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Market value system

A very good blog article on Customer Focus versus Product Focus.

If you need convincing which is better, this article on why Apple has the lions share of the profits in the mobile handset market even though it is not the largest player may help: 7 Reasons Your Brand Will Never Be as Awesome as Apple

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What’s the number-one attribute Warren Buffett, arguably one of the most successful investors in the world, looks for in a company? “Sustainable competitive advantage,” he told an interviewer.

Competitive Advantage is a set of factors or capabilities that allows firms to consistently outperform their rivals. (adapted from Roberts, 2002)

If competitive advantage is so valuable, how does a business acquire it? Competitive advantage can be found at many levels. It can come from a variety of competitive differentiators. At the business model level some companies, such as Ebay, have sustainable competitive advantage from network effects. The low-cost airlines have a business-model advantage – they actively avoid the additional costs associated with serving high-demand, package travel and long-distance customers. Some very lucky businesses have monopolies. Some have a cost advantage, perhaps from scale or some technological or process advantage, which allows them to make excess profits while competing on price. Some businesses focus on having the best customer service.

For it to be a competitive advantage only one company can be best at whatever it is. For it to be a sustainable competitive advantage there must be some structural reason that another business could not emulate or beat it.

At the individual level, competitive advantage should be a key focus of every salesperson – if the salesperson can help the customer quantify how their particular solution benefits the customer, or by changing the proposition move the advantage away from a key competitor, then price becomes far less of an issue in the sales process.

What tools are available to help create competitive advantage? Michael Porter’s revolutionary approach to competitive advantage is now over 30 years old. Developed around the same time as the personal computer and before the mobile phone, the internet and worldwide web, it is an industrial-era theory. It focuses on creating competitive advantage within value chains within a business- the processes that make the product. However, the internet and globalisation has fragmented value chains into value systems.

It takes not one, but hundreds of collaborating and competing companies to manufacture a smartphone, for instance. So competitive advantage has firstly to be understood in the context of complex and dynamic value systems.

Network effects were not a consideration 30 years ago, and are not even mentioned in Michael Porters Competitive Advantage, but are a major source of competitive advantage in the modern world for companies like Ebay, Amazon, Facebook and Skype. Network effects have created businesses with the fastest growth rates ever seen.

The theory of disruptive innovation was developed in the 1990’s. It is not a new phenomenon – the huge ice transportation industry which provided ice for icehouses built for the homes of the wealthy was disrupted by the development of the refrigerator in 1844, and Schumpeter published his ideas on creative destruction in capitalism in 1942 – but Christensens’ theory was the first that analysed the circumstances in which disruption happens and why market incumbents are powerless to protect themselves despite their resources. Disruption in markets is growing and the rate at which companies enter and leave the list of Fortune 1000 companies is constantly increasing as a result. The theory of disruptive innovation has some very useful tools for understanding all types of competitive strategy.

Using Porter’s ideas, these tools and others, I’ve developed an analytical methodology for identifying and creating competitive advantage which I call The New Competitive Advantage – follow this link for a presentation of the key ideas. It updates Michael Porters approach for the information age. It introduces ideas and concepts that were not developed 30 years ago and moulds them into an approach that can take a technology, a product or a business model and create competitive advantage.

When applied to a technology (in the example I apply it to a new fundamental technology, the recently-discovered room temperature maser), the process helps understand when the technology will be good enough for particular markets. It can be used to discover early new market or potentially disruptive uses of the new technology. When applied to products it helps create differentiated propositions. I have used it to help several startups to create a business model that creates a clear competitive advantage in their market. I hope it is of similar use to you.

When a new technology comes along it is often described as ‘disruptive’. The usually unasked question is, who exactly is it disrupting and why?

I studied disruptive innovation to find out whether I could use it to develop a potentially disruptive business, rather than just recognise one ex-ante. The key ideas I took from Christensen’s disruptive innovation work and which are applicable to the analysis of all sorts of innovation, are:

  • analysing the capabilities of an innovation against substitutes (not just direct competitors) using the Good-Enough/Not Good Enough approach, and mapping these to potential uses;
  • the Jobs to be Done segmentation approach to identify new market opportunities or product improvements, including unsatisfied or over-served users that could be satisfied by a cheaper solution as in my earlier blog on the business continuity solution;
  • the Resources, Processes and Values framework to identify whether a particular industry or target business can accept an innovation, or how a business can be designed so that industry incumbents cannot respond without hurting their revenues and their stakeholders short-term interests.

Thinking about disruption alongside other business concepts led to some other insights. Thinking about fragmentation of the value systems that make up a market led to the understanding that, for a new innovation (disruptive or not) to be adopted, every business that remains in the new value system must be better off or it won’t be adopted. I’ve seen this happen with a number of potentially-disruptive innovations – the developer cannot get into the market because it is not in the best interest of one of the parties that would be involved in getting  the product to the customer. This is usually because the innovator is looking for a high growth route to an existing customer base.

The value system is the flow of products and services that go to make up the entirety of a product or service to the end-user, which could be an individual or a business. In the early days of the industrial revolution, and particularly before the development of the computer, companies were usually vertically integrated – they designed and built all of the parts of the products they manufactured and either sold directly to the end-user or wholesale to retailers. The computer and global communications changed that. Now a complex product like a mobile phone is the result of the combined efforts of several hundred different competing and co-operating businesses that form a market value system. If it is a fully-competitive market (ie, there is no dominant brand, natural monopoly or other factor limiting competition) then the average price will be closely related to costs.

These thoughts led to game theory and the Nash equilibrium via a little-known but very interesting book, “The slow pace of fast change” by Bhaskhar Chakravorti. I realised that competitive markets settle into a metastable equilibrium in which everyone tries to do the best they can, given what everyone else is doing. Businesses in the market system compete and co-operate to minimise two main things – input costs and risk. Lots of individual businesses fail because of poor execution or wrong resources, but on the whole the market is stable – as measured by average product price. When a new market innovation comes along that removes significant cost from the value system there is a relatively quick step change in price (once the disrupted incumbents exit) and the product settles on a new, lower average price. This seems to have happened sequentially in the PC industry, for instance, where home desktop computers were initially in the £4000 region and have dropped in steps to a price of around £300-£400 today – and are likely to disappear from most homes completely.

So who is being disrupted depends on where in the market value system the innovation is introduced and what costs are being substituted. For a new market disruption, such as the transistor radio, Honda’s Cub motorbike or Ebay auctions, a whole new value system with new customers may have to be created. The disruption is then an underperforming (by the values of the existing market products) substitute to the main markets’ products, but one that is good enough for the unserved and overserved. The tools of disruptive innovation can help us to understand whether our innovation is new market or cost-reducing, who we should be bringing along with us from the existing value system (if any), and what our proposition to them should look like.