?ts 92; better
positioning 10; change 50, 62;
complexity 263; concept 92–4;
cooperation 6; coopetitors 97–100;
creators classi?ed 231–2; de?nitions
6; disruptive technologies 206–8;
entry 317–18; environment 256–61;
game theory 293–9; generation
11–13; international element 101–2;
Internet 106–9; locus shifts 104; long
tail 73; marginal contribution 289;
new game activities 102–3; Ryanair
11–12, 60; uncertainty 263; value
captured 93
value shop 348–50
venture capital 257–8, 260–1
VIDE 355–7
video tape recorders 76–7
VRIO framework 353–5
Wal-Mart: coopetitors 43; discount
retailing 74; ?rst-mover advantages
(FMAs) 13; new game strategies 16;
rural areas 74
weaknesses: strategic innovation
89–195; SWOT 326; see also
handicaps
Whole Foods Markets 75, 77
Wii see Nintendo Wii
Wikinomics 107–9
written word 76
Xbox 434–41
482 Subject Index

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