Benefit. The new business model is superior to the incumbent’s model due to lower costs and/or the ability to charge higher prices. In Vanguard’s case, their business model resulted in substantially lower costs (the elimination of expensive portfolio managers, as well as the reduction of channel costs and unnecessary trading costs) which then translated into superior product deliverables (higher average net returns). Due to their business structure of returning profits to their fund-holders, they realized value from market share gains (s in the fundamental equation of strategy), rather than ramping up differential profit margins (m).
Barrier. The barrier for Counter-Positioning seems a bit mysterious: how could a powerhouse (such as Fidelity Investments in this case) allow itself to be persistently humbled by an upstart over such an extended period? Couldn’t they foresee the potential success of Vanguard’s model? Freqently in such situations, naïve onlookers castigate the incumbent for lack of vision, or even just poor management. Often, too, they level this accusation at companies with prior plaudits for business acumen. In many cases, this view is unjust and misleading. The incumbent’s failure to respond, more often than not, results from thoughtful calculation. They observe the upstart’s new model, and ask, “Am I better off staying the course, or adopting the new model?” Counter-Positioning applies to the subset of cases in which the expected damage to the existing business elicits a “no” answer from the incumbent. The Barrier, simply put, is collateral damage. In the Vanguard case, Fidelity looked at their highly attractive active management franchise and concluded that the new passive funds’ more modest returns would likely fail to offset the damage done by a migration from their flagship products.
With this preliminary understanding, I can now place Counter-Positioning on the 7 Powers Chart:
Figure 3.4: Counter-Positioning in the 7 Powers
This allows me to define Counter-Positioning:
A newcomer adopts a new, superior business model which the incumbent does not mimic due to anticipated damage to their existing business.
The Varieties of Collateral Damage
There can be several possible reasons for the incumbent’s failure to mimic the upstart. In this section I will detail those differences, as knowing them will clarify the correct strategic posture. Here’s a useful way to visualize this: imagine the incumbent CEO’s business development team must evaluate the prudence of investing in the challenger’s new approach.
Stand-Alone Unattractive is Not Counter-Positioning. In its first step, the business development team would hive off those situations in which a stand-alone assessment of the new approach forecasts an unattractive return, as these are not Counter-Positioning. To this end, the team would pose this question:
If “No” is the answer, then collateral damage does not account for the incumbent’s rejection of the challenger’s approach to the business. The new approach is simply a poor bet all by itself.
Here the example of the digital camera challenge to Kodak is instructive. Kodak’s business model was legendary, built on the customer’s continuing need to purchase film, a product in which Kodak was wildly profitable due to both Scale Economies and a proprietary edge (this Power type is Cornered Resources, to be covered in Chapter 6). Kodak offered the first of its path-breaking Brownie cameras in 1900. By 1930 it was one of the firms in the Dow Jones Industrial index, and it stayed in that group for more than 40 years—one of the great business empires.
Until digital photography came along, that is. Anyone could extrapolate from Moore’s Law that analog chemical film was eventually doomed. Pundits have looked back and chided Kodak for poor management, lack of vision, and organizational inertia, and a reasonable person might well ask, “How could a company high on the lists of the best companies in the world succumb to such a defeat?”
A reasonable question. And the answer is much simpler than many suggest: in fact, Kodak was fully aware of its eventual fate and spent lavishly to explore survival options, but digital photography simply was not an attractive business opportunity for the company. Kodak’s business model was built on its Power in film—it was not a camera company. The digital substitute for film was semiconductor storage, and Kodak brought nothing to this arena. As a company, Kodak had excellent management; thus the observed wheel-spinning, their fruitless explorations in the digital world, simply reflected the strategic cul-de-sac they faced. The technological frontier had moved: consumers were better off, but Kodak was not.
More generally this situation can be characterized by three conditions:
A new superior approach is developed (lower costs and/or improved features).
The products from the new approach exhibit a high degree of substitutability for the products from the old approach. In this case, as semiconductor topologies shrunk, digital imaging came to completely supplant chemical imaging.
The incumbent has little prospect for Power in this new business: either the industry economics support no Power (a commodity), or the incumbent’s competitive position is such that attainment of Power is unlikely. Kodak’s formidable strengths had little relevance to semiconductor memory, and those new products were on an inevitable path to commodization.
Such reinvention is quite common, as are the associated, and often unfair, castigations of the incumbent’s management failures. “The gales of destruction” was Schumpeter’s famous turn of phrase for such occurrences.
But this is not Counter-Positioning. Kodak’s failure to respond had nothing to do with collateral damage within their film business; rather it indicated only that digital photography as a stand-alone business failed to offer even the faintest promise of Power for Kodak.
Facing such a situation, our hypothetical CEO would nix any commitment of investment, branching in the following way:
Before turning to those cases in which collateral damage serves as the decisive inhibitor, I would like to comment on another frequently discussed issue. Kodak could have easily taken the view that their business was image storage, not film, thus avoiding “marketing myopia.”29 Unfortunately this broader view of the business would have been to no avail, as the lack of semiconductor capabilties would have remained and been decisive in determining a negative outcome.
1. Milking: Negative Combined NPV. Suppose the new approach was unlike digital storage for Kodak and instead looked promising on a stand-alone basis. In this case, our hypothetical CEO would face another set of issues:
This was the situation faced by Ned Johnson, the CEO of Fidelity, when passive mutual funds started to appear. Unlike the Kodak case, Fidelity possessed all the capabilities to develop and distribute passive funds. They were a mutual fund powerhouse, and one could even reasonably argue that their capabilities in this space were superior to those of challenger Vanguard.
However, the impact of entry into passive funds on their remaining base business of active funds would have been subtractive. Active funds carry radically higher expense charges and many even had upfront sales commissions (loads). For the assets they would have cannibalized, the revenue decline would have been dramatic. Further, many at Fidelity felt they were facing an existential threat, and the introduction of passive funds would have taken them off-message in the rear-guard advocacy of active funds. They assumed, reasonably, that any conceivable gains made with these new funds would have been more than offset by losses in their base business of active funds.
In similar hypotheticals, then, a rational incumbent CEO would decide to eschew the new approach. This type of “don’t invest” determination represents one type of Counter-Positioning (CP). The term I use is “Milk” because the CEO is essentially choosing to milk a declining original business even though the new model is attractive.
To be explicit, while the decision to invest may have offset damage to the incumbent’s original business (collateral damage), there remain some advantages to the decision to kill that investment. This is the Barrier.
There is a dynamic to CP: Milk has practical importance, especially for the
challenger. As the challenger cannibalizes the incumbent’s customer base, two parts of the incumbent’s negative attribution lessen: (a) the incumbent’s original business shrinks, and (b) the uncertainty surrounding the viability of the challenger’s approach diminishes. As this scenario plays out, the risk-adjusted size of expected collateral damage declines. At some point, a rational incumbent, our hypothetical CEO, will then find the collateral damage insufficiently off-setting—an investment is warranted. Such delayed entry happens frequently, and while some may characterize it as incumbent foot-dragging, it is often simply a rational response to the circumstances.
2. History’s Slave: Cognitive Bias. Suppose an outside objective analyst examined the incumbent’s potential entry into the challenger’s new business model and found that the incremental NPV of doing so was positive. Certainly this would warrant an investment, yes? Not so fast. There’s more to our collateral damage story. Thoughtful CEOs still might forego entry investment if their opinions differed from this objective view and they perceived deeper decrements.
Our next effort, then, is to explore reasons for such a difference:
What are the potential causes of such decrements? They could be numerous, but over several decades of client strategy work, I have noted two that seem common.
The first involves two characterisitics of challenges to incumbency:
1. The challenger’s approach is novel and, at first, unproven. As a consquence, it is shrouded in uncertainty, especially to those looking in from the outside. The low signal-to-noise of the situation only heightens that uncertainty.
2. The incumbent has a successful business model. This heritage is influential and deeply embedded, as suggested by Nelson and Winter’s30 notion of “routines,” and with it comes a certain view of how the world works. The CEO probably can’t help but view circumstances through this lens, at least in part.
Together these two characteristics frequently lead incumbents to at first belittle the new approach, grossly underestimating its potential. In the face of low-cost passive funds, Ned Johnson of Fidelity once famously inquired, “Why would anyone settle for average returns?” This negative cognitive bias can lead to a “don’t invest” decision, even if an objective observer might judge such an investment favorably. Here we arrive to the second type of Counter-Positioning:
3. Job Security: Agency Issues. There’s a second source of decrement that can lead our CEO to reject an objectively attractive investment decision: the differences between the objective of the firm (maximum value) and that of the CEO, or other investment decision-makers. Economists refer to these situations as “agency problems” because the agent’s actions are at odds with the organization she represents.
Usually, it’s about incentives. For example, it is devilishly difficult to design a CEO’s compensation so that it closely mimics long-term enterprise value. Addressing the threat of a Counter-Positioned competitor frequently requires upending the incumbent’s business in multiple ways, and such turmoil is rarely symmetric in its impact on enterprise value and compensation, even with best practice Long-Term Incentive Plans in place.
This completes our parsing of the collateral damage Barrier in Counter-Positioning:
As the finalized chart indicates, there are three varieties of Counter-Positioning, depending on the particulars of the collateral damage involved: Milk, History’s Slave and Job Security. I should note that Agency and Cognitive Bias issues are not mutually exclusive; frequently they appear in concert, as they are connected with the to-and-fro that accompanies the upending of a well-established business.
To finish up our treatment of Counter-Positioning, I will cover three more topics in this chapter: the relationship of Counter-Positioning to the well-known concept of Disruptive Technologies, some general comments about the characteristics of Counter-Positioning and finally some simple illustrative math.
Counter-Positioning versus Disruptive Technologies
I have benefited from the scholarship of Clayton Christensen and from his deep insight into the currents of technical change. His work is so well-known in the business world that I felt obliged to map my view of Counter-Positioning to his notion of Disruptive Technologies.
At the heart of Counter-Positioning lies the development of a new business model that, over time, has the potential to supplant the old. In the more general sense of the word, it is disruptive. However, when we consider the more specific meaning of Disruptive Technologies (DT) developed by Christensen, the waters muddy. Consider these examples:
Kodak vs. digital photography. This is a DT, but not CP.
In-N-Out vs. McDonald’s. This is CP, but not DT (no new technology involved).
Netflix streaming vs. HBO via cable. This is both CP and DT.
As evinced by the list, the concepts are not at all synonymous. Or more formally, there is a many-to-many mapping. This is also true more generally: there is a many-to-many mapping of all Power Types to Disruptive Technologies. Because Disruptive Technologies tell us nothing about Power they do not inform us about value.31 Because of this, the subject is only a sidebar in the Statics of Strategy.
With the Dynamics of Strategy, a topic developed later in this book, Christensen’s work has far more bearing. In Part II, we will learn that invention is the first cause of Power. It does not necessarily lead to Power, but it can sometimes create the circumstances in which Power may be established. Disruption, of course, is one consequence of invention.
Observations on Counter-Positioning
Before wrapping up this chapter, I want to offer up a few observations about Counter-Positioning that will be specifically useful to a strategist.
As noted in the Introduction, Power must be considered relative to each competitor, actual and implicit. With Counter-Positioning, this is particulary important, because this type of Power only applies relative to the incumbent and says nothing regarding Power relative to other firms utilizing the new business model. So it remains only a partial strategy. To assure value creation, it must be complemented by a route to Power respective to other like competitors. For example, In-N-Out has Counter-Positioning Power over McDonald’s, but this helps them not at all in facing like competitors such as Five Guys Burgers and Fries.
As noted in our discussion of the collateral damage types, Cognitive Bias can play a role in deterring the incumbent. But the challenger, by its posture, may be able to influence such a move. How to attempt this? In its ascendancy, the challenger should avoid the temptation of trumpeting its superiority, instead suppressing that urge and adopting a tone of respect toward the incumbent. This behavior may result in the incumbent delaying objective cognition, giving the challenger a headstart on the new business model.
Counter-Positioning is not an exclusive source of Power. The two prior chapters covered Power types that were exclusive: there could be only one company with Power. This is a reflection of the “Competitor Position” portion of the leverage calculation I have detailed. For these earlier types, there can be only one firm with a favorable competitive position. In contrast, there could be—and often are, in fact—many challengers Counter-Positioned respective to the incumbent.
A Counter-Positioning challenge is one of the toughest management challenges. When I started teaching at Stanford in 2008, Nokia was the leader in smartphones. By 2014 they had disappeared from this market. Their CEO Stephen Elop’s “Burning Platform” memo in 2011 captures well the immense frustration of a Counter-Positoned incumbent: While competitors poured flames on our market share, what happened at Nokia? We fell behind, we missed big trends, and we lost time. At that time, we thought we were making the right decisions; but, with the benefit of hindsight, we now find ourselves years behind.
The first iPhone shipped in 2007, and we still don’t have a product that is close to their experience. Android came on the scene just over 2 years ago, and this week they took our leadership position in smartphone volumes. Unbelievable.
— Stephen Elop, Nokia CEO
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Though this isn’t always the case, I have noticed a frequently repeated script for how an incumbent reacts to a CP challenge. I whimsically refer to it as the Five Stages of Counter-Positioning: Denial
Ridicule
Fear
Anger
Capitulation (frequently too late)
Elop’s comments above reflect the “Anger” stage.
Once market erosion becomes severe, a Counter-Positioned incumbent comes under tremendous pressure to do something; at the same time, they face great pressure to not upset the apple cart of the legacy business model. A frequent outcome of this duality? Let’s call it dabbling: the incumbent puts a toe in the water, somehow, but refuses to commit in a way that meaningfully answers the challenge.
Counter-Positioning often underlies situations in which the following developments are jointly observed: For the challenger Rapid share gains
Strong profitability (or at least the promise of it)
For the incumbent Share loss
Inability to counter the entrant’s moves
Eventual management shake-up (s)
Capitulation, often occuring too late
The Challenger’s Advantage
An entrenched incumbent with established Power is formidable—this is axiomatic. Unless the incumbent is incompetent over an extended period of time, challenging it is most often a loser’s game, and playing that game is no fun—AMD’s long and enervating battle to emerge from the shadow of Intel yields a case in point.
That said, there are fighting styles which turn the contest on its head by converting strength into weakness. Think of Muhammed Ali’s defeat of the intimidating George Foreman with his improvised Rope-A-Dope: Ali relied on Foreman’s straight-ahead style and confidence to lure him into strength-sapping flurries.
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