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MANAGING BEFORE AND AFTER HOSTILITY STARTS

by Donald V. Potter

Low levels of profitability for most competitors make a hostile industry a tough place to compete. Low profits, alone, would make such an industry a difficult environment in which to manage. But managing a company in a hostile industry is even more difficult because a market acts differently after hostility is under way than it did before hostility started.

We have seen several important areas of difference:

Product price Leadership

Before hostility, industry price leadership belongs to strong competitors who raise prices at least as fast as inflation. Then, the primary issue is “what the market will bear”. After hostility price leadership shifts to weaker competitors whose discounts keep prices rising slower than inflation. And the primary issue becomes “who the price will discourage”.

Customer Price Levels

Before hostility, an individual customer would see a wide range in the prices offered by various competitors but little difference in the price paid by one customer compared to another. In the personal computer market of the late ‘80s, prices for similar products could vary by 50% from one supplier to another but the customers of an individual supplier all tended to pay similar prices.

After hostility starts, product price differences narrow considerably, say to 5% or so, across all competitors but the range of prices charged by an individual supplier to his customers diverges a great deal, to 10-30%, or even more. The management of price at the level of the individual customer because a necessary tool in hostile markets.

Benefits That Move Share

A market that is not hostile sees a good deal of share moving from one supplier to another because the share gaining supplier introduced a successful new feature. An example is Citibank’s introduction of its massively successful AAdvantage rewards credit card, which gave the user frequent flyer mileage credit for charges on the credit card.

After hostility, share changes hands more slowly, and does so on different benefits. A respected brand name or high service levels become the key share moving benefits. So a manager facing a newly hostile market must often develop not only different kinds of improvements in his product/service package but, also, more patience in waiting for them to grow his share.

Building Blocks of Profitability

Before hostility grips a market, the building blocks of profitability are individual products. The majority of both revenue and overhead costs are readily traceable to individual products. Product profitability is the keystone of the management control system.

But in hostile markets, product profitability is relatively meaningless. Most customers buy multiple products and services from the company. Customer mix and special pricing deals blur the product revenue picture. More of the overhead costs belong, not to specific products, but to segments of customers. Customer demands even disrupt previously straight-forward product manufacturing and distribution cost assumptions. The profitability of individual customer relationships underpins the management control system. Management uses product information to control costs, not to evaluate profitability.

Basis of High Returns

High returns in a market that is not hostile is revenue-based. The industry return on investment leaders achieve results from either high unit prices or very fast growth in sales. High unit prices are most common with brand name leaders and high growth usually associates itself with smaller firms who introduce unique features.

Hostility takes most of these revenue advantages away. Brand leaders usually have to match their prices to several other peers. And unique features become less common. Competitors copy them more quickly so customer concerns shift more toward issues of dependability and short order cycle time.

Rather, superior returns in hostility are cost-based. Companies with the best returns have the lowest unit costs. The largest firm in the industry has a natural advantage here because it spreads its costs over more units. But smaller firms also achieve high returns – usually by avoiding costs that will not bring them revenue.

Closing Thought

The shift in the way management must think in a hostile market is so significant that the vast majority fail to make the transition. Most companies fail in hostility.

(Note: This Perspective was written in the context of the economy in 1994. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)