1st March 2019
Outside Fortress Europe Excerpts
This second foundation Global Business Strategy Blog essay is based upon unabridged excerpts from Chapter Four, Theories of Strategy and Competition, in Outside Fortress Europe: Strategies for the Global Market.
Outside Fortress Europe Excerpt
The following quote extracted from a letter to the Editor of the Harvard Business Review by a global business leader is illustrative of the global context of economic activity:
Today every national economy is an integral part of the world economy. We cannot consider the best interests of any nation as an issue separate from the economic good of the world as a whole.
This statement by Eiji Toyoda, Chairman of the Toyota Motor Corporation, reflects a principle which underpins the economics of international business which we have discussed throughout the book thus far, especially the observations relating to our nineteenth-century economics hero, David Ricardo: free trade in goods and services between countries brings a range of benefits (over time) for all nations. Conversely, a climate which fosters protectionism and raises barriers to trade damages world economic growth. It is widely accepted, for example, that a major determinant of both the depth and length of the Great Depression of the early 1930s was the protectionist trade policies pursued by the major industrial countries throughout the period and it is generally acknowledged that the lessons learned as a consequence still underpin government policies around the world. Consider also the following observation of Roberto Azevêdo, the head of the WTO at the time of writing, on the inevitable destructiveness of trade wars (made following the imposition of new US steel and aluminium tariffs announced by Donald Trump): “Once we go down this path it will be very difficult to reverse course. An eye for an eye will leave us all blind and the world deep in recession” (cited in Economist, 2018, March 10th. Briefing: The Looming Trade War).
Free trade and the world economy
The economic arguments supporting free trade have changed little over time, but the fundamental nature and dynamics of the world economy have altered beyond recognition in recent decades. Several factors are driving what can be described as the globalization of the world economy. By this we refer to the economic dependence which countries (or groups of countries) have on each other. Such interdependence was clearly illustrated during the US equities market crash of October 1987 when stock exchanges and bourses around the world collapsed in a simultaneous sequence interrupted only by international time zones. The old cliché that ‘when America sneezes the world catches a cold’ was never illustrated better, albeit the virus was relatively short-lived in that particular case. This real-world scenario opened Chapter One, Ten Years That Shook the (Capitalist) World: 1988-1998, and the febrile nature of global financial markets has been documented to the present day in the Chapters which have followed, including this one.
Less than three years after the brief hiatus of the 1987 ‘financial crisis’ the collapse of the Japanese Nikkei index and the concern regarding its potential impact on world trade and global competition provided a further demonstration of the globalization of the world economy even though, as discussed in Chapter One (Japan’s Lost Decade?) the biggest hit was taken by the Japanese economy itself while its companies continued to develop globally. During the same period China’s economy soared, culminating in the country’s entry to the World Trade Organization in 2001 and its rapid industrialization and export boom thereafter. International trade development during the first two decades of the twenty-first century was notable for emerging markets such as Brazil, Russia and India, and also for an inexorable rise in consumerism across Southeast Asia.
A ‘new new world order’ has emerged which, while different in character, shares the same fundamental ideals of nineteenth-century free trade philosophy laid down by Adam Smith, David Ricardo and Jean-Baptiste Say. Speaking at The World Economic Forum on 25th January 2018, Jackie Ma, the CEO of online retailing colossus Alibaba, made the following observation in a keynote speech (featured in CNN coverage of the event):
I think globalization cannot be stopped. Nobody can stop globalization. Nobody can stop trade. And I believe, if trade stops, war starts. Trade is the way to dissolve the war, not cause the wars. We think that shutting ourselves off from the rest of the world and isolating ourselves will not lead us into a good future. Protectionism is not the answer.
Alibaba is a Chinese company.
(See Clark, 2016, Alibaba: The House that Jack Ma Built, for a fascinating account of the rise of this giant corporation along with biographical insights into its enigmatic founder, Jack Ma).
The globalization of the world economy and competitive strategy
At the level of the firm, the ability of individual companies to determine their own future remains one of the fiercest areas of debate within the strategic management and marketing literature, as we have demonstrated throughout this Chapter. This discussion readily cascades into broader areas of social theory, particularly the literature which examines the sociology of organizations and their impact on state and society. Although we have explored some such points of contention the broader level of analysis required is beyond the scope of the Outside Fortress Europe project. In the next section, however, we pick up on a general point raised in earlier sections of this Chapter: the powerful role of customer preference as a driving force in the economic process.
Professor Philip Kotler, the doyen of marketing academics, has noted that companies must strive to seek a balance between customer and competitor orientations in contemporary marketing environments. He offers a simple matrix and argues that – over time – companies have shifted from a product orientation, when they cared little for ‘anyone’ other than themselves, through development of a customer orientation, then a competitor orientation and, finally, a market orientation.
While on the surface this is an over-simplification, the idea that we should analyse the customer-competitor dynamic as a major influence on the change dimension of strategic management is a powerful one. More generally, if market structures (e.g. oligopoly) are applied to the Kotler framework then valuable insights can be gained from an examination of the economic processes which underpin the management of strategy and strategic change. A matrix of customer focus and competitor focus with market equilibrium threats (the # bullets) is shown in Figure 1 below.
In Cell 1, Low customer focus-low competitor focus, the only sustainable market structure is monopoly. In practice monopolies rarely exist although very dominant firms may demonstrate monopolistic behaviour, i.e. they abuse the market power they enjoy. The ability of monopolists to control output gives them tremendous scope to extract unreasonable prices and/or to sustain gross inefficiencies in operations. In market-based industrial economies (the US being a major exception) the historical tendency has been for governments to assume ownership of ‘natural monopolies’ i.e. market structures where the minimum efficient scale (MES) of output is so high that the industry can only support one profitable supplier (very common historically in utilities such as gas, electric, water, railroad networks and telecommunications). While nominally in the consumer interest, the reality of state ownership and operational management of natural monopoly is somewhat different. Governments have systematically exploited the monopoly power they own, using sole-supplier status to charge monopoly prices, an indirect tax indiscriminately charged on rich and poor alike. They have also tended to starve the industries of appropriate levels of capital investment, compromising customer service levels and laying the foundations for chronic infrastructure problems and the ultimate erosion of national competitiveness.
There have been undoubted benefits to society from nationalised industries, the most notable being the ability of such sectors to support very high levels of employment. In sector after sector, country after country, however, the status quo which has existed is being shattered. The twin market structure equilibrium threats of deregulation and privatisation are forcing competition into previously protected market spaces. The dynamic is being shaped and accelerated by a growing intolerance within the world trading institutions, including the WTO and the EU, of the heavy subsidies such industries attract from their governments. Another major pressure on this market structure is technological innovation and business process disruption which, as we demonstrate in Chapter Five, Analysing Global Markets and the Intelligent Company, can have a dramatic impact on cost structure and revenue earning potential.
Even the most rigid of market structures – government-owned monopoly – is cracking under multiple pressure points. With few exceptions, and these only partial and/or transient, governments of the large industrial democracies are washing their hands of business management, a philosophy rapidly adopted by the ex-communist countries of the Soviet Bloc and the highly interventionist states of South America. The process of privatisation in these countries has been far from smooth: in societies where elites persisted during the communist-inspired economic transformations of the post-war period, subsequent privatization programs have been tarnished by varying degrees of nepotism, cronyism and multiple variants of corruption, ranging from ‘squeaky-clean’ beaten-up states such as Slovenia and Croatia, through the despotic regimes of certain South American countries to the grossness of excess found in the former ‘nation-states’ of the USSR.
History has a long track-record whereby if economic power exists, tangible or otherwise, attempts will be made to usurp it, whether in the name of religion, the ‘greater good’ or plain, unadulterated, individual greed à la fictional character Gordon Gekko whose epigram ‘Greed is good’ opens this book. Or, if fiction is not your genre, see the stranger-than-fiction Jordan Belfort’s, The Wolf of Wall Street (Belfort, 2007; and movie with the same title, 2014) for real-world contemporary insights.
(We will refer to Jeremy Corbyn’s critique of ‘greed is good capitalism’ at the 2018 Labour party conference in a subsequent post. As a cultural reference, he was two decades off the mark!).
Reverting to Figure 1, Cell 2, Low customer focus-high competitor focus: the only sustainable market structure here is oligopoly, i.e. where most of the total market share is owned by a few large firms. In a typical oligopolistic market structure, for example, five firms might account for 70% of total output. A tendency towards oligopoly is a characteristic feature of capitalism, particularly where benefits of scale are readily apparent, and where the merger and acquisition of assets are unfettered by regulation and/or is facilitated by liquid equity markets. Although it is an economic concept, oligopoly can also be explained by reference to behavioural theories of the firm (Cyert and March 1963) and the typical feature of modern capitalism whereby ownership and management of the firm are divorced (Berle and Means, 1967). Regarding behavioural theories of firm conduct, it has been convincingly argued that senior managers do not pursue the corporate profit-maximising behaviour suggested by economic theory. On the contrary, executives are more likely to pursue self-interest, a condition typically fulfilled, both financially and psychologically, by expanding their realm of control through strategies of Mergers & Acquisition (see Chapter Nine, Acquisitions, Joint Ventures and Strategic Alliances in Global Business Strategy, for discussion and insights).
Oligopoly is characterised by industry concentration. This, in turn, leads to a high level of interdependence between the main firms in the industry. Typically, the firms become very competitor-oriented, forever wary of their next moves and/or reactions. Strategies tend to be reactive or ‘follower’ in nature. Overall, the output of such market structures tends to be of ‘me-too’ type products, market position (and relative market share) being secured by ownership of distribution, heavy advertising expenditure, high capital intensity of production and a range of additional ‘entry barriers’ peculiar to any specific sector. While the theory of oligopoly accommodates the Chamberlinian concept of product differentiation discussed earlier, in practice any advantage gained is typically short-lived since it will be readily matched by eagle-eyed rivals. New service supports are immediately matched, new value propositions imitated or bettered. If price alone is used to gain a competitive advantage, expect the impact to be short-lived. Copying price is the easiest copycat tactic of all, regardless of its mid- to long-term futility from a strategic brand management perspective (see Chapter Six, Marketing Strategy and Global Brand Management) and immediate erosion of stakeholder value (see Chapter Twelve, A Stakeholder Perspective on Global Business Strategy).
The combination of follower strategies and me-too products is likely to create a price-sensitive customer base since price is the only value signal available within the individual consumer’s choice set. When industry concentration reaches its natural or legal limit individual producers will be strongly tempted to win share through price, particularly if the industry is mature and carrying excess capacity. In practice, however, firms are fully aware (or strongly perceive) that price cuts will be instantly matched, thus damaging industry profitability.
In oligopolistic market structures, then, there is an inherent tendency towards a ‘cartel culture’, whereby firms avoid price cuts through a variety of mechanisms ranging from simple price leadership by a dominant supplier through to tacit or overt collusion. Oligopolistic behaviour is the dominant modus operandi of modern capitalism, but it is inherently unstable. As Figure 1 demonstrates, its fragile structure and market equilibrium are subject to bombardment on several pressure points. The most obvious is regularity constraint, enacted through ongoing observation of industry behaviour and the vetting of mergers and acquisitions which are judged to have anti-competitive implications. In practice, the vetting role is easier though arguably more politically sensitive. In contrast, observations of persistent anti-competitive behaviour are extremely difficult to prove, as many famous cases have demonstrated: if all firms are charging the same price, or moving price points in tandem, this can be explained both by competitive or anti-competitive behaviour!
The principal concern of anti-trust is consumer protection. As Adam Smith observed, “people of the same trade seldom meet together, even for the merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices”. Despite the policing difficulties of proving collusion, there is growing evidence that the anti-trust question is being taken far more seriously by the regulatory authorities, increasingly within the auspices or under the watchful eye of international trading conventions.
A distinctive characteristic of oligopoly is the chronic inefficiencies which this type of market structure accommodates. This factor leaves tremendous scope for rival firms to penetrate the market and such attacks normally come from two disparate sources. First, new entrants, attracted by the high prices attainable and often enjoying lower cost structures, will penetrate the market, often radically changing the economics of the industry in the process. Second, innovations in product and process technologies will radically enhance economic utility and thus reconfigure the nature and structure of demand. These twin forces have been rapidly accelerated by the globalization of competition, most notably the ‘new competition’ emanating from Southeast Asia, India, South America and the aspiring ‘young’ nations of Africa, most notably Nigeria and Kenya.
A further pressure point on this market structure, particularly in the consumer goods industry, arises from the growing concentration of retailers, especially for global fast-moving-consumer-goods (FMCG) manufacturers such as Nestlé, Danone, P&G, Unilever et al. In his highly regarded book American Capitalism‘, the influential economist John Kenneth Galbraith long ago drew attention to the theory of countervailing power to explain what he described as “the paradox of the unexercised power of the large corporation”. His theory was founded on the following proposition:
… private economic power is held in check by the countervailing power of those who are subject to it. The first begets the second. The long trend toward concentration in industrial enterprise in the hands of a relatively few firms has brought into existence not only strong sellers … but also strong buyers… The two developed together, not in precise step but in such a manner that there can be no doubt that the one is in response to the other.
He sees this as an inevitable process and concludes that, in general, most positions of market power in the manufacture of consumer goods will be covered by positions of countervailing power in the supply chain, concepts subsequently ‘popularised’ by Prof. Michael Porter in his 5-Forces Industry Structure Model (‘bargaining power of suppliers’; ‘bargaining power of buyers’).
Market power, then, and its use and effectiveness must be viewed in context. Perhaps the most significant aspect of power is the reaction of those who are affected by it and, most noticeably, their tendency to resist it where the achievement of their own goals is being threatened.
Reverting to Figure 1, Cell 3, High customer focus-high competitor focus: at first glance, this position appears to characterise perceptions and realities of contemporary competitive environments. Customers have power, they are increasingly exercising it and a focus on their needs and preferences seems essential. Competitors are many, they are global, they are sophisticated and they are aggressive. A focus on their strategic orientation, competitive bases and market responsiveness seems essential. If pushed, economists confusingly label this cell ‘monopolistic competition’, a type of market structure which is characterised by excess capacity, many independently-minded suppliers and buyers, relatively free market entry and exit and a heavy emphasis on product differentiation. Any tardiness to accept this definition will probably relate to the conceptual requirement of low entry barriers, arguably a weakness rooted in the static definitions associated with general theories of intermediate market structures such as oligopoly and duopoly.
It is highly predictable that, in the years ahead, the global economy will have a market structure which demonstrates oligopolistic characteristics (a few giant firms dominating global industries). This contention is mere cold comfort for companies struggling to come to terms with the competitive environment they must cope with right now. The market dynamics within Cell 3 of Figure 1 most closely approximate the efficient market hypothesis (EMH), a general theory which, inter alia, in this context argues that any surplus value a company creates will be eroded by sophisticated consumers and/or efficient and effective rivals. Product life cycles will be short, technological advantage rapidly transferred and diffused and there will be a premium on time-to-market. Pressure points on this cell include the ubiquitous Porterian new entrants, technological substitutes and, spanning both these forces, ‘breakthroughs’ in process technologies as all market players will constantly strive for efficiency gains. There will be a tendency towards industry consolidation through mergers and acquisition as companies seek solace (and market power) through scale. Similarly, a sharp focus on transaction costs and a desire to control opportunistic behaviour by supply chain members will lead some firms towards vertical integration. Alternative solutions to the challenges of the market dynamics in Cell 3 will be the growth in cross-border mergers and acquisitions and the creation of joint ventures and strategic alliances as firms fail to cope alone, particularly as market structures will increasingly be defined globally. Within this cell a strategic orientation is essential, a theme neatly captured in the widely-cited ‘three Cs’ of market economics: Corporation (capabilities); Customer; and Competitors.
This three-pronged conceptual approach to the study of strategy was echoed in Anderson’s seminal article linking marketing with strategic planning and a new theory of the firm wherein he identified a threefold role for marketing:
- To identify strategic positions that will ensure customer support;
- To generate strategies to achieve those positions by developing competitive advantages over firms with similar positioning aspirations;
- To negotiate with management and other functional areas to obtain the resources with which to pursue the selected strategies.
Focusing specifically on the business orientation essential for survival and prosperity in Cell 3 of Figure 1, Narver and Slater concluded that there was a significant positive impact of marketing orientation on profitability for both commodity and non-commodity businesses. The three constituent elements of marketing orientation in their study were customer orientation, competitor orientation and inter-functional coordination.
An underlying theme of these three contributions to the strategy and marketing literature is that they provide universally applicable heuristics for all organizations, a theme we develop throughout this book. To summarize here, the predominant thesis of contemporary marketing and strategic management wisdom is that successful organizations, whether service- or product-based, whether large, medium or small in size, need to plan strategically, need to understand their competitors and need to adjust their market position in accordance with the desired matching of company resources, customer needs and competitor stance.
Reverting to Figure 1, Cell 4, High customer focus-low competitor focus: this structural position rests uneasily in the scheme of things as we are presenting them here. This theoretical difficulty is offset to some extent by the practical reality that few markets demonstrate this structural condition or that long term (independent) survival is tenable. While a monopolist company could occupy a position where competition was meaningless history suggests that such an organization is more likely to appropriate surplus value than distribute it to customers. Likewise, basic economics suggests that any company earning high returns from having a sharp customer focus will very quickly find itself in competition with rivals seeking a piece of the action. The essential dynamic of Cell 4, then, is towards Cell 3 as new entrants challenge the incumbent firms, a threat even faced by the Silicon Valley behemoths who have created and dominated new industries and/or challenged others in recent years (Economist, 2018, January 6th).
Outside Fortress Europe Excerpt References
Anderson, P. F. (1982). Marketing, Strategic Planning and the Theory of the Firm. Journal of Marketing Management(Spring), 15-26.
Belfort, J. (2007). The Wolf of Wall Street. New York: Bantam Dell.
Berle, A. A., & Means, G. C. (1967). The Modern Corporation and Private Property. New York: Harvest.
Clark, D. (2016). Alibaba: The House that Jack Ma Built. New York: Harper Collins.
Cyert, R. M., & March, J. G. (1963). A Behavioural Theory of the Firm. Englewood Cliffs, NJ.: Prentice Hall.
Economist. (2018, March 10th). Briefing: The Looming Trade War. The Economist, 23-26.
Economist. (2018, January 6th). The year of the incumbent: In 2018 conventional firms will give Silicon Valley a run for its money. The Economist, 49.
Galbraith, J. K. (2012). American Capitalism: The Concept of Countervailing Power: Reprint of 1952 Edition. London: Martino Fine Books.
Kotler, P. (2000). Marketing Management: Analysis, Planning, Implementation and Control (The Millennium Edition) (10 ed.). Englewood Cliffs, NJ: Prentice Hall International.
Narver, J. C., & Slater, S. F. (1990). The Effect of a Market Orientation on Business Profitability. Journal of Marketing, 54(October), 20-35.
Ricardo, D. (2018). On the Principles of Political Economy: And Taxation (Classic Reprint). London: Forgotten Books.
Schoorl, E. (2015). Jean-Baptiste Say: Revolutionary, Entrepreneur, Economist (Routledge Studies in the History of Economics). London: Routledge.
Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. Edinburgh: Strathan & Cadell.
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All content © Colin Edward Egan, 2020