Strategically Escaping Price Compression: A Summary of D’Aveni’s Hyper-competition

The longer I work in pricing strategy, the more I’m hit with a common challenge facing executives:  Price Compression.

Firms work hard to deliver high-quality, well-engineered, products and services, yet find that their ability to capture the value they create and deliver to customers is squeezed by competitive price pressures. Executives turn to cost-cutting and lean-manufacturing to improve margins, but these improvements are short lived as competitors continually squeeze pricing power away.

How can a firm escape these challenges?  Why are the mantras of “value” and “price to benefits” insufficient?  Where should executives lead their firms?

I am not the first to ask these questions.  In fact, before I studied pricing strategy, I was a student of corporate strategy.  In my studies, I came across Richard A D’Aveni’s Hyper-competition: Managing the Dynamics of Strategic Maneuvering (1994).

Hyper-competition made a big splash in the popular business press when it was first released probably because the term “hyper-competition” alone was enough to warrant executive attention.  Yet its popularity was short-lived.  Perhaps the short shelf life was due to the near unreadability of the text.  Its jargon-laden prose is relatively unfathomable and its cyclical approach to clarifying arguments is a dirge to digest.  It reads almost morosely, working to demonstrate the futility of common corporate strategies instead of providing direct answers to direct challenges.  Reading it is akin to self-inflected punishment for the sake of enlightenment.  Politely stated, it is dry and difficult.  This is unfortunate.

D’Aveni’s Hyper-competition brilliantly elucidates competitive strategy.  Over the years, I have referred to ideas presented in D’Aveni’s Hyper-competition on several occasions in clarifying strategic challenges and highlighting strategic opportunities.

I would like to be able to suggest this insightful text to executives, but I know few people have the patience and tolerance needed to read it.  Rather than directing executives to read Hyper-competition, what follows is my attempt to summarize the key concepts underlying D’Aveni’s Hyper-competition.

Why the Old Version of Competitive Strategy Fails

By the middle of the twentieth century, the concept of competitive advantage had underlain most firms’ corporate strategies.  According to D’Aveni, the old version of a competitive advantage is a resource which enabled a firm to launch a value proposition and exploit its profit potential for an extended period of time until the firm’s competitive advantage is inevitably eroded by a competitor’s counter-attack.  See exhibit “Old Version of Competitive Strategy”.

In the corporate golden-era long past, the period of exploitation and high-profits earnings could be measured in decades.  Investors could expect to earn above-market returns by identifying firms with good, exploitive, competitive advantages.  (In many ways, Warren Buffett’s investment strategy over the past 50 years fits this characterization.)  Executives could define their corporate strategy as extending the period of exploitation and improving their ability to exploit their competitive advantage.

Today, the period of exploitation is at best measured in months, not years — let alone decades.  The compression of the competitive cycle has converted mere competition into hyper-competition.  Investment strategies reliant on long-term exploitation of competitive advantages are doomed.  And, executives working in these firms can no longer expect to deliver strong results simply by exploiting a competitive advantage.

For D’Aveni, the key to managing the modern hyper-competitive environment is not to focus on extending the period of exploitation, but to practice self-renewal in order to constantly redefine the terms of competition.   Channeling Joseph Schumpeter, he calls for self-disruption to make room for competitive innovation and warns that those who fail to self-disrupt will face disruption by a competitor.

Clearly this is not easy medicine to take.

D’Aveni can appear a tad pessimistic.  Yet his focus is not on comforting managers and investors but on driving firms to excel.

Evidence supports his claim that firms cannot excel simply repeating the same actions, even when initially successful:  “[A] survey of the fifty oldest US companies found that they have persisted not by exploiting a single advantage but by ceaselessly altering and renewing their technologies and products and sometimes too, their capital structures.” (p. 24)

How is a firm to survive and win in this new period of hyper-competition?  D’Aveni proffers a solution that relies upon dynamically competing across “four arenas” via the “7 S’s”.  (I did state the text was jargon-laden.) D’Aveni four arenas are:  (1) Price and Benefits, (2) Timing and Know-How, (3) Strongholds, and (4) Deep Pockets.  The 7 S’s are alliterations describing vision, capabilities, and tactics.

Competitive Arena 1:  Price and Benefits

In the Price and Benefits arena, firms compete in positioning their value proposition.  (D’Aveni uses the terms “cost” and “quality” but I have chosen to update his terminology to a more current use of business language.)  See Round 0: Competitive Positioning.

At any given moment, firms are generally encouraged to position products along the value equivalence line.  But D’Aveni points out that competition isn’t static.  Overtime, competitors have incentives to improve a product’s benefits without improving costs as much, or reducing prices without reducing benefits.  In other words, competition is dynamic.  A quick glance at the game console market would support these claims.  We can show this in a sequence of diagrams.

Consider the Round 0 plot above and suppose the differentiated (blue) competitor chooses to improve its value proposition in order to take more market share.  The move could be diagramed as shown in exhibit Round 1.

Once the differentiated competitor has improved its value proposition, the low-cost competitor has a strong incentive to match this repositioning with a benefit improvement of its own.  See exhibit Round 2.

This sequence of attacks and counter-attacks is repeated over and over again making the issue of “who moved first” or “who counter-attacked” immaterial from a high-level viewpoint.  What is material is the overall usefulness of product positioning as a source competitive advantage.  Overtime, any market advantage a firm seeks in improving their offering is negated by the counter-attack of their competitors.

This has led to D’Aveni’s best known plot from Hyper-competition, the positioning and repositioning of products within the price-to-benefits map that eventually leads to the ultimate value line where firms can compete on nothing more than price.

According to D’Aveni arguments, customers eventually do not value further improvements in benefits along one specific dimension.  For instance, think of light bulbs.  People need light bulbs to light a room and firms can make lights brighter.  But at some point, a brighter bulb is not useful.  It is just blinding.  In the same way, products can be improved along a dominant dimension of benefits, but at some point, customers will not value any further incremental improvements, or at least, not at the price that would be required to deliver further improvements.

Once further incremental improvements cannot be had along one dimension of benefits, temporary competitive advantage may be gained by exploiting a different dimension of benefits.  But this too is just temporary in D’Aveni’s mind, for competitors copy successful business models.

D’Aveni concludes that all competition in the Price-to-Benefits arena eventually leads to positioning along the ultimate value line where price compression destroys profitability.

Competitive Arena 2:  Timing and Know-How

In the timing and know-how arena, firms compete by creating entirely new industries or redefining existing industries.

Channeling Peter Drucker, D’Aveni argues that knowledge is the strategic resource needed to compete in timing and know-how.  Knowledge and the unique assets it produces (patents) are the intangibles that really drive value to D’Aveni.  He states that when customers buy a firm’s products, what they are really paying for is the firm’s unique ability to build and design a product, not the components themselves.  A quick glance at the Apple iPhone would support his assertions.

By exploiting these intangible assets, the firm creates a new industry and seizes first-mover advantage.  If the new industry has significant customer-switching costs, the firm can profit handsomely.

However, competitors will imitate the first mover and switching costs erode overtime.  Moreover, imitators enjoy much lower research and development costs to enter the newly-formed industry and can learn from the mistakes of the first mover.  Hence, first-mover advantage is elusive and fast-imitators are often more profitable over the long term.

One approach D’Aveni suggests for competing in the long-run in the timing and know-how arena is to transform the firm’s knowledge assets from a focus on innovation to a focus on efficiency and cost reduction once imitators have arrived.  D’Aveni notes that successfully reinventing a firm’s focus from innovation to efficiency is accomplished by only a rare few firms.

An alternative approach to competing in the timing and know-how arena is to leapfrog one’s competitors.  With new technology, a firm can leapfrog its competitors by generations of product evolutions within an industry and even across industries.  D’Aveni notes that overtime, each new leap in technology is increasingly expensive and the returns on taking that leap become increasingly short-lived.  As an example, he examines Sony’s fortunes in the 70’s and 80’s.

In the timing and know-how arena, D’Aveni concludes that the first-mover and fast-follower advantages are both short lived, and that sustaining the gains created by know-how through either transformation or further leapfrogging the competition, is difficult and fraught with risk.

Competitive Arena 3:  Strongholds

In the creation and destruction of strongholds arena, firms strive to reduce competitive pressure.

Channeling Michael Porter, D’Aveni notes that competitive pressure can be reduced through increasing barriers to entry — thus discouraging entry, power over buyers, power of sellers, power over substitutes, and tacit collusion itself.

For example, D’Aveni points to regional competitors which restrain from entering each other’s territory.  Each competitor therefore develops a stronghold in their own market from which they can earn above-market profits.

However, restraint from competition is unnatural among capitalistic firms.   Every firm, once they have developed a stronghold, is naturally inclined to seek further growth which drives them into their competitor’s stronghold.  While frontal attacks may be avoided, firms will attempt to chip away at weak points in each other’s stronghold while shoring up defenses within their own.  Unfortunately, profits are eroded due to the costs these skirmishes.

One approach to competing in the strongholds arena for the long run is to identify markets too small to efficiently support multiple competitors.  Thus, once a stronghold is developed, competitors have little incentive to enter.  However these small markets only encourage a firm holding them to foray out into its competitors’ markets.  Alternatively, the markets themselves may grow, thus encouraging competitors to enter.

In the strongholds arena, D’Aveni concludes that all strongholds become vulnerable over time as new capabilities develop.

Competitive Arena 4:  Deep Pockets

In the accumulation and neutralization of the deep-pockets arena, firms use superior strength to squash competition.

D’Aveni suggests that firms can derive advantage through a larger resource base and superior concentration of focus to crush a smaller competitor through brute force.  These advantages however can be neutralized within a single competitive cycle.  For instance, competitors can use mergers and acquisitions to develop equally-matched or even deeper-pockets (witness Anheuser-Bush Inbev vs. SABMiller).  Alternatively, franchise and partnership arrangements can neutralize the advantages of direct sales or vertical integration.  And, large firms always face the potential of an anti-competitive government legal action.

In the deep-pockets arena, D’Aveni concludes that brawn is no match for brains.

7 S’s: D’Aveni’s Solution

It isn’t until a reader gets to page 204 of his 423 page tome that D’Aveni clarifies his solution to the challenges presented.  Briefly stated, he suggests a firm develop the vision, capabilities, and tactics necessary to create market disruption and uses seven words starting with ‘s’ to elaborate.  See the market disruption exhibit.

The beauty of this solution isn’t the words, but in D’Aveni’s admonition of executives to refuse the past’s preeminence as a predictor of the future.

To D’Aveni, firms can succeed and make above-market returns only by leading the industry, not by accepting the status quo.  In seizing the initiative, a firm is continually creating a series of temporary advantage which propels it forward into the next competitive cycle.  If the firm chooses instead to accept the status quo, it is only ensuring its defeat by allowing room for a competitor to seize the initiative, thereby forcing the firm into a constant game of catch-up.

Seizing the initiative is accomplished by moving the firm within the competitive arenas and across the competitive arenas.  That is, by making market disruptions.  To make these moves competently, the firm must have the vision to know which competitive action will generate strong returns, have the capability to take those actions quickly, and know how to use tactics that keep its competitors off-guard.

Using D’Aveni’s Hyper-competition

D’Aveni captured many of the common challenges facing today’s executives and highlighted the need to think differently about one’s own industry.  For instance, consider the following examples

• Antivirus software makers often focused on having the strongest Antivirus solution in the market.  Yet today, there is little difference in the quality of basic antivirus software.  The same could be said of antiviral soaps.  The price-to-benefits arena has played out at the bottom of this market leaving only price compression to come.
• Barnes and Noble’s late entry into the e-reader market has cost it dearly, while Amazon’s Kindle is able to compete despite Apple’s iPad.  Timing and Know-How matter.
• MySpace is little more than a memory in the days of Facebook while it was once social media’s darling.  Strongholds erode.
• After the mergers and acquisitions leading to Anheuser-Busch InBev and SABMiller, we are looking at Heineken following suit.  Deep-pockets are leveled.

More examples could be provided, but readers are better served by letting their creative juices run loose.

Strategic plays get played out and new plays must be invented.  D’Aveni provided a thorough examination of common corporate strategies, their limitations, and routes to developing new ones.

The overarching message of Hyper-competition is that the only real sustainable competitive strategy lies in a firm’s ability to re-invent itself.  For proof, consider GE, Emerson, Amazon, or Apple.

Yet this book is far from the final word on competitive strategy.  While it may be true that all strategic advantages get eroded, firms like Southwest, Coca-Cola, and Exxon-Mobile have repeatedly reused their playbooks to deliver superior results over the course of several executives’ productive lifespans.

A firm’s strategy doesn’t have to be perfect; it just has to be better than its competitors.   D’Aveni Hyper-competition provides a way to interpret industry developments and anticipate winning competitive strategies.  The brilliant ideas the terse Hyper-competition espouses makes the book worth paying attention to, or, at the very least, it makes its summary version worth reading.