Competitive considerations in strategy
This is an excerpt from the 2021 Castlin Manifesto. To obtain the full e-book, become a paying subscriber to Strategy in Praxis.
As previously discussed, competitive considerations are often an unescapable aspect of strategy and, as a result, strategic evaluation. It makes intuitive sense, of course, and most strategists also have a natural inclination to “beat the competition”, “win in the marketplace” and so on.
Indeed, as Phil Rosenzweig once wrote, it is not enough to do well in business — what matters is doing better than one’s competitors. It seems entirely logical a conclusion; if that were not the case, sustainable business performance would be a matter of the absolute, not relative, and therefore achievable by means of simple formulas just as popularly claimed by those unperturbed by reality (and continuously taken to task throughout this document).
Michael Porter has even gone so far as to argue that outperforming competitors is a mandatory requirement of doing business, and the dominant industry view echoes his conclusion. But, as one might expect by now, it turns out it is not that simple.
The call to focus on competitor-oriented objectives in strategy is believed by some to have started with Porter’s Competitive Strategy. However, while his work is the most cited, the importance of understanding competitive dynamics clearly precedes his work by a significant distance.[1]
Arguably the most central theory is that of firm action and reaction under the guise of creative destruction, as defined by Austrian economist Joseph Schumpeter in the early 1940s. In short, he argued that the “perennial gale” of competition was created by extraordinary profits earned by first movers. These motivate competitors to overtake the leader and thereby enjoy the same spoils themselves. Over time, Schumpeter believed, such creative actions and reactions by challengers would inevitably erode the leader’s position, lead to a new apex organization, and the process would begin anew.
Creative destruction relies on competitive considerations for obvious reasons — it is inherent to the fundamental premise. Though first movers do not necessarily need to consider competitors in order to create transient monopolies and abnormal profits (one could hypothetically launch a product or service without considering the market, or create one that had thereto not existed), any response to their actions would automatically be competitor focused. Indeed, the size of the benefit as such would be relative to the speed of the response; abnormal profits would only be achievable by the virtue of rival “lag”. Or to put it slightly differently, actors would gain an economic rent of sorts from successful action, while non- or slow-responding competitors would suffer market share losses or missed profit opportunities. The longer the delay, the wider the gap.
But, contrary to traditional theory, aiming to create and/or destroy advantages is not necessarily the only or best way to do business; neither striving for market share supremacy nor being the market leader is a guarantee for profitability. While share gains can bring a myriad of benefits, there exists, as Besanko et. al. highlight in Economics of Strategy, no causal mechanism whereby they automatically translate to profit. In fact, there is a growing body of evidence to suggest that companies which focus on market share over profitability perform worse than those that do not.
Armstrong and Green summarize the case well in Competitor-oriented Objectives: The Myth of Market Share. They note, among other things, that Boston Consulting Group’s portfolio planning matrix (which analyzes performance relative to competitors and was until recently included in Kotler’s Marketing Management) has been discovered to substantially reduce the profitability of subjects’ decisions. Companies that employed similar strategies were also found to provide lower return to shareholders and deliver lower return on capital.
Granted, one might suspect that companies that focus more on profit would also be more likely to be profitable, if for no other reason than sheer executive and financial prioritization.[2] But that competitor-oriented objectives can be — indeed often are — negatively correlated with profitability is nonetheless important to note for anyone doing strategy in practice. Creative destruction hinges on aggressive competition; efforts to gain market share to maintain leadership, dethrone leaders or reduce gaps held are central to the premise. Porter’s work, of course, does too. However, despite its significant impact on strategy theory and practice alike, it contains practically no evidence at all to support the argument, and his only presented defense has been to repeatedly insist that competition today is no different from competition 70 years ago. This is, shall we generously say, a debatable claim at best, but also a deflection; it does nothing to solve the underlying problem.
Consequently, strategists would do well to question whether competitor-focused objectives and market share goals deserve a place in their work. Setting out to beat the competition may be essential, but it ultimately has to depend on the strategic purpose behind the exercise. Markets are complex, interconnected and best understood in contextual terms, yet seldom if ever zero-sum. Rather, they are in a perpetual state of flux. In some cases, they move towards equilibrium. In others, they move away from it. Failing to acknowledge this point can, particularly for large organizations, be dangerous as it may lead one to miss strategic risks and opportunities alike.[3]
Once again, we therefore find ourselves needing a balance. Understanding the market is never a bad thing per se and it puts performance into perspective. But focusing too heavily on competitors can be; it may lead to imitation at the cost of innovation, reactive behavior rather than proactive thinking, and decreasing profits.
Or to put it slightly differently, machoistic claims for treating markets as theatres of war may lead one to win the occasional battle, but also lose the overall effort.
[1] The argument for comparative competitive objectives in strategy (albeit not by the particular term) can be traced back at least as far as the 19th century. By the mid 1950’s, the use of competitive objectives was in fact so common that several economists and academic scholars of the time — Alfred Oxenfeldt perhaps most notably — publicly lamented their widespread and almost unescapable implementation. Competitive considerations in general go back further still; Adam Smith introduced his theory of absolute advantage in Wealth of Nations, published in 1776. This was, in turn, broadened by David Ricardo’s principle of comparative advantages in On the Principles of Political Economy and Taxation (1817). Although many roads lead to Porter, most go past him.
[2] It is important to note that chasing profit also can lead to unwanted behavior, of course. A recent lawsuit alleged Boeing focused on profit rather than safety while developing the 737 MAX aircraft, with disastrous results.
[3] Recent research by the Ehrenberg-Bass Institute has also demonstrated that the larger the company, the likelier firm growth is to come via category, not share, growth.
