Chapter 8

Strategic Positions for Volatile Industries

Introduction

In the last chapter, you learned about possibilities or options in the range of strategic choice. The goal of choosing a strategic position is to make investments and decisions that will align your firm with the environment and the opportunities—a sort of fine tuning for best performance. However, when industries are changing rapidly, the ideas of alignment or fit may not be so meaningful: Can you achieve fit with a moving target with investments and commitments that take time to be effective? To the extent that strategic investments tend to be long term and difficult to reverse, volatility and change complicate your decisions, increase your risks, and may limit your effective range of action.

Consider the nature of a product or industry life cycle. Figure 8.1 shows the typical course of events. When an industry emerges (or, equivalently, a new product-market does), the volume of product adoptions tends to be low. There are often many firms—usually small—seeking to identify the salient buyer needs or purchase drivers. Over time customer choices about what works and what doesn’t (i.e., what they’ll actually buy) pushes the designs firms produce toward the features and benefits most consumers want. Adoptions or purchases begin to accelerate quite rapidly. This is the growth phase of industry life, and in this stage competing product designs converge to a dominant design.¹ This means that most firms in the industry are producing the same sort of solution. It also means that since the products are converging in features, other buyer needs, such as price, assume more importance, which will drive marginal- or high-cost producers out of the market. As an example, the early days of the automotive industry were characterized by competition between three technologies: electric, steam, and internal combustion engines. Obviously, the internal combustion engine won the design battle, and for nearly a century there have been no significant producers of steam or electrical vehicles (though that appears to be changing!). Moreover, the industry has historically seen a steady consolidation as small, cost-hampered producers are bought out or driven out. Industry maturity is reached when the growth curve turns over and slows.

According to researchers, strategic choice likely reflects this evolution. In young industries, few firms want to commit resources to competing on efficiency or cost leadership (through costly investment in production) when volumes are low and it is not clear what the right or winning technology will be. What is the right strategy here? At the mature end of the cycle, the opposite is true: There are usually fewer, larger firms operating in an environment where needs are well defined. What strategy makes the most sense now?

In this chapter, you’ll learn about the merit of life cycle: strategy choice recommendations as well as what works when conditions are even more extreme. That is, the industry life cycle described earlier can be interrupted by catastrophic events; by fundamental changes in the regulatory environment, which are sometimes called discontinuous or punctuated equilibrium problems; and by evolutionary changes that are more continuous. In some industries, product life cycles plunge to mere months, which means producers have to pick the right new product very often. In others, the technological underpinnings on the supply side are shifting or even emerging: Uncertainty and the price of entry are high, and the cost of choosing the wrong platform is often failure. How then do managers choose? In this chapter, you’ll read about ways to discern if your industry is, in fact, volatile; reasons why such industry level changes occur; and some strategies for managing in those environments.

Your Industry May Be Volatile If…

Since all industries experience change to some degree or another, how would you know if your firm competes in an industry that is considered volatile or rapidly changing? In this section, we’ll look at some classifications and measures of change rate.

One sort of industry volatility is technological in origin.² Technological changes can occur upstream (as a supply issue), in the industry (as a dominant design issue), and between the industry and its customers (as an intermediating issue). Technological change can be measured in many ways, such as patents, but industries vary in how firms create and protect intellectual property, making assessment a bit more difficult. Nonetheless, following are some indicators.

As noted earlier, industries in the early stages of development or industry life cycle tend to have more and smaller firms experimenting with product designs and features. All else equal, emerging industries are more volatile than mature industries. Relatedly, you can assess the number of competing technologies vying to solve the same problem³ because if there are several, your industry is in the period before a dominant design emerges and therefore reasonably early in the cycle.

The rate of innovation can also be a good indicator. In some, but not all industries, patents are the preferred way to protect new intellectual property. Research indicates that the higher the patent rate (filing and granting), the more firms alter production inputs, changing how they solve the fundamental economic problem.⁴ While there are databases and reports you can purchase that will give this information on all industries, you can begin preliminary investigations through the United States Patent and Trademark Office (USPTO) website. The USPTO carries years of data on product and process patents organized by technological similarity.⁵ Likely, you’ll also need to understand the classification system and note that firms in your industry might be active in two or more classes. With this, you can assess the absolute number of patents being granted in an industry and the rate of change in patenting, both of which can be useful indicators.

A limitation to these counts is that industries vary in the extent to which member firms use patents as the primary means of intellectual property protection. For instance, research shows that patenting is very important in the pharmaceutical, chemical, and petroleum industries but less so in industries like automobiles or office equipment.⁶ Partially, this may be because patents in such industries can be more easily invented around or subverted. Thus, an alternative measure is based on the new product development cycle for your industry or how the rate of new product introductions changes.

The basic idea here is that the shorter the life cycle of products, the more that firms in an industry need to invest in new product extensions and, as a riskier move, platforms or completely new product directions. The length of product life cycles (and, really, what you are interested in is the “half life” as new work is being done to replace those aging products) can be estimated as the duration between introduction and removal from the product catalog or offering. The product life cycle and the share of industry revenues from new products can be used to distinguish between fast and slow cycle industries. Fast cycle or fast clockspeed industries have much shorter product cycles and generate a larger portion of total revenues from those new introductions. Examples of such industries include computers, semiconductors, fashion clothing, cell phones, and toys while slow cycle industries include construction, automobile, and aircraft production.⁷ Note that product complexity is often a barrier to short product cycles because more components or modules need to be properly and reliably integrated, the assurance of which is time consuming. Fast cycle industries are clearly more volatile because the basis for competition keeps changing in unpredictable ways.

Another measure of volatility (called market volatility⁸) is in how revenue streams for industries change. Volatile industries might exhibit significant changes in total industry revenues in either direction with an annual 10% change offered as a boundary between stable and volatile.⁹ Other market-based measures include firm entry and exit rates as well as acquisition and merger activity. In these latter measures, you should be interested in both an absolute level and the change in rates. For example, the U.S. brewing industry, until about 1990, had experienced increasing maturity and consolidation such that the number of brewers had dropped to about 50. However, for reasons we’ll explore in the next section, microbrewing became a feasible strategy and the number of entrants ran into the thousands. Certainly, these were by definition small firms and many of them failed, but they do illustrate a fundamental shift in the stability of the industry.

What Causes Industry Change and Turbulence?

Anita McGahan has developed a useful framework for assessing issues in industry change, evolution, and obsolescence.¹⁰ She argues that two sorts of challenges emerge: Threats of obsolescence to core activities (what industry firms do to provide value to customers—i.e., how they solve the problem) and threats of obsolescence to core assets (which is more of a firm level problem, but not exclusively). From these, four types of industry change are derived.

Because they attack how the industry problem is solved, threats to core activities are an industry wide problem. Here are some sources:

Environmental change or changes at the PEST level can render current industry solutions valueless or change the rules for determining why they are valuable. (Donald Sull calls these “sudden death threats”¹¹). For example, changes in regulation (a P, or political, shift) can attack activities in competition-constraining or enhancing ways. Some changes impair or destroy what industry firms do: When the U.S. government imposed Prohibition in 1919, the effect on alcohol producers was obvious and dramatic, forcing a switch to other sources of revenue. The Jim Beam distillers turned to rock quarrying and fruit farming while brewers entered industries as diverse as production of baking yeast or ice cream, shipping, and real estate. Ultimately and not unexpectedly, the attrition rate in these industries was very high.

Alternatively, some changes can encourage competition or make it easier to enter and compete. One example is the deregulation of the U.S. air carrier industry in the late 1970s, which led to many new entrants and the failure of legacy carriers in relatively short order. An even more recent example is what happened after the telecom industry was deregulated in 1996. This very quickly led to the convergence of the networking products industry (firms like Cisco or Bay Networks) with the telecommunications industry (firms such as Nortel, Alcatel, etc.). Combined with the deployment of Internet technologies, this change in regulation led to an enormous surge in new entrants mergers, acquisitions, and failures. This was an exceedingly volatile period in that industry’s history.

Another source of change is in sociocultural values. Consider how the evolving social attitudes toward tobacco usage, animal furs in clothing, or consumption of meat products or alcohol has affected their respective industries. In all cases, consumption in the United States and Europe has been decreasing and will likely do so in the future because these tend to reflect fundamental shifts in values and beliefs about a “right” life.

Demand and supply shifts can also cause turbulence. The Great Recession of 2008–2010 (like all recessions) has had an adverse effect on luxury goods makers. Even though the affluent often continue to purchase such goods, the aspirational or nearly-as-affluent segment that tends to buy up in good times, does not do so in recessions. The price-to-value relationship has been eroded.

Fundamental technological shifts can create newly important substitutes from innovation occurring outside (usually) the core industry. This makes what focal industry firms do irrelevant (or less relevant) because the demand for those activities has disappeared. For instance, the web has broadly decreased the value created by auto dealerships. Because gathering information was costly to consumers (How far would you go to get comparative prices on a new car?), dealers were able to control prices and command higher prices. The advent of various information sites such as Kelley Blue Book or Edmunds.com have made price shopping much easier and pricing much more uniform. Dealers have been cut out of the pricing system and increasingly function as supply and service depots.

Threats of obsolescence to core assets challenge how firms do their own value adding activities. This happens within an industry (not just to the industry). That is, the core resources, knowledge, and brand capital that have previously been deployed can be affected. This is a firm level issue, but note that if a number of firms have similar resource or asset profiles, the challenge can be broadly disruptive. Patent expiration in the pharmaceutical industry is an illustration of how industry structures can shift. Patents in this industry mean more here than in other industries because of the drug approval process that new treatments have to go through, but when the patent for a drug expires, generics usually flood the market. If the drugs in question are blockbusters or major sellers, a real shift in industry structure can result. Thus, because the number one and two prescription drugs in the United States (Pfizer’s Lipitor with sales of $11.2 billion in 2009 and Bristol-Myers Squibb’s Plavix with 2009 sales of $9.5 billion¹²) are going off patent in 2011, the prospects for upheaval in the industry are high.

McGahan also notes that challenges to core assets are often the outcome of buyers acquiring new, better, or just more knowledge from the emergence of a superior marketplace of ideas. People are better-informed buyers, and those who specialized in previously abstruse information have less value. Some firms can capitalize on this and so do not have less value. Further, innovation within the industry, which unlike the emergence of substitutes described earlier implies evolutionary changes to how the industry firms solve customer problems, can challenge the assets of some but not all firms. An example used earlier in chapter 2 dealt with the changes in how the bookselling industry have evolved. A more detailed example comes from the changes in the American brewing industry and the rise of microbrews where a once very stable industry has suddenly become quite dynamic.

The explosive growth in the brewing industry was described earlier—but what caused it? There are likely a number of contributors. First, regulatory change set the stage. In 1978, President Carter repealed a regulatory artifact from the end of Prohibition that outlawed home brewing. The repeal spawned a tremendous growth in the hobby as brewers could now acquire malted grains, yeast, and hops that let them create or replicate beer styles that were not possible to purchase. The skills that many home brewers developed in the garage or basement provided the technical foundation for the next step: commercial brewing. Fairly quickly, two home brewers—Ken Grossman and Paul Camusi—started up Sierra Nevada Brewing Co., which not only survived but ranked in 2009 as one of the top 10 brewers in the United States.

Second, there were some shifts in customer preferences and demand. American beers had been converging for decades toward a style called the American standard lager, a relatively light, effervescent brew. By the 1980s, this was virtually the only domestic style available, and while it was very uniform in terms of production and quality control, an increasing number of consumers found it deficient in flavor and aroma compared to other styles of beer. And, these consumers knew this because local markets were increasingly open to higher priced beers from Europe.

A related but even broader demand shift—the emergence of “lifestyle” based consumption in the ’70s and ’80s—was another driver of the craft brewing movement. This period saw the emergence of the educated class or the white collar meritocracy. The first great bump of baby boomers graduated college in the 1970s. Their embrace of and engagement in the concurrent growth of information technology as well as the shift away from manufacturing employment has meant the emergence of a large number of the well educated and well compensated workers. This led to a certain style of consumption. This educated class rejected conspicuous consumption of luxuries, such as boats or furs, but embraced spending a great deal for necessities (though at a very high end) and a cultivated appreciation of uncommon versions of commonplace goods such as coffee, building materials, water, and so on. Brooks describes the ethos as one focusing on the “authentic, natural, warm, rustic, simple, honest, organic, comfortable, craftsmanlike, unique, sensible, [and] sincere.”¹³ Thus, we have seen the emergence or resurgence of firms like Starbucks, Republic of Tea, Viking, Whole Foods, and so on.

These purchasing patterns readily extend to beer, particularly with respect to local breweries as an alternative to the uniform products of megabreweries. Early on, this manifested as a growth in import beer sales in the early 1980s. While this has persisted, the real growth has been in the conscious consumption of locally and regionally produced beers that emphasize either a resurrection of old styles of beer, such as ales, porters, stouts, lambics, and the like, or particularly American interpretations of these styles, such as American pale and pumpkin ales and rye and chili beers. As an illustration of this growth, the Beer Advocate website lists reviews of more than 13,000 labels in its American Ale section.¹⁴

Collectively, these changes in the environment upset a very mature and stable industry. There was likely little attack on the core activities of the older incumbents (brewing is still brewing) but the threat to core assets, such as reputation and brand image, of most of the larger firms has been intense. In fact, while overall sales in the industry have been flat, growth in the microbrew or craft segment has been robust—which means that the historic incumbents have been watching revenue and share drop.

In a general sense, these threats can be combined to describe four types of change trajectory but from an industry-wide perspective, two are of most interest. These are radical change (when both assets and activities are threatened) and intermediating change (when activities are threatened but assets are not). An excellent example of radical industry change is what happened in the computing industry in the 1970s1–990s. Consider the transition from mainframe to minicomputing. This represented a challenge to activities and assets on many levels. First, the old mainframe model focused on large customers, such as governmental agencies, banks, insurance companies, and the like, which all shared similar computing problems in that the data files were large. The solution was centralized and large-scale computing that served a relative few customers. However, advances in integrated chips reduced the cost and increased the efficiency of computing which made smaller architectures (such as mini and then PC based platforms) possible. These solved smaller problems such as engineers and architects adopting small office minicomputers in the 1970s from Digital Electronics Corporation (DEC) and Data General for drafting and project management. The challenges to core activities for mainframe makers was quite clear but what about core assets? Most of the mainframe firms (and particularly IBM) focused on overall problem solving through direct sales engineering. This is a version of Treacy and Wiersema’s CI model, but recall that this requires that the industry firm create and maintain a certain dependency by the customer. However, the emergence of new computing architectures and information about them educated potential customers, attacking the value proposition.

Intermediating change takes industry players out of their central role. Aside from what happened in the brewing industry, an interesting example comes from the shaving industry. Before King Gillette, men shaved themselves with straightedge (or cutthroat) razors, or more frequently they patronized barbershops. Even those who shaved themselves faced the problem of caring for and properly sharpening the razor. Gillette’s invention of the safety razor at the turn of the 20^th century about killed barbering as an industry because the core activities—the knowledge and skill that barbers had to shave customers with a straight razor—was captured in a technological shift. Curiously enough, the Internet has spawned a renaissance in and return to older styles of shaving as a rejection of the current dominant designs in razors—including Gillette’s!

What to Do in Turbulent Industries

As you’ve seen, when change rates and uncertainty in an industry are high, it is likely an error to make a large bet—that is, strategic investments—on a particular outcome because the price of failure or guessing wrong can be crippling, if not fatal. This is why strategy researchers in this area often advise a policy of active waiting or investing to improvise and respond. Donald Sull describes this as first, keep the vision fuzzy but the priorities (short- and medium-term goals in operating or market results) clear.¹⁵

Similarly, Shona Brown and Kathleen Eisenhardt argue that in highly volatile industry environments, adopting a strategic process between rigid planning or investing in a particular version of the future and pure reaction to market forces can be effective.¹⁶ When change rates are high, it is unclear what demand will be. In their analysis of technology firms, Brown and Eisenhardt found that the more successful firms stayed on top of the changes using four future probing mechanisms: experimental products or line extensions, alliances with customers, appointing staff whose responsibility was to act as “futurists,” and facilitating (and expecting) extensive communication between project groups. To this, Sull adds the recommendation of a good cash position or war chest for rapid action when opportunity presents.

Probes into the future are designed to identify new opportunities and how markets might shape up. These are designed to be low-cost product experiments, such as extensions to or new options in existing product lines intended for new markets. Probes can also be rudimentary or “quick and dirty” approaches that just test a perceived opportunity for customer acceptance. The virtues of this approach are that it is usually fast (the technological core is often in place) and usually doesn’t require the resources for development that larger-scale projects do. In addition, because they are low cost, failure isn’t as significant. In fact, failure can provide valuable learning.

Alliances with certain kinds of customers can also form a probe, provided the customers are not mainstream. Mainstream partners can be exceedingly valuable, but they likely won’t give you the insight into what’s new that you’ll need. The right partners here are those suppliers and customers whose needs are underserved by the industry and perhaps not even understood. We can use the information and telecommunications (ITC) industry as a good example. Technological change in this industry has been incredibly rapid and diverse for two decades, and the problem that all firms face is that not one of them is a master of all knowledge domains. Nor is it even desirable to be so as the cost of competence (through R&D investments) is exceedingly high, given that many emerging technologies never make it to market. Another limiting factor is that learning takes time, and the pace of innovation limits how much a firm’s intellectual talent can absorb and integrate. Time is too short to own it all.

Increasingly, alliances in this industry are used as way to cope. First, transitory alliances are designed to quickly tap and combine partner knowledge with the firm’s own knowledge base as a probe. These are fast to build, fast to kill alliances that focus on the very near term through experimentation with joint technologies.¹⁷ Second, firms can use alliances to keep a watchful eye on emerging technologies. In the ITC industry, most of the major players, such as Cisco, Intel, Nokia, Alcatel, and Lucent, have operated what amount to venture capital funds. These firms take equity positions in small startups developing new technology. Obviously, these technologies often fail, so full-scale investment in them by the larger incumbents is probably premature. However, the equity stake gives the investor the right to observe the technology closely and learn and, if it looks very promising, to move on with acquisition of the startup, its technology, and the technology developers.¹⁸ A third way firms in this industry use alliances is to control some of the uncertainty of picking winning products through managing how technological standards emerge. Most standardization efforts are accompanied by, if not directed by, multilateral associations of firms organized to develop testing and interoperability expectations. This not only expedites the standardization process it also defines at earlier and earlier stages which technologies will succeed.¹⁹

Futurists are, as mentioned in chapter 3, people who have made a study of how trends emerge and what they mean. Brown and Eisenhardt argue that more successful firms attend to and encourage internal experts with skills in both the technological base and the associated markets to form evolving projections. Obviously, reading the future often misses. Just think of IBM president Tom Watson, Jr.’s reputed observation in 1947 that there was a world market for perhaps five computers or DEC president Ken Olson arguing in 1977 that no one would ever want a computer in the home! Nonetheless, these projections can provide the basis of active conversation and debate and provide the roadmap for the reconnaissance and alliances described earlier.

Alternatively, some firms use scenario planning as a probing mechanism. Scenario development is a semi to very formal way of asking and answering, “What happens if…?” The purpose is to identify key future change factors, such as environmental issues or political conditions; assess how they could change; construct models that link the change factors as in cause and effect linkages or issues centered around a common theme; and assess the implications of the scenarios that result when variables change (i.e., is the difference slight or significant?).²⁰ In a sense, this is quite similar to the work you’ve already done in PEST and industry analysis. The difference here is that you want to be stretching yourself to consider not just likely changes but also the strange and unlikely.²¹ A well-known example is that of Royal Dutch/Shell in the early 1970s and how they identified, among other issues that could happen, the rise of OPEC and subsequent disruptions to petroleum production. The point is not that this was predicted—it was not—but that Shell managers had already anticipated how they would respond if it happened (and they did so quite effectively).²²

These firms are also serious about extensive internal communication. This can be formal, as in structured, scheduled meetings or less so as in consistent, within-project discussion. Even more important is idea- and insight-sharing across product or project groups where the “not invented here” syndrome is explicitly rejected. New ideas and approaches (and the lessons of failure) are disseminated quickly.

Finally, successful firms in these industries have accumulated cash or capital reserves to be able to move when opportunities present themselves.

Summary

Commitment to a strategic direction is intended to provide internal consistency in investments, processes, and governance mechanisms. Some will argue this all goes out the window (and is therefore meaningless) when industries are chaotic, uncertain, or turbulent. It is true that under such conditions, it is much more difficult to be confident about choices, and as you’ve already seen, long term investments in a specific direction can be ill-advised. This does not mean that you are paralyzed, though!

If you’ll reflect on the sorts of strategies discussed in the last chapter, you’ll likely recognize that a number of them are perfectly adaptable to these sorts of environments. To reiterate some points made earlier, when technologies and customer choices are evolving and unclear, making a commitment to efficiency or cost leadership type strategies is hazardous. These typically require substantial investment in specialized capital that requires relatively long production runs to reduce costs. If the solutions customers want change and the specialized equipment isn’t adaptable, the investment is lost or obsolete. That can be fatal! On the other hand, strategies like the prospector from Miles and Snow or the PL and even the CI approaches from Treacy and Wiersema are quite consistent with what has been discussed as successful practices in this chapter. Recall how these strategies emphasize flexibility, creativity, and dynamic responsiveness. Structures and processes such as job shop environments, experimentation, organization around projects, and fluid reporting structures are what support the adaptive objectives of probing, alliance, and communication. Thus, turbulence can moderate your choices, but there are still solid choices to be made.