Economic Perspectives of the Strategic Positions
The three strategic positions are focused on three distinct economic perspectives (see figure 8.4). The economic implications of the best-product position are shown in Part A of the figure. The average business performer reflects the average cost of the industry and the margin available to the average player. In contrast are the lowcost competitor and the differentiated competitor; these two positions are the basic trade-offs represented in classic strategic positioning.
Figure 8.4: Economic Perspectives of the Strategic Positions
The lowest-cost performer is able to obtain a higher margin while still competitively pricing the product. This is a strong competitive advantage because the efficiency of the cost structure allows pricing below the cost of the average competitor that, in the long run, might put the average performers out of business. This is why the alternative to low cost must be differentiation, offering unique product attributes that the customer values and will pay a premium for. The differentiated player could have a higher cost than the average performer while still enjoying a fairly high margin because of the inherent additional value of the product. While the graph is simplistic, it represents important economic hurdles. To have a genuine low-cost position, a company needs to demonstrate lower relative unit costs. To have the economic leverage of a differentiated product, a company needs to show clearly that the customer will pay more, and that this premium is more than the added costs.
By contrast, the customer solutions position (shown in Part B of figure 8.4) centers on how products and services will impact the customer economics, either by lowering the customer's internal costs or by allowing the customers to have higher revenue. The customer solutions provider may have higher costs, but these are far outweighed by the economic contributions to the customer. The economic hurdle here is to show measurable and positive impact on the customer's profit.
Finally, we can contrast the economics of the system lock-in position with the other alternatives by recognizing that the scope is further enlarged to encompass the total system of which products or services are part. The economic hurdle is both to create additional value to the system as a whole through the heavy investment by complementors, and then to be able to appropriate this value. Part C in figure 8.4 shows an average competitor whose complementors modestly add value to the overall system. In contrast, the owner of a proprietary standard has been able to get significant investments from its complementors, which adds value to its system. At the same time, its ability to appropriate this added value is evident in its higher margins.
The Bonding Continuum
Bonding is a primary element in each distinct strategic position and deserves closer examination. Bonding is a continuum that extends from the customer's first loyalty to a product to full system lock-in with proprietary standards. We have identified four stages in bonding (see figure 8.5).
Figure 8.5: Bonding Continuum
Establishing Dominant Design
In the first stage, dominant design, customers are attracted to a product because it uniquely excels in the dimensions they deeply care about. If the product positioning is one of low cost, then low price leads to loyalty. If the strategic positioning is differentiation, the features or services that accompany the product could attract and retain the customer.
In an embryonic industry that does not yet have a defined product design, various competitors do enormous experimentation. Product variety eventually consolidates to a common design that has the features and characteristics that customers expect from the product type. This emerging dominant design fills the requirements of many users for a particular product, although it may not exactly meet the requirements of any particular segment of the customer base. In that regard, the dominant design is generic and standardized as opposed to customized. The competitor generating this design captures the first element of loyalty from customers and has firstmover advantage.
For example, IBM benefited from a dominant design—the IBM PC. Its format included a monitor, a standard disk drive, the QWERTY keyboard, the Intel chip, open architecture, and the MS-DOS operating system. They came together to define the ideal PC for the market, which every other PC-compatible manufacturer would later have to emulate.
Locking In Customers
Beyond the stage of dominant design, there are clear opportunities to achieve higher, more tangible switching costs on the part of the customer. One such move is to enhance the product's inherent characteristics by offering additional support that makes it more accessible and attractive and thus harder to switch from, thereby locking in the customer. Collateral assets, which the firm owns and which complement the core product, can be effective in achieving this goal. Ownership of distribution channels, of specialized salesforces, and of technical support staff and, very importantly, a brand-supporting image can significantly increase product function, make it more appealing to the customer, and make the whole package more difficult to imitate. Brands as a collateral asset can reinforce lock-in when the product is unfamiliar and the functionality unknown, so that the assurance of support can dissipate doubts about product performance and encourage repeat purchase.
National Starch, a customer solutions company, provides an excellent example of customer lock-in. National Starch appears deeply rooted in rather mundane and pedestrian products, glue and starch. However, it has an unsurpassed history of longterm superior performance, not only in its industry, but also compared to most U.S. corporations. The source of its success is its extraordinary technological capabilities coupled with an intimate knowledge of all its key customers. R&D personnel, technical service staff, and marketing and sales managers have accumulated enormous knowledge on customer needs, the state of new product development, and ways to aid customers in revenue expansion and cost containment. The essence of National Starch's business is a joint working relationship with the customer.
One spectacular product that emerged from this relationship was a most sophisticated adhesive that eliminated welding airplane wings to an aircraft body. This product has two critical characteristics: One, the product contributes to the total quality of the final product, the airplane. Second, despite its great criticality, the product accounts for a negligible portion of the total cost of the airplane. With these two conditions, National Starch faces high profit potential. The moral here is that by creatively constructing a tight working relationship with the customer, a company can "decommoditize" a product. The bonds are strong because the company is not only providing a product but embracing the customer's own activities and enhancing its economics.
Price structure can influence bonding with customers as well. Two of the most innovative marketing programs in the 1980s were American Airlines' Frequent Flyer program and MCI's "Friends and Family" promotion. Both programs were widely acclaimed because they created some lock-in for traditional commodity businesses.
Customized products and services can also lock in customers, through personalized services, customer care, and even billing. In the consumer market for the financial services industry, Merrill Lynch first introduced customer management accounts, but Fidelity, Schwab, and other institutions followed. The accounts are tailored to the user's circumstances; characteristics of bill payment, brokerage, mutual fund investments, IRA accounts, credit cards, and checking accounts are specific to and chosen by the customer. The effort to move this information to a new account creates a switching cost for the customer.
Another benefit of close customer proximity is that the customer and the supplier bond over time. A newcomer finds it hard to break into a relationship that has developed mutual investments and benefits. Additionally, a product can create its own learning experience. For example, once you learn how to use the Lotus 1-2-3 spreadsheet application, there is a significant additional effort to switch to Microsoft Excel.
Locking Out Competitors
There is a thin line between locking in customers and locking out competitors. First, once a company acquires a customer, it is hard for that customer to switch to an alternative. Second, significant barriers make it difficult for a competitor to imitate or to enter the business.
Four forces contribute to competitor lock-out. The first is based on the restrictions of distribution channels. Physical distribution channels, in particular, are limited in their ability to handle multiple product lines. At the extreme end of the spectrum are channels that carry only one product, such as soda fountains that serve only one brand of soda. If Coca-Cola captures the channel, Pepsi is preempted from that specific market and vice versa.
In this environment, brands can also generate competitor lock-out. They create customer demand that causes retailers to stock the branded product, at the expense of competitive products, given the physical constraints. In turn, shelf presence further enhances demand and the brand because people can buy only the products available. This reinforcing loop causes branding to be particularly effective for consolidating share and creating system lock-in when the industry structure includes physical distribution channels; this is in contrast to an industry that uses expandable channels such as telemarketing or direct mail.
Another way to lock out competitors is to establish a continuous stream of new products that can result in self-obsolescence and create enormous barriers to imitation or entry. Digital Equipment Corporation's origins in the 1950s provide a good example of competitor lock-out in an embryonic industry. DEC engineers had great freedom to both propose and follow through on their innovations. There was an unprecedented stream of new computers, with one breakthrough after another. DEC produced more than fifteen new versions in less than six years. As a result, competitors had difficulty passing a moving target. Furthermore, DEC users had to develop tailor-made software applications. Most importantly, all DEC computers were compatible with each other; therefore legacy software could run on the new equipment. The DEC architecture was not open; competitors thus not only had to match the technical features, but also had to be compatible with the existing software base. In ten years, DEC became the second largest computer company in the world.
Patents can lock competitors out, but also offer some challenges. In the pharmaceutical industry, a significant portion of a patent's length is often consumed before the product is released because of the time required for trials and FDA approval. Sometimes, half a patent's life expires before the product is introduced. This is compounded when patents are required in other countries, each with different requirements for documentation, languages, testing, legal compliance, and so on. In this situation, speed is key to competitive lock-out.
Sustaining Proprietary Standards
If a firm is able to reach and sustain proprietary standards, the rewards are immense. There are two requirements for this position. First, customer switching costs need to be high. Second, it has to be difficult or expensive for a competitor to copy the product. There are a number of ways to achieve system lock-in and to secure a proprietary standard. While one might presume that this would be the dominant of the three positions in our business model, it is not always possible to develop a standard in every market segment. Even if a standard can be developed, a single firm might not be able to appropriate it. And not all firms have the capabilities to achieve a proprietary standard.
Managers can ask several questions to assess whether their company can achieve a proprietary standard:
Do we have an open architecture, or can we create one? An open architecture allows the attraction, development, and innovation of many complementors.
Is there a potential for a large variety and number of complementors that can be enabled through a standard?
Is the standard hard to copy? A complex interface that is rapidly evolving makes it difficult for competitors to imitate.
Is the industry architecture being redefined?