You’ve been described as a combination where Henry Kissinger meets Sun Tzu the author of The Art of War, is that a compliment?What’s the difference between the way you think about strategy and the way someone like Michael Porter thinks about strategy?
I think it’s great. I loved Henry Kissinger and I spent a lot of time reading his books. Sun Tzu’s The Art of War is, of course, the bible of strategists all over the world. So being bracketed with them is a great honour.
It’s vastly different. Porter’s model from his 1980 book is about the creation of an oligopolistic industry, one in which all the players co-operate, and build barriers to entry so that they keep out companies that are unfriendly. And then inside the barriers they build friendly companies that divide up the market place and collude on price – though, of course, they do that all through signals rather than explicitly. Porter talks about the de-escalation of rivalry in an industry to increase margins.
What I like to talk about is the use of even price wars to create growth. So you change your margins by lowering them, create shareholder value by creating more rapid growth, and rather than living in peace with each other you actively disrupt each other’s core competency. You attempt to obsolete the leader’s core competency, and when you do that you become the new leader.
In Porter, thanks to barriers to entry, there are a few industry leaders and they’re unchallengeable so that you are left with a peripheral market. If we followed Porter’s model all we would have is a world of people pre-described in a cast system, a world of corporations stuck in their cast. And the greatest companies don’t see the barriers there. I’ll give you a very simple example, Toyota versus General Motors. General Motors spent years and years building up a service dealer network. Eventually, it had between 6,000 and 7,000 service dealers and spent billions on supporting those franchisees or dealerships. Then Toyota shows up and simply makes a car that needs much less service. And all of those billions are sunk costs and wasted, and actually work against you.So you say that differentiation is over rated?
Yes I do. Because you have to really change an industry structure to deal with the problems we see in today’s world, especially when it comes to commoditization which is a black plague on modern corporations, a deadly disease that’s spreading like crazy.Which brings us neatly to your new book, Beating the Commodity Trap, which you’ve been working on for a number of years. Can you explain the genesis of that? What got you interested in commoditization?
Well commoditization is one of the most virulent forms of hypercompetition. Commoditization is the process of a diamond gradually finding its facets worn off by wind, water and handling, until it becomes simply a rough stone. And it’s similar with products. Products that commoditize basically go from being differentiated to having lost their uniqueness. Most people think the solution is to create a continuous differentiation process to re-carve new facets on to the stone. The trouble is everyone can do the exact same thing. Imitation now is so quick, you end up running faster and faster in to stay in the same place. Like the Red Queen in Alice in Wonderland, you run so fast that you get nowhere at all.The first commodity trap you describe is deterioration, how does that work, can you give us an example?
It turns out that not all commoditization takes place in the same way. People have one word for it, but it actually has three heads. And one of the heads is deterioration. That method of commoditization is typically wrought by a low-end discounter. This low-end discounter provides such low prices that people only buy on price. The other firms then have to deal with the discounter’s market power. So, they start to sink into this hole of low prices and low quality, effectively destroying their own advantages. Alternatively, they move out to become stuck in tiny little niches.
Looking at different industries and companies – such as Wal-Mart in retailing and Ryan Air or South West in the airline industry -- there have been basically three responses to take advantage, escape or undermine that trap. My favourite response is, rather than succumbing to the market power of that low-end discounter, you seek to undermine it. Several different strategies came to light in my research about how to undermine the strategy of a low-end discounter. One was to find a way to make its power obsolete. Another was to apply another of the commodity traps -- proliferation -- to the low-end discounter to basically take it out of the market by nibbling at it from multiple directions. So there’s deterioration, there’s proliferation, and the final head on the monster is escalation?
Yes that’s right. And this is the toughest one to beat, because a momentum builds up. Imagine a price quality map, and you find players moving towards the corner of low price and high quality. It’s a game of one-upmanship. Each player raises their quality, lowers their price, and the next one has to match. It starts to become like the Cuban missile crisis, but it’s an arms race to the bottom because the first one to the bottom blows himself up. You end up giving away your product for almost nothing.
So the question is can you control the momentum towards that? The potential solutions are to reverse the momentum in one direction, to slow or freeze the momentum, or to harness the momentum, so that you move faster than everybody else towards the point of commodity. But then, just as you bring everybody to the commodity cliff, you jump and change the dimensions of the map so you’re no longer playing on the same quality scale and the rest of your industry jumps into commodity hell.To carry on mixing our metaphors, the current crisis has revealed another element to commoditization which is evaporation; can you tell us some more about that?
Yes, that’s a particular problem showing up during the recession. Demand evaporation is simply that people stop buying. They buy so much less than they did before that all products have to lower their prices to sell anything at all. There’s excess capacity and a lot of price competition develops as a result. So evaporation isn’t really a commodity trap in the traditional sense. It’s not the market whittling down the facets of the diamond, it’s really a temporary problem of recessionary periods. And here the solutions are to recognise that you’re in a tremendous storm, and to batten down the hatches. To also learn how to float with the changes, so you can be very flexible as things unfold. And then finally to be able to preposition yourself for landing on your feet when the storm subsides. I could go into the details of those if you want.In these troubled times strategy is still important, still makes difference?
Yes, at least if you do it right. Even more so today I think. A lot of it is about pre-positioning for the future; looking at how you can consolidate the industry, so that when you’re done the industry will be able to function without excess capacity; and finding methods where you co-operate with the government, as in financial services.
The financial services industry doesn’t quite get it, but the government is going to take over a lot more control from individual corporations and this is a great opportunity not a threat. On Wall Street they see it as a threat, but if you can put in regulations, co-operate to put in all kinds of rules to prevent another credit crunch, you can also create tremendous barriers to entry, and create a world at the end of which you’re one of the last guys standing. The last man standing strategy plays out in a lot of industries today.
Stuart Crainer is editor of Business Strategy Review, a visiting professor at IE Business School and co-creator of the Thinkers 50.