Losing By Winning:The Danger Zone of Adverse

Competitor Replacement

Richard Makadok (Emory)

David Gaddis Ross (Columbia)

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Not to be confused with thispopular weight-loss book…

Adverse Competitor Replacement (ACR)

• Scenario:– You compete against a weaker rival in a market with entry barriers.– Although weaker, your rival isn’t so weak that you can push it out

of the market.– Potential entrant is stronger than your current rival...

• Strong enough that its profit in competition with one incumbent would justify the cost of overcoming the entry barriers...

• But not so strong that the profit it would earn in competition with both incumbents can justify the cost of overcoming the entry barriers.

– Stable situation until something happens to push the weaker rival out of the market. (What “something”?)

• Hooray! I won! Victory!– Potential entrant then enters and, being stronger than the exiting

rival, reduces your profit.• Sorry, you lose. Too bad, so sad.

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4

E

ACR Via Backfiring

a a a aa d

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E

ACR Via Backfiring

a a a aa d

6

E

ACR Via Backfiring

a a a aa d

Now I willcrush you!

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E

ACR Via Backfiring

a a a aa d

Now I willcrush you!

Run away!

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E

ACR Via Backfiring

a a a aa d

Now I crushthis entry barrier!

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E

ACR Via Backfiring

a a a aa d

Pick on someone your

own size!

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ACR Via Unforced Error

E

a a a aa d

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d

E

ACR Via Unforced Error

a a a aa

I give up!

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E

ACR Via Unforced Error

a a a aa d

HereI come!

Pick on someone your

own size!

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ACR Via Intensified Rivalry

E

a a a aa d

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E

a a a aa

ACR Via Intensified Rivalry

d

Boo hoo.Bye bye.

That’smy cue.

Oh no, not again!

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What’s Interesting About That?

• Presumption in RBV that stronger is always better

• One well-known exception: Strength = Inflexibility

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Too Strong For Your Own Good?

• We’re interested in finding other exceptions to the rule• Why? RBV’s overlooked boundary conditions or hidden

assumptions

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Competitive Strength:Less Is more? When?

• “Disadvantage of competitive advantage” research program

• Several exceptions we are investigating:– Friend of my enemy, i.e., balance of power– Desperate measures, i.e., cornered animal– Partner demotivation– Diminished commons– Disproportionate scrutiny/enforcement– Friendly fire, i.e., collateral damage– Frienemies– Adverse competitor replacement (ACR)

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What “Something” Can Trigger ACR?

• “Danger zone”: – Wrong level of strength sends rival to brink of failure– Small perturbation can push over edge, triggering ACR– If you see the danger & can prevent it, you should, but...

• Can’t always see the danger:– Rival has incentive to conceal extent of weakness from

customers, investors, suppliers, distributors, employees– May overlook potential entrant or underestimate its

strength, and entrant may conceal its interest in entry– May misjudge magnitude of entry barrier

• Can’t always prevent the perturbation:– Can refrain from further strengthening, but can’t prevent

rival’s self-inflicted wounds and other misfortunes– Exogenous intensification of rivalry (frictions drop via new

technology, deregulation, reduced trade barriers, etc.)

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But Does ACR Really Happen?

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Yes!

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Transatlantic Air Routes To London

• BA made huge efficiency improvements in 1980’s in preparation for 1987 privatization.– BA came to dominate London/U.S. routes.– Inefficient TWA & Pan Am lost market share in

London market, exiting in 1990.– Replaced by more efficient AMR & UAL.– “Materially reduced” BA’s profit.– BA execs felt “betrayed by [U.K.] Transport

Minister” for allowing AMR/UAL entry.• In effect, had counted on continued protectionism.

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Electric Toothbrushes

• 1960’s-70’s: – 72% of electric toothbrush owners didn’t use it:

• Motors vulnerable to water damage & cheap ones break easily• Charging capacity of rechargeable batteries degrades fast• Water-tight body = no replacing worn-out rechargeable batteries• Replacement heads expensive & hard to find

– 20+ firms enter, but only 1 still in market in 2000.

• 1980’s-90’s– Technological arms race:

• Rotary speed, pulsing water jets, sonic, ultrasonic, lithium batteries, timers, pressure sensors, ultraviolet sanitizers

• Low end decimated: Average price jumped up to $99 by 1988.• Cheapest ($20-25, still not cheap) held <10% share in 2000

• 2000: Entry of SpinBrush at $5 price, including batteries– Grabbed 29% market share by 2001– High-end brands lost 20% market share from 2000 to 2002

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U.S. Motorcycle Market

• 1901-1945: H-D & Indian dominate market– H-D #1, Indian #2, only surviving domestics– 1945: New owner, new strategy

• Can’t beat H-D head-to-head• Target different buyers: Smaller, cheaper

“recreational” bikes for family/youth market• Perfect strategy, but botched execution

– Quality/cost problems & old dealer network

– 1959: Indian exits & Honda enters• Same strategy/target market, similar ads/products• Better execution: Quality, engineering, dealers• Honda extends line, devastates H-D for 20+ years

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Is Threat of ACR ImportantEnough To Take Seriously?

• Advantaged firm may have to make a mistake.• But it does occur...

– BA defeating TWA & PanAm in London allows entry of UAL & AMR.– High-end electric toothbrushes decimate low end, opening gap for

Spinbrush entry.– Harley-Davidson defeating Indian in U.S. opens gap for Honda’s entry.

• Inherent empirical challenges/ambiguities:– Prevalence? Compared to what? Relative to what group?– What is the “risk set” of advantaged firms? Which are “at risk” of ACR?

• Empirical prevalence understates conceptual importance:– ACR threat relevant not only when occurs, but also by motivating

incumbent decisions to prevent it:• Perhaps avoid trap by curtailing investment in improvements.• Example: Firms gaining dominant market share reduce % of

workforce in professional R&D (Rosenberg, 1976).– Difficult to gauge this impact on decisions, since “near misses” leave no

traces in any records (like near misses on highway).

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Research Questions

• In light of these inherent conceptual challenges, as a first step, we resort to first principles.

• Formal economic model of ACR:– What are the necessary conditions for ACR to

be possible & how realistic are these?– What factors push a firm closer to the

threshold of triggering ACR?– What factors affect the severity of ACR if it

occurs?

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Model Assumptions

• Biform game model• 2 horizontally differentiated customers, a & d• 3 firms:

– Advantaged (A), disadvantaged (D), & entrant (E)– Make market participation decisions in that order,

subject to cost of participating (D>A>E also OK).– A’s product better for a, D’s product better for d– A has efficiency advantage over D– E is identical to D except for greater efficiency– After participation decisions, total value divided

among firms & buyers via free-form bargaining– Confidence parameter: firms bargaining power

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Case 1: A Always Stays In Market

γ = Baseline cost (for firm D)δ = A’s cost advantage over Dε = E’s cost advantage over D

κ = Market participation costλ = Degree of horizontal differentiationα = Firms’ bargaining power

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Case 2: E’s Entry Pushes Out A

γ = Baseline cost (for firm D)δ = A’s cost advantage over Dε = E’s cost advantage over D

κ = Market participation costλ = Degree of horizontal differentiationα = Firms’ bargaining power

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Results: What affects distance from ACR threshold & severity of ACR?

• Reducing market differentiation (or other friction) moves A closer to ACR threshold.– Harder for D to stay in market vs. A, but also...– Harder for E to stay as A strengthens still further

• Lower firm bargaining power moves A closer to ACR threshold.

• ACR impact on A’s profit increases with firm bargaining power or with E’s cost advantage– Up to & including possibility of E pushing A out of

the market in turn.• Escape by A through further strengthening is

– Easier with greater bargaining power– Harder with stronger E

Boundary Conditions On Parameters

• Friction allows D to survive competition with A– Product differentiation/customer heterogeneity– Imperfect price discrimination (Cournot)– Gaps between (Chatain & Zemsky 2011)

• Meaningful entry barriers/costs– Not necessarily monetary– Tapered ACR: Firm E already in some parts of

market but Firm D’s demise at Firm A’s hands allows Firm E to expand to other parts• Boeing defeats Lockheed, helps Airbus grow• Kodak defeats GAF, helps Fujifilm grow

Structural Assumptions of Model

• Entry order of A>D>E or D>A>E– E must go last it will enter and keep D out

• This is the whole point of our analysis– This matches our examples

• Honda started building bikes long after Indian• TWA and PanAm got the London slots first• Spinbrush entered market very late

– Strong firms are often slow to enter new markets• Organizational rigidities (Henderson 1993)• Cognitive biases (Christensen 1997)• Postpone cannibalization (Ghemawat 1991)• Easier to catch up = Can afford to wait and see how

market uncertainties resolved (Teece 1986)

More Structural Assumptions

• Assumed E couldn’t pay D to leave– Like nearly all models of blockaded entry– Do profitable trades always occur? Coase Theorem says yes,

but even Coase himself didn’t always agree– D’s self-interested managers may resist– Behavioral causes of bargaining failure– Any imperfect information can result in bargaining failure

(Myerson & Satterthwaite, 1983)• We didn’t model this explicitly, but it is likely in practice

– Multi-party bargaining (e.g., US/UK air routes) doesn’t necessarily succeed even with complete information (Chatterjee et al., 1993)

– Capital constraints: Newcomer can’t always raise a fortune to buy out incumbents before proving its viability

– Politics/regulations may block, especially across borders• Honda had trouble persuading postwar MoF to let it take even

$250,000 to U.S. to open a sales office

Still More Structural Assumptions

• Didn’t let A diversify to occupy D’s niche D’s exit– Sometime this is possible, but it isn’t always

• Antitrust• Counter-synergistic business combinations

– Conflicting demands: Low-cost & regular airlines– Competency: A might be lousy at D’s niche

• Question of rationality:– ACR may require misjudgment or mistake

• Misjudgment: Overlooking potential entrants, or unexpected exogenous shift in frictions or in D’s strength

• Mistake: Intentional strengthening backfires on A, or D weakens itself through self-inflicted wounds

– Or may also be possible via information asymmetry• Weak rival concealing extent of true weakness• Potential entrant conceals its interest in entry or its

strength

Structural Assumptions of Model

• Expanding beyond three firms would yield similar results– But this would complicate problem, due to

the issue of coordination among multiple strong incumbents

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Implications

• For RBV theory:– Anomalous exception exposes hidden

assumptions & boundary conditions– ACR isn’t the only one. Look for more.

• For managers:– Important to identify potential entrants &

assess their strength– Important to know how weak rivals really

are, how close to brink of exit– Exogenous decreases in market frictions

are more dangerous if risk triggering ACR

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Closing Thoughts

• ACR = New boundary condition on RBV– Greater strength = Closer to brink, more risk of

unexpected exogenous shock triggering ACR– Intentional strengthening may backfire

• Value of resource depends on how it affects interactions with both actual & potential rivals

• ACR threat may reverse effect of market frictions on profitability of competitive advantage:– Market frictions usually reduce profitability of

competitive advantage (Makadok, 2010; Chatain & Zemsky, 2011)

– But frictions also help weaker incumbent to stay in the market longer as stronger incument’s advantage increases, thereby forestalling ACR.

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Seeking Additional Examples of ACR

• Please contact us if you know or find any!• richard.makadok@emory.edu

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Thank you!