“The Structure of Strategy” is a summary of parts of my book, “The Foundations of Corporate Success”, and was reprinted in “The Business of Economics”
1. The Structure Of Strategy
In 1986 I was offered the opportunity, and substantial resources, to answer the question, ‘What are the origins of industrial success?’ There are, perhaps, more important questions, but not many, and that was certainly the most important question I felt in any way equipped to try to answer. So I accepted the challenge.
It was obvious that there was no shortage of data. Every corporation is required to file detailed returns of its activities. In all Western economies there are several journals which track the performance and activities of leading companies. Case studies, business histories and business biographies describe how decisions were made and problems overcome. I began to understand that what was needed was not to collect new information, but to establish a framework for understanding what was already known.
There were those who told me that the task I had set myself could not be done, or was not worth doing. Business problems were too complex to be susceptible to the use of analytic techniques. Every situation was unique and there could be no valid generalisations. It had even been argued by some (as in Abernathy and Hayes 1980) that the attempt to apply analytic methods to business issues is at the heart of Western economic decline.
It might be true that there can be no valid generalisations about business, and that there can be no general theories of the origins of corporate success or failure. But it does not seem very likely that it is true. It is not just that similar observations were made ahead of much greater leaps in scientific knowledge. How could we hope to understand something so complex, and so subject to change, as the motion of the planets or the makeup of genetic material?
The strategy of the firm is the match between its internal capabilities and its external relationships. It describes how it responds to its suppliers, its customers, its competitors, and the social and economic environment within which it operates. These aspects of management activity are the subject of strategy. Did it make sense for Benetton, an Italian knitwear manufacturer, to move into retailing, and was it right to decide to franchise most of its shops to individual entrepreneurs? Should Saatchi & Saatchi have attempted to build a global advertising business? What segment of the car market was most appropriate for BMW? These are typical issues of corporate strategy. Corporate strategy is concerned with the firm’s choice of business, markets and activities.
Should Eurotunnel offer a premium service or use its low operating costs to cut prices? How should Honda have approached the US motor cycle market? Faced with three different standards for high definition television, and a market potentially worth tens of billions of pounds, what stance should a television manufacturer adopt? What will be the future of European airlines as deregulation progresses? These are typical issues of business, or competitive, strategy. Competitive strategy is concerned with the firm’s position relative to its competitors in the markets which it has chosen.
On the face of it, these are issues which respond to analytic tools, and if analysis has failed to offer at least partial answers it is because it is bad analysis, not because the objective is misconceived. The analysis of strategy uses our experience of the past to develop concepts, tools, data and models which will illuminate these decisions in future. Taking corporate and business strategy together, we learn why some firms succeed and others fail. Why did EMI fail to profit from its body scanner while Glaxo succeeded brilliantly in marketing its anti-ulcer drug, Zantac? Why has Philips earned so little from its record of innovation? Why has Marks & Spencer gone from strength to strength when so many other retailers have enjoyed spectacular, but purely transitory, success? What are the origins of corporate success?
What is Success?
One paradox was immediately apparent in my pursuit of the origins of corporate success. If I asked what was meant by corporate success, many different answers were proposed. Some people emphasised size and market share, others stressed profitability and returns to shareholders. Some people looked to technical efficiency and innovative capability. Others stressed the reputation that companies enjoyed among their customers and employees, and in the wider business community.
Yet this disagreement was hardly reflected at all in disagreement about which companies were successful. Whatever their criteria of success, everyone seemed to point to the same companies – to Matsushita and to Hewlett-Packard, to Glaxo and to Benetton, to BMW and to Marks & Spencer. I formed the view that the achievement of any company is measured by its ability to add value – to create an output which is worth more than the cost of the inputs which it uses. These different opinions on how success should be measured were partly the result of disagreement about how added value was created, but rather more the product of different views as to how, once created, added value should be used. Successful companies, and successful economies, vary in the relative emphasis to be given to returns to shareholders, the maximisation of profits, and the development of the business. Different firms, and different business cultures gave different weights to these purposes. But the underlying objective of adding value was common to all.
I began by asking the managers of successful companies to explain the sources of their success. They told me that success depended on producing the right product at the right price at the right time. It was essential to know the market, to motivate employees, to demand high standards of suppliers and distributors. I recognised that all these things were true, but those who emphasised them were describing their success, not explaining it. There was much that had been written on strategic management. But stripped of rhetoric, most strategy texts offered checklists of issues that senior executives needed to address in considering the future of their business. That literature posed questions but yielded few answers.
Economists had studied the functioning of industry, but their concerns were mostly with public policy, not business policy, and I was sure that industrial success was founded on the behaviour of firms, not on the decisions of governments. Sociologists had studied the functioning of organisations, but only a few had matched the characteristics of the firm to the economic environment that determined its competitive performance.
I came to see that it was the match between the capabilities of the organisation and the challenges it faced which was the most important issue in understanding corporate success and corporate failure. There are no recipes and generic strategies for corporate success. There cannot be, because if there were their general adoption would eliminate any competitive advantage which might be derived. The foundations of corporate success are unique to each successful company.
That uniqueness is a product of the firm’s contracts and relationships. I see the firm as a set of relationships between its various stakeholders – employees, customers, investors, shareholders. The successful firm is one which creates a distinctive character in these relationships and which operates in an environment which maximises the value of that distinctiveness.
Few who drive a BMW car know what the initials stand for, or realise that the distinctive blue and white propeller badge reproduces the colours of the state flag of the State of Bavaria. The Bayerische Motoren Werke were established during the first world war. They specialised in the manufacture of engines. The company subsequently diversified into what are now its two principal product ranges: automobiles and motor cycles. Today BMW is one of Germany’s largest and most successful companies.
BMW cars are not the most powerful, or the most reliable, or the most luxurious on the market, although they score well against all these criteria. No one has ever suggested that they are cheap, even for the high level of specification that most models offer. Although BMW rightly emphasises the quality and advanced nature of its technology, its products are not exceptionally innovative. The design of the company’s cars is conventional and the styling of its models is decidedly traditional.
The achievements of BMW are built on two closely associated factors. The company achieves a higher quality of engineering than is usual in production cars. While most car assembly has now been taken over by robots or workers from low wage economies, BMW maintains a skilled German labour force. The company benefits, as many German firms do, from an educational system which gives basic technical skills to an unusually high proportion of the population. Its reputation has followed from these substantial achievements. In this, BMW is representative of much of German manufacturing industry.
Yet BMW’s success was neither easy nor certain (Monnich, 1989, 1991). In 1945, the company was Germany’s leading manufacturer of aeroengines. Its primary market and its capital equipment were both in ruins. Its principal factory at Eisenach was across the border in the Soviet occupation zone. While German recovery through the l950s occurred at a pace which attracted the title of economic miracle, BMW did not prosper. Uncertain of its future, the company emphasised automobiles but its products ranged from tiny bubble cars, manufactured under license, to limousines. In 1959, the firm faced bankruptcy and a rescue by Mercedes seemed its only hope of survival.
Instead, BMW found a powerful shareholder – Herbert Quandt – who perceived the company’s inherent strengths. The turning point came when the firm identified a market which most effectively exploited its capabilities – the market for high-performance saloon cars, which has since become almost synonymous with BMW. The BMW 1500, launched in 1961, established a reputation for engineering quality in the BMW automobile brand. The brand in turn acquired a distinctive identity as a symbol for young, affluent European professionals. That combination – a system of production which gives the company a particular advantage in its chosen market segment, a worldwide reputation for product quality, and a brand which immediately identifies the aims and aspirations of its customers – continues to make BMW one of the most profitable automobile manufacturers in the world.
Today, the BMW business is structured to maximise these advantages. Retail margins on BMW cars are relatively high. The company maintains tight control over its distribution network. This control supports the brand image and also aids market segmentation. BMW cars are positioned differently and priced very differently in the various national markets. The same tight control is reflected in BMW’s relationships with suppliers, who mostly have continuing long associations with the company. BMW’s activities are focused almost exclusively on two product ranges – high performance saloon cars and motor bikes which reflect its competitive strengths. The company also uses the brand to support a range of motoring accessories.
BMW is a company with a well-executed strategy. It is a company which came – after several false starts – to recognise its distinctive capabilities and chose the market, and subsequent markets, which realised its full potential. Its dealings with its suppliers and distributors, its pricing approach, its branding and advertising strategies, are all built around that recognition and these choices. There was no master plan, no single vision which took BMW from where it was in 1959 to where it is today. There was a group within the company which believed strongly that a model like the 1500 was the firm’s main hope of survival. There were other views, other options. No one had more than partial insight into what the future would hold. But BMW’s success was no accident either.
Honda’s redefinition of the US motor cycle market is a classic case in corporate strategy (HBS 1978). Motor bikes in the US in the 1950s were associated with a subculture now best recalled through movies, leather jackets, the smell of oil, and teenage rebellion. In 1964, five years after its entry into the United States, one in three motor cycles sold there were Hondas. The best selling product was a 50cc supercub, marketed under the slogan, ‘You meet the nicest people on a Honda.’
There are two views of this achievement. In one, Honda’s strategy was an archetype of Japanese penetration of Western markets. The aggressive pursuit of domestic volume established a low cost base for expansion overseas. This was the conclusion of a Boston Consulting Group study for the British government (BCG 1975). A rather different account was given by Richard Pascale, who went to Tokyo to interview the elderly Japanese who had brought the first Honda machines to the United States. As they recalled it, Honda had aimed to secure a modest share of the established US motor cycle market.
‘Mr Honda was especially confident of the 250 cc and 305 cc machines. The shape of the handlebar on these larger machines looked like the eyebrows of Buddha, which he felt was a strong selling point.’
These hopes were not realised. The eyebrows of Buddha had little attraction for the leatherjacketed Marlon Brando.
‘We dropped in on motor cycle dealers who treated us discourteously and, in addition, gave the general impression of being motor cycle enthusiasts who, secondarily, were in business.’
The first supercubs exported to the United States were used by Honda employees for their own personal transport around the concrete wastes of Los Angeles. It was only when these caught the attention of a Sears buyer and the larger machines started to show reliability problems, that Honda put its efforts behind the 50cc machines. The ‘nicest people’ slogan was invented by a University of California undergraduate.
Neither of these accounts is entirely convincing. The BCG account is an expression of the near paranoia created for many Westerners by Japanese achievement. But Pascale’s suggestion that Honda’s success was simply the result of good fortune would be more persuasive if the company had not been blessed by such good fortune quite so often in the course of its spectacular rise. The ‘eyebrows of Buddha’ are all too reminiscent of the South Sea island girls who teased Margaret Mead with ever more extravagant accounts of their sexual exploits.
We shall never know the extent to which Honda’s success was truly the result of chance or rational calculation. But while knowing may be important to the business historian, it is of little significance to the corporate strategist. Quinn, Minzberg and James (1988) – in what is perhaps the best of recent strategy texts – pose for their readers the question (p. 81), ‘Ask yourself while reading these accounts, how the strategic behaviour of the British motor cycle manufacturers who received the BCG report might have differed if they had instead received Pascale’s second story.’ The correct answer, of course, is ‘Not at all.’ Suppose it were shown conclusively that Honda’s success was the result of purest chance. It would not then follow that the right approach for British firms was to wait for similar good fortune to fall on them. This was what they in fact did, with notable lack of success.
Honda effected a brilliantly successful market entry. Like all successful strategies, it was based on a mixture of calculation and opportunism, of vision and experiment. Like all successful corporate strategies, it was centred on Honda’s distinctive capability – an established capacity to produce an innovative but simple, low-cost product. Its realisation depended on a successful competitive strategy, which made full use of segmentation and involved the creation of a distinctive distribution network which bypassed the traditional retail outlets of the enthusiasts. The lessons we can learn from that strategy are much the same whether Honda conceived it by grand design or stumbled on it by accident.
The Nature of Strategy
The issues that BMW and Honda handled so successfully are the central questions of strategy. BMW and Honda had to consider what markets to enter, how to position their products within these markets, how to build relationships with dealers and component manufacturers. The subject of strategy analyses the firm’s relationships with its environment, and a business strategy is a scheme for handling these relationships. Such a scheme may be articulated, or implicit, pre-programmed, or emergent. A strategy – like that of BMW or Honda – is a sequence of united events which amounts to a coherent pattern of business behaviour.
If the subject of business strategy focuses on the relationship between the firm and its environment, there are many key management issues which it does not address. Strategy is not principally concerned with employee motivation, or with finance, or with accounting, or with production scheduling and inventory control, although these may influence the firm’s strategy and be influenced by it. In the last two decades, the pretensions and prestige of the subject of strategy have been such that strategists have stressed not only the central importance of the issues with which they deal but also the relevance of strategy to all aspects of business behaviour. For the same reasons, everyone involved in business – from the personnel manager to the public relations consultant has asserted a right to contribute to the strategy process.
But strategy is not simply another word for important. There are many aspects to good management, and to say that strategy and operations management are distinct facets of it is not to disparage either. Yet there is a difference between strategy and these other elements of management practice which illuminates the nature of strategy itself and may partly explain its supposed primacy. In most industries, there are many firms which have their finance and accounting right, their human relations right, their information technology adapted to their needs. For one firm to succeed in these areas does not damage others. In implementing finance and accounting, human relations and information technology, it is right, and normal, to look to the best practice in other firms.
But strategy is not like that. Honda and BMW did not establish their market positions by methods which built on the best practice of their competitors. For both companies attempts to match their rivals’ strategies failed. BMW’s bubble cars were not as well regarded as Innocenti’s, and its limousines were inferior to those of Mercedes. Honda was able to sell powerful motor bikes in the US only after its success with quite different products had destroyed its competitors’ finances and established its own reputation. Successful strategy is rarely copycat strategy. It is based on doing well what rivals cannot do or cannot do readily, not what they can do, or are already doing.
Despite its current well publicised problems, IBM has been, for the last three decades, perhaps the most successful corporation in the world. It has dominated a large, rapidly growing and profitable market and its products have changed every aspect of business behaviour. IBM is a high tech company but its strength is not simply derived from its technology, where it has often chosen to follow rather than to lead. IBM’s most famous advertising slogan – ‘No one ever got fired for choosing IBM’ was not devised or used by the company, but by its customers. It reflects the company’s true distinctive capability – its ability to deliver not just hardware but solutions to its clients’ problems, and its reputation for having that ability.
European politicians and businessmen have long dreamt of creating a European IBM. The British government promoted ICL, the Germans Nixdorf and Siemens, the Italians supported Olivetti. These companies have succeeded only in subsectors of the computer market. The European government most determined to resist IBM’s hegemony across the full range of computers has been the French, and the European company most determined to resist it has been Groupe Bull.
Bull is, curiously, named after a Norwegian whose patented punch card system proved popular with French banks before the second world war. But Bull’s greatest success came when its gamma sixty range offered perhaps the most advanced and innovative machines available as the computer age dawned in the 1960s. That gave the company a worldwide name, and marketing capability, but the ninety range which followed failed to live up to specifications. The company recognised that it lacked the technical capacity to challenge IBM alone and that the US would be by far the largest geographic market for computers. It looked for a US partner, and found a strong one in General Electric. De Gaulle, outraged by the dilution of the vision of a French world leader in computing, first blocked the deal. When it eventually went ahead, the irate President established a state owned, and wholly French, competitor, Cii. Cii was less successful than Bull and in 1976 the two companies merged. The firm soon reverted to its original name but the French state now had a majority stake.
General Electric came to an early conclusion that the computer market was IBM’s, and quit it completely. Bull found a new American partner in Honeywell. The company enjoyed a captive market in the French public sector, and did well more generally in Francophone countries, but elsewhere the gap between IBM and either Honeywell or Bull continued to widen. Through the 1980s Bull struggled, surviving only on the continued support of its indulgent principal shareholder. Eventually Honeywell too gave up the chase, and Bull bought out its partner.
In 1989, Groupe Bull acquired a new chief executive, Francis Lorentz, who reasserted the company’s primary objective – ‘To become the major European supplier of global information systems’ The emphasis had shifted slightly from a French to a European base, but the central message remained the same. But by now even IBM was faltering. IBM’s distinctive capabilities remained strong, but markets had changed. A computer had become a commodity, not a mystery, and there could be one on every manager’s desk. In 1990 Bull posted large losses, and 1991 was a worse year still. Early in 1992, Bull announced an alliance with IBM, and Lorentz left the company soon after.
For thirty years Groupe Bull has been a company driven not by an assessment of what it is but by a vision of what it would like to be. Throughout it has lacked the distinctive capabilities which would enable it to realise that vision. Bull – and the other attempts at European clones of IBM – epitomise wish-driven strategy, based on aspiration, not capability. Effective strategy, like that of BMW or Honda, starts from what the company is distinctively good at, not from what it would like to be good at, and is adaptive and opportunistic in exploiting what is distinctive in these capabilities.
There is nothing new in saying that strategies should be adaptive and opportunistic, or that planning should start with an assessment of the firm’s distinctive capabilities. Yet these observations are often misinterpreted. Adaptive strategy is contrasted – quite mistakenly – with analytical approaches to strategy, while the real contrast is with the vision, the mission, and the wish-driven strategy, about which there is nothing analytical at all. To say that we cannot forecast where our organizations will be in five years time is not to say that we cannot plan for the future. To say that successful businesses, and successful entrepreneurs are opportunistic, like Honda, is not to say that firms and managers should, like the British motor cycle industry, wait to see what turns up.
When strategists talk of distinctive capabilities they quickly turn to talk of how to build them. This is evidently important, and most distinctive capabilities have, in some sense or other, been created by the firms which hold them today. Yet the attempt to establish distinctive capabilities confronts its own version of wish-driven strategy. Building distinctive capabilities must be a task of exceptional difficulty because, if it were not, the capability would soon cease to be distinctive. The story of Komatsu’s conquest of Caterpillar – how a small Japanese company took on the world’s largest producer of earth-moving equipment, and won has become the business equivalent of ‘from log cabin to White House’ (HBS, 1985, 1990). But, like the epic of Abraham Lincoln, it is often misinterpreted . The lesson of Lincoln’s success is not that anyone can become President of the United States if they try hard enough, but that in an open society exceptional talent can thrive however humble its origins. The lesson of Komatsu is that the internationalization of modern business creates commercial opportunities as wide-ranging as the political opportunities offered by the democratization of the United States. Komatsu succeeded because of the quality and competitive price of its products. Its achievement was the product of its competitive advantage, not the strength of its will.
So firms should generally look to define and identify distinctive capabilities rather than create them. Although it is possible to create distinctive capabilities, success is more often based on exploitation of those capabilities which the firm already enjoys. These may derive from its history or from its location, or they may be capabilities which it has already established in related markets or industries. Strategy begins with an understanding of what these distinctive capabilities are.
Saatchi & Saatchi
Saatchi & Saatchi was, for a time, the best known advertizing agency in the world. An advertizement devised to promote birth control, which showed a picture of a pregnant man, created a mixture of controversy and envy which promoted a small agency controlled by Charles and Maurice Saatchi to national fame. The agency’s contribution to Margaret Thatcher’s first successful election campaign in 1979 turned that domestic reputation into an international one.
But international recognition was not enough. The Saatchis’ determined to create an international business. In 1983, it is reported (by Fallon 1988:203), Maurice Saatchi read a famous article in the Harvard Business Review on the development of global markets (Levitt 1983). Inspired by the vision it held out, he flew the Atlantic to learn the full details of the new doctrine. These trans-Atlantic flights were to become more frequent as the operating companies within Saatchi & Saatchi came to span not just Britain and the United States but other continents and other markets.
By the end of the decade, Saatchi & Saatchi was, as the brothers had intended, the world’s first truly international, interdisciplinary, marketing and consultancy organization. It was also in serious financial difficulty. Under pressure from bankers and stockholders, the Saatchis’ relinquished executive control and a new management team set to work dismantling the empire which the brothers’ vision had put together.
Saatchi & Saatchi began with a reputation that was unmatched in its business, and a creative team that was almost equally admired. These are characteristic assets of the highly successful professional service firm. The firms it bought were firms which had precisely these assets themselves. Its largest acquisition, Ted Bates, was itself one of the largest and most respected advertising agencies in the United States and had no need of the Saatchi label. It already enjoyed an equivalent reputation in its own market and there was never any suggestion that it would trade under the Saatchi name. International customers did not bring their business to the new merged agency. They took it away, fearing conflicts of interest as the enlarged concern was often already handling the accounts of its competitors. Ted Bates was worth less to Saatchi & Saatchi than to almost any other purchaser. Saatchi already had those things which made Bates valuable and they were worth less, not more, under Saatchi ownership.
But in the grip of the strategic objective of internationalization, Saatchi paid a large premium to gain control of that and other businesses. For a time, the inherent weaknesses of the strategy were concealed by the growth in the underlying earnings of the businesses, and the capacity of the Saatchi share price to drift ever upwards on a cushion of hot air. Eventually, earnings faltered and the hot air escaped. The company was left with a mountain of debt and a collection of businesses that, while sound in themselves, were not worth the prices that had been paid for them.
Wish-driven strategy failed for Groupe Bull because the goal was unattainable. Wish-driven strategy failed for Saatchi & Saatchi because the goal, although attainable and attained, was not a sensible one for that particular company to pursue. Wish-driven strategy emphasises the importance of the corporate vision, frequently starts with an assertion of the mission statement, and creates a company driven by a view of what it would like to be. The Saatchi strategy was based on a dream, rather than an analysis of the competitive strengths of the business, and the company adapted to market realities only when corporate collapse was staring it in the face.
Sustainability and Appropriability
A capability can only be distinctive if it is derived from a characteristic which other firms lack. Yet it is not enough for that characteristic to be distinctive. It is necessary also for it to be sustainable and appropriable. A distinctive capability is sustainable only if it persists over time. Honda’s achievement was not only to redefine the US motor cycle market, but to remain leaders in that market. A distinctive capability is appropriable only if it exclusively or principally benefits the company which holds it. Often the benefits of a distinctive capability are appropriated instead by employees, by customers, or by competitors. There are relatively few types of distinctive capability which meet these conditions of sustainability and appropriability. There are three which recur in analysis of the performance of successful companies. Innovation is an obvious source of distinctive capability, but it is less often a sustainable or appropriable source because successful innovation quickly attracts imitation. Maintaining an advantage is most easily possible for those few innovations for which patent production is effective. There are others where process secrecy or other characteristics make it difficult for other firms to follow. More often, turning an innovation into a competitive advantage requires the development of a powerful range of supporting strategies.
What appears to be competitive advantage derived from innovation is frequently, in fact, the return to a system of organization capable of producing a series of innovations. This is an example of a second distinctive capability which I call architecture. Architecture is a system of relationships within the firm, or between the firm and its suppliers and customers, or both. Generally, the system is a complex one and the content of the relationships implicit rather than explicit. The structure relies on continued mutual commitment to monitor and enforce its terms. A firm with distinctive architecture gains strength from the ability to transfer firm product and market specific information within the organization and to its customers and suppliers. It can also respond quickly and flexibly to changing circumstances. It has often been through their greater ability to develop such architecture that Japanese firms have established competitive advantages over their American rivals.
A third distinctive capability is reputation. Reputation is, in a sense, a type of architecture but it is so widespread and so important, that it is best to treat it as a distinct source of competitive advantage. Easier to maintain than to create, reputation meets the essential conditions for sustainability. Indeed, an important element of the strategy of many successful firms has been the transformation of an initial distinctive capability based on innovation or architecture, to a more enduring one derived from reputation.
From Capabilities to Competitive Advantages
A distinctive capability becomes a competitive advantage when it is applied to an industry and brought to a market. The market and the industry have both product and geographic dimensions. Sometimes the choice of market follows immediately from the nature of the distinctive capability. An innovation will usually suggest its own market. Pilkington discovered the float glass process, a system by which thin sheets of glass were formed on a bed of molten tin, which made the traditional grinding and polishing of plate glass unnecessary. Little need be said about the industry and markets where such an innovation is to be applied and it is other aspects of strategy that are critical. There are few geographical boundaries to innovation. While most innovating firms will begin in their home markets, successful innovation is rarely inhibited by national boundaries. The appropriate product market for an innovation is not always obvious, and identifying precisely what it is can be crucial. The demand for video cassette recorders turned out to be based on pre-recorded films rather than home movies. That required a playing time of three hours rather than one. JVC saw that small difference more quickly than Sony, and that was one key influence on success and failure in that particular market. The liquid crystal display, a scientific curiosity when it was introduced, was an innovation waiting decades for an application.
Other firms have distinctive capabilities based on their architecture, and the same architecture advantage can often be employed in a wide range of industries and markets. For BMW, the choice of industry and market segment was by no means obvious, but was ultimately crucial. For Honda, the choice of market segment did seem obvious. In the wide open spaces of the United States, they anticipated little demand for the small machines which were popular in congested Japan. But this view was doubly wrong. The market for large bikes which they had chosen was one in which Honda had no competitive advantage. Success came only from a very different product positioning. The market segments these companies selected, high performance saloons for BMW, lightweight, low-powered motor cycles for Honda, were both innovative but well suited to their underlying distinctive capabilities.
Reputations are created in specific markets. A reputation necessarily relates to a product or a group of products. It is bounded geographically, too. Many reputations are very local in nature. The good plumber or doctor neither has nor needs a reputation outside a tightly defined area. Retailing reputations are mostly national. But an increasing number of producers of manufactured goods, from Coca-Cola to Sony, have established reputations worldwide, and branding has enabled international reputations to be created and exploited for locally delivered services in industries as diverse as accountancy and car hire.
A firm can only enjoy a competitive advantage relative to another firm in the same industry. So BMW may enjoy a competitive advantage over Nissan, but be at a competitive disadvantage to Mercedes. As this example illustrates, a competitive advantage is a feature of a particular market. These three firms compete in several different markets, or market segments, and the pattern of relative competitive advantages and disadvantages is different in each one. The value of a competitive advantage will depend on the strength of the firm’s distinctive capability, the size of the market, and the overall profitability of the industry.
It is easier to sustain a distinctive capability in a narrow market than a wide one, more profitable to hold it in a wide market than a narrow one. And the profitability of a firm depends both on the competitive advantage the firm holds relative to other firms in the industry, and on the profitability of the industry itself. If there is excess capacity in the industry – as in automobiles – then even a large competitive advantage may not yield substantial profits
But if entry to an industry is difficult, then a firm without any competitive advantage may nevertheless earn very large returns. There is little reason to think that the large monopolistic utilities which control many parts of the European energy, transport and communications industries have strong distinctive capabilities of the kind that characterise BMW, or Honda, or IBM. Their market dominance has not been built on doing things that others could not do as well, but on doing things that others were not permitted to do at all. Yet many of these firms are very profitable. There can be no greater competitive advantage than the absence of competitors. Profits come not only from distinctive capabilities but from possession of strategic assets – competitive advantages which arise from the structure of the market rather than from the specific attributes of firms within that market.
Glaxo and EMI
Corporate strategy is concerned with matching markets to distinctive capabilities. Business strategy looks at the relationship between the firm and its competitors, suppliers and customers in the markets which it has chosen.
In the 1970s, two British firms, Glaxo and EMI, developed important
innovations. Both depended critically on their sales in the US medical
services market (dell’Osso 1990). Glaxo had found an effective anti-ulcer drug, Zantac. EMI’s scanner was the most important advance in radiology since the discovery of X-rays. Glaxo transformed itself from a medium ranking drug company with uncertain future, to Europe’s leading pharmaceutical producer. EMI, crippled by losses on its scanner business, ceased to exist as an independent company and is no longer involved in medical electronics. EMI’s capability was much the more distinctive. The scanner won the Nobel Prize for Physics for its inventor, Geoffrey Houndsfield. The market for anti-ulcerants has long been recognised as a potentially lucrative target – ulcers are common, persistent and rarely fatal. An effective therapy emerged from the research of a British scientist, Sir James Black, but it was a US company, SmithKline, which developed Tagamet, the first commercial product based on it. Zantac was discovered after Glaxo refocused its research programme following the publication of Dr Black’s results.
For both Glaxo and EMI, the choice of markets was not a difficult issue. Their markets were suggested by the nature of their innovation. (Although this was less obvious at an earlier stage of development in the scanner. EMI had a defence-based technology seeking an application, and it was a lateral leap by Houndsfield which took the company into medical electronics. For Glaxo, however, the innovation followed the market and the market the innovation).
The key questions for both companies were issues of business strategy. The choice of market identified suppliers, customers and competitors. Relationships with suppliers were not of special importance to either company, but relationships with customers and competitors most certainly were. EMI attempted to create its own US distribution network and to price at a level designed to recoup development costs. President Carter, concerned about spiralling medical bills, imposed a ‘certificate of need’ requirement on publicly funded hospitals. This delayed sales while General Electric developed its own version of the scanner. Although EMI had little experience of any manufacturing in this field, far less overseas, the company established a US manufacturing plant, which ran into serious output and quality problems. When GE entered the market, EMI was rapidly swept away and the rump of the business was sold to its larger competitor.
Patent protection – which had not proved sufficiently effective either for SmithKline or EMI – served Glaxo well, and helped ensure that its competitive advantage was sustainable. Glaxo began to market its drugs in the US through Hoffmann-La Roche, whose sales of Librium and Valium had made the firm by far the most effective European pharmaceutical company in the US market. Glaxo entered Japan through a joint venture with a Japanese partner. In Britain and Italy, where Glaxo had a strong established market reputation, Glaxo skilfully exploited concern about possible Tagamet side effects, priced Zantac at premia to Tagamet, which reflected the company’s own variable relative strength in different markets. By the mid-1980s, Zantac had become the world’s best selling drug, and over the decade the company earned about £4 billion in profits from its sale. By any standards, Glaxo is an outstandingly successful European company.