Aggressive marketing in the context of format wars

WEEK 5 LECTURE 1

WEEK 5 LECTURE 19

Strategic Framework for Managing Innovation

The focus of this lecture will be on the strategic framework for managing innovation. We will review the nature of competition and strategy in high-technology industries. Technology refers to the body of scientific knowledge used in the production of goods or services. High-technology (high-tech) industries are those in which the underlying scientific knowledge that companies in the industry use is rapidly advancing, and, by implication, so are the attributes of the products and services that result from its application. The computer industry is often thought of as the quintessential example of a high-technology industry. The circle of high-technology industries is both large and expanding, and technology is revolutionizing aspects of the product or production system even in industries not typically considered high-tech. Although high-tech industries may produce very different products, when developing a business model and strategies that will lead to a competitive advantage and superior profitability and profit growth, they often face a similar situation. Technical Standards and Format Wars Technical standards are a set of technical specifications that producers adhere to when making the product or a component of it that can be an important source of competitive advantage. Battles to set and control technical standards in a market are referred to as "platform or format wars" - essentially, battles to control the source of differentiation, and the value that such differentiation can create for the customer. image1.png A standard is a format, an interface, or a system that allows interoperability. Adhering to standards allows us to browse millions of different web pages, ensures the light bulbs made by any manufacturer will fit any manufacturer’s lamps, and keeps the traffic moving in Los Angeles (most of the time). Standards can be public or private. Public (or open) standards are those that are available to all either free or for a nominal charge. Typically, they do not involve any privately owned intellectual property, or the intellectual-property owners make access free (such as Linux). Private (proprietary) standards are those where the technologies and designs are owned by companies or individuals. If I own the technology that becomes a standard, I can embody the technology in a product that others buy or license the technology to others who wish to use it. Thus, in smartphones the major rival standards are Apple’s iOS and Google’s Android. Apple’s iOS is used only in Apple’s mobile devices; Android is licensed widely. Table 9.3 below and in the course textbook page 256, lists several companies which own key technical standards within a particular product category.

image2.png A. Examples of Standards A familiar example of a standard is the layout of a computer keyboard. The standard format (QWERTY) makes it easy for people to move from computer to computer because the input medium, the keyboard, is set in a standard way. Examples of products that rely on technical standards include the dimensions of shipping containers such as trucks and railcars, and the components included in a personal computer. When an industry relies upon a common set of features or design characteristics it is called a dominant design. Embedded in this design are several technical standards. B. Benefits of Standards Standards emerge because there are economic benefits associated with them. Following are the benefits: A technical standard helps to guarantee compatibility between products and their complements. Standards help reduce consumer confusion. The emergence of a standard can help to reduce production costs. Once a standard emerges, products that are based on the standard design can be mass produced, enabling the manufacturers to realize substantial economies of scale while lowering their cost structures. The emergence of standards can help reduce risks associated with supplying complementary products, and thus increase the supply for those complements. C. Establishment of Standards Standards emerge in an industry in three primary ways: When the benefits of establishing a standard are recognized, companies in an industry might lobby the government to mandate an industry standard. Technical standards are often set by cooperation among businesses, without government help, and often through the medium of an industry association. When the government or an industry association sets standards, these standards fall into the public domain, meaning that any company can freely incorporate the knowledge and technology upon which the standard is based into its products. Often, however, the industry standard is selected competitively by the purchasing patterns of customers in the marketplace - that is, by market demand. In this case, the strategy and business model a company has developed for promoting its technological standard are of critical importance because ownership of an industry standard that is protected from imitation by patents and copyrights is a valuable asset - a source of sustained competitive advantage and superior profitability. Format wars are common in high-tech industries where standards are important. D. Network Effects, Positive Feedback, and Lockout There has been a growing realization that when standards are set by competition between companies promoting different formats, network effects are a primary determinant of how standards are established. Network effects arise in industries where the size of the “network” of complementary products is a primary determinant of demand for an industry’s product. Network effects are important in the establishment of standards. The classic example of a format war can be considered: the battle between Sony and Matsushita to establish their respective technologies for videocassette recorders (VCRs) as the standard in the marketplace. Sony was first to market with its Betamax technology, followed by JVC with its VHS technology. As more prerecorded VHS tapes were made available for rental, the VHS player became more valuable to consumers, and therefore the demand for VHS players increased. A large number of companies signed on to manufacture VHS players, and soon far more VHS players were available for purchase in stores. Before long, it was clear to anyone who entered a video rental store that there were more VHS tapes available for rent and fewer Betamax tapes available. This served to reinforce the positive feedback loop, and ultimately Sony’s Betamax technology was shut out of the market. The pivotal difference between the two companies was strategy: JVC and Matsushita chose a licensing strategy, and Sony did not. As a result, JVC’s VHS technology became the de facto standard for VCRs, whereas Sony’s Betamax technology was locked out. When two or more companies are competing with each other to get technology adopted as a standard in an industry, and when network effects and positive feedback loops are important, the company that wins the format war will be the one whose strategy best exploits positive feedback loops. As the market settles on a standard, an important implication of the positive feedback process occurs: companies promoting alternative standards can become locked out of the market when consumers are unwilling to bear the switching costs required to abandon the established standard and adopt the new standard. In this context, switching costs are the costs that consumers must bear to switch from a product based on one technological standard to a product based on another technological standard. However, consumers will bear switching costs if the benefits of adopting the new technology outweigh the costs of switching. Strategies for Winning a Format War Firms benefit when they exploit network effects and when positive feedback loops are in operation. The various strategies that companies should adopt in order to win format wars are centered upon finding ways to make network effects work in their favor and against their competitors. Winning a format war requires a company to build the installed base for its standard as rapidly as possible, thereby leveraging the positive feedback loop, inducing consumers to bear switching costs, and ultimately locking the market into its technology. A. Ensure a Supply of Complements It is important for the company to make sure that there is an adequate supply of complements.One way for companies to ensure a supply of complements is to diversify into the production of complements and seed the market with sufficient supply to help jump-start demand for their format. Also, companies may create incentives or make it easy for independent companies to produce complements. B. Leverage Killer Applications Killer applications are applications or uses of a new technology or product that are so compelling that they persuade customers to adopt the new format or technology in droves, thereby “killing” demand for competing formats. Killer applications often help to jumpstart demand for the new standard. C. Aggressive Pricing and Marketing One common tactic to jump-start demand is to adopt a razor and blade strategy: pricing the product (razor) low in order to stimulate demand and increase the installed base, and then trying to make high profits on the sale of complements (razor blades), which are priced relatively high. This strategy owes its name to Gillette, the company that pioneered this strategy to sell its razors and razor blades. Aggressive marketing is also a key factor in jump-starting demand to get an early lead in an installed base. Substantial upfront marketing and point-of-sales promotion techniques are often used to try to attract potential early adopters who will bear the switching costs associated with adopting the format. If these efforts are successful, they can be the start of a positive feedback loop. D. Cooperate with Competitors Companies have been close to simultaneously introducing competing and incompatible technological standards a number of times. They understand that the nearly simultaneous introduction of such incompatible technologies can create significant confusion among consumers, and often lead them to delay their purchases. E. License the Format Licensing the format to other enterprises so that those others can produce products based on the format is another strategy often adopted. The correct strategy to pursue in a particular scenario requires that the company consider all of these different strategies and tactics and pursue those that seem most appropriate given the competitive circumstances prevailing in the industry and the likely strategy of rivals. Although there is no single best combination of strategies and tactics, the company must keep the goal of rapidly increasing the installed base of products based on its standard at the front of its mind. By helping to jump-start demand for its format, a company can induce consumers to bear the switching costs associated with adopting its technology and leverage any positive feedback process that might exist. It is also important not to pursue strategies that have the opposite effect. Capturing First-Mover Advantages Lead Time or "first mover." Tacitness and complexity do not provide lasting barriers to imitation, but they do offer the innovator time. Innovation creates a temporary competitive advantage that offers a window of opportunity for the innovator to build on the initial advantage. The innovator’s lead time is the time it will take followers to catch up. The challenge for the innovator is to use initial lead-time advantages to build the capabilities and market position to entrench industry leadership. Intel in microprocessors, Cisco Systems in routers, and Canon in inkjet printers were brilliant at exploiting lead time to build advantages in efficient manufacture, quality, and market presence. Conversely, innovative British companies are notorious for having squandered their lead-time advantage in jet planes, radars, CT scanners, and genomics.

image3.png In high-technology industries, companies often compete by striving to be the first to develop revolutionary new products, that is, to be a first mover. First movers initially have a monopoly position. If the new product satisfies unmet consumer needs and demand is high, the first mover can capture significant revenues and profits. Such revenues and profits signal to potential rivals that imitating the first mover makes money. Despite imitation, some first movers have the ability to capitalize on and reap substantial first-mover advantages - the advantages of pioneering new technologies and products that lead to an enduring advantage. Some first movers can reap substantial advantages from their pioneering activities that lead to an enduring competitive advantage. They can, in other words, limit or slow the rate of imitation. But there are plenty of counterexamples suggesting that first-mover advantages might not be easy to capture and, in fact, that there might be first-mover disadvantages - the competitive disadvantages associated with being first. A. First-Mover Advantages There are five primary sources of first-mover advantages:

1. The first mover has an opportunity to exploit network effects and positive feedback loops, locking consumers into its technology.

2. The first mover may be able to establish significant brand loyalty, which is expensive for later entrants to break down.

3. The first mover may be able to increase sales volumes ahead of rivals, and thus reap cost advantages associated with the realization of scale economies and learning effects.

4. The first mover may be able to create customer switching costs for its customers that subsequently make it difficult for rivals to enter the market and take customers away from the first mover.

5. The first mover may be able to accumulate valuable knowledge related to customer needs, distribution channels, product technology, process technology, and so on.

B. First-Mover Disadvantages Balanced against the first-mover advantages are a number of disadvantages:

· They have to bear significant pioneering costs that later entrants do not.

· They are more prone to make mistakes because there are so many uncertainties in a new market.

· They run the risk of building the wrong resources and capabilities because they are focusing on a customer set that is not going to be characteristic of the mass market.

· They may invest in inferior or obsolete technology.

C. Strategies for Exploiting First-Mover Advantages

First movers must strategize and determine how to exploit their lead and capitalize on first mover advantages to build a sustainable long-term competitive advantage while simultaneously reducing the risks associated with first-mover disadvantages. There are three basic strategies available:

· Develop and market the innovation.

· Develop and market the innovation jointly with other companies through a strategic alliance or joint venture.

· License the innovation to others and allow them to develop the market.

The optimal choice of strategy depends on the answers to three questions:

· Does the innovating company have the complementary assets to exploit its innovation and capture first-mover advantages?

· How difficult is it for imitators to copy the company’s innovation? In other words, what is the height of barriers to imitation?

· Are there capable competitors that could rapidly imitate the innovation?

1. Complementary Assets Complementary assets are the assets required to exploit a new innovation and gain a competitive advantage. Among the most important complementary assets are competitive manufacturing facilities capable of handling rapid growth in customer demand while maintaining high product quality. Complementary assets also include marketing knowhow, an adequate sales force, access to distribution systems, and an after-sales service and support network. All of these assets can help an innovator build brand loyalty and more rapidly achieve market penetration. 2. Height of Barriers to Imitation Barriers to imitation are factors that prevent rivals from imitating a company’s distinctive competencies and innovations. Barriers to imitation give an innovator time to establish a competitive advantage and build more enduring barriers to entry in the newly created market. 3. Capable Competitors Capable competitors are companies that can move quickly to imitate the pioneering company. Competitors’ capability to imitate a pioneer’s innovation depends primarily on two factors: