Four Tracks to Market Leadership

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Within a single decade, the music industry underwent a revolution in which digital upstarts triumphed over the market leaders. In 2006, record labels generated US$9.4 billion in CD sales in the U.S.; a mere 10 years later, their sales had dropped 84 percent, to $1.5 billion. The cause of this decline, of course, was digital online music.

Significantly, the revolution happened in two waves. In the first wave, during the late 2000s, the record companies became spectators in their own industry. They still produced the songs people purchased, but by 2010, Apple, with its iTunes site and iPod mp3 player, had siphoned off most of the profits.

Then came the second wave. Apple had barely had time to enjoy its ascendancy when it, in turn, was overtaken. In 2015, streaming music replaced downloads as the industry’s biggest source of revenue, accounting for 34.3 percent of sales. Spotify, a company launched in 2008 but barely on most people’s radar until 2012, is now the leader in the music industry.

These shifts took place so quickly and were so thorough that the music industry is often viewed as a perfect example of disruption. It is said that stalwarts such as Sony, Warner Bros., and Universal made themselves vulnerable by failing to anticipate the impact of digital technologies. But there is another, more relevant way of looking at this episode: as a case study in the dynamics of market leadership.

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Market leadership is perhaps the most critical challenge in today’s business environment. It is the ability of a company to dominate and shape its business ecosystem: the chain of activity leading from suppliers to end customers. It has long been a recognized and sought-after source of business power and profitability.

But the idea of market leadership is more complex than it would seem at first blush. Different industries have different patterns of market leadership; only if you understand the particular pattern in your industry can you position your company effectively. Apple and Spotify took over their industry not by disrupting it and changing it entirely, but by recognizing and working with the dynamics that were already there. And certain companies in every industry are poised to do the same.

That’s the conclusion suggested by a collection of Industry Perspectives developed earlier this year. Between January and May 2016, Strategy, PwC’s strategy consulting group, published a series of articles examining the current state of play in major industries. Companies in all the industries we looked at — aerospace and defense, auto, chemicals, commercial aviation, commercial transportation, engineering and construction, entertainment and media, financial services, industrial manufacturing, oil and gas, retail and consumer products, technology, utilities, and wealth management — are struggling to differentiate themselves and shape their future. Today’s executives understand their companies can no longer be all things to all people, and many are focusing their company’s efforts on a more coherent identity: one based on a distinctive value proposition and a few powerful capabilities. Their efforts are complicated, however, by the mutable and somewhat blurred paths to market leadership in their industries.

According to the Industry Perspectives, four broad types of market leadership dynamics — recurring patterns of industry behavior that affect the way companies jockey for position — are taking place. They are the Commoditization Spiral (in which companies struggle to avoid having to compete on cost alone), the Table Stakes Game (in which many contenders fight over the same broad customer base with similar capabilities and offerings), the Supercompetitors’ Pie (carved up by the companies with the most distinctive edge), and the Dominating Platform (in which one company controls most of the playing field).

Apple and Spotify took over their industry not by disrupting it entirely, but by working with the dynamics that were already there.

Some industries combine several of these dynamics. Retailers, for example, may be enmeshed in all four at once. Moreover, these dynamics don’t appear to be static. Industries move from one to another. Thus, the music industry has shifted from the Table Stakes Game (where it was before iTunes) to the Dominating Platform (under Apple) to either the Supercompetitors’ Pie or the Commoditization Spiral (depending on how the shift to streaming turns out).

If you want to lead your industry, it matters which types of dynamics affect your enterprise. The Industry Perspectives, and the trends they uncovered, provide worthwhile clues.

The Commoditization Spiral

In most industries, companies compete by having a distinctive and hard-to-replicate way to serve customers. But in a Commoditization Spiral dynamic, there isn’t any easy way to differentiate. The only value proposition that seems effective is to offer the lowest price to customers.

In this dynamic, competition is so fierce and products are so similar that customers can play manufacturers off against one another to negotiate better deals. Almost as soon as a new product or service is introduced, others in the industry — including new entrants from emerging economies — offer something similar, and frequently at a lower price. When caught in this dynamic, companies tend to panic and eliminate costs as quickly as possible, often hurting themselves by cutting corners on processes, on employee development, and on procurement to maintain the slimmest of margins on their products and services.

Many people think the music industry will end up here — but it hasn’t happened yet. Purveyors of recorded music can still differentiate themselves by the method of distribution (who has the best streaming network), the quality of the content, and the breadth of material (e.g., including work by a wide range of independent musicians).

Commoditization does seem to be happening, however, in the chemicals industry. A couple of decades ago, chemicals companies relied on formulations with unique properties, known as specialty chemicals, to set up exclusive relationships with customers. The popularity of these products allowed companies to offer bundled packages that included a range of items and yielded relatively high profits. That strategy went by the wayside, however, as low-cost suppliers took aim at the specialty market by packaging all their products separately, dropping prices on the less desired products, offering discounts, and winning over customers.

Surviving the Commoditization Spiral is difficult; in fact, it may be possible only for companies that double down on differentiation. This often means investing in innovations that help companies provide solutions to customer problems. For instance, in the engineering and construction sector, which had been slow to adopt new technologies, a few companies have begun to provide advanced software that allows information to be shared across project sites and the home office. Alterations in design and materials can be added directly into these systems, reducing wasteful discrepancies and rework and boosting safety. In addition, project simulation programs are increasingly popular, offering the opportunity to experiment with different materials and construction techniques before the project begins. Similarly, in the chemicals arena, one supplier has installed sensors in dispensing equipment that allow its technical services people to optimize product usage at a customer’s site. In these examples, the product is commoditized but enhanced with special features and characteristics for which customers are willing to pay more.

The Table Stakes Game

This dynamic takes its name from “table stakes” capabilities: competitive skills that every company in an industry needs just to stay in business. In the recorded music industry, for instance, every company has to know the basics of maintaining technical audio quality in distributed sound. In industries caught in the Table Stakes Game, many companies are competing at once — not necessarily on price, but on quality and features. Although they don’t fall into commoditization, it’s very hard for any of them to stand out and reach market leadership.

The recorded music industry was in this position during the 1980s and 1990s. Many record companies were thriving, each with its own line of artists usually covering a wide range of genres. Some of these companies, such as Warner/Elektra/Asylum, Columbia, EMI, PolyGram, and MCA, enjoyed competitive advantages because of their size and economies of scale. But they could never dictate terms to, say, record store chains or major recording artists. They were too dependent on hits — which were virtually impossible to predict — and they topped the industry only when they were fortunate enough to top the Billboard charts.

This dynamic can be found today in automobiles, oil and gas, some consumer packaged goods sectors (e.g., beer), appliances, and any industry where a large number of major companies rely on similar capabilities. Because the customer base is deep enough and the potential revenue pool sufficiently wide, companies can maintain profitability by touting ancillary features on their many product and service choices while fine-tuning scale across extensive manufacturing, distribution, and supplier channels. There tend to be many players and no clear winners.

More recently, technological advances have made it easier to gain table stakes capabilities. The Internet introduced new sales, marketing, and communications channels that anyone could adopt with relative ease while the digitization of the back office, front office, factory floor, and organizational functions swelled the amount and usefulness of data that any company could tap into. Large and small businesses took advantage of these new tools to leapfrog each other. More industries are thus falling into this dynamic, and challenging their leading companies to escape it.

The auto sector represents an especially visible example of the Table Stakes Game. There is no shortage of enthusiastic customers for vehicles at the moment, and most car buyers seek the same features for a reasonable price: reliability, performance, advanced electronic amenities (such as easy-to-use smartphone connectivity), safety (including features developed for autonomous vehicles), easy financing, and environmentally friendly features. For their part, automakers have so successfully learned from one another that they all have similar capabilities. They can all, for example, manufacture vehicles using the kind of continuous improvement and lean production that was once limited to Toyota and Honda. They also have similar capabilities in auto styling, dealer relationships, financing, and automotive electronics.

Meanwhile, the car is undergoing a design and engineering revitalization whose level of activity rivals that of the golden age of automobile invention a century ago. In the coming years, new cars will run on a variety of powertrains. The highways will be shared by internal combustion (gasoline) vehicles, cars and truck with diesel engines, vehicles with fuel cells (hydrogen engines), electric vehicles (powered by batteries), and hybrids. Some automakers will stake their future on connected cars and autonomous (self-driving) cars, while others continue to base their brand on styling, performance, or value. But in a table stakes environment, no matter which niche they choose, there will be plenty of competition. The industry would have to consolidate a great deal to move out of this dynamic, and it’s not yet clear how that would happen.

How do you get to market leadership in a Table Stakes Game industry? It’s not easy. There appear to be two tracks. In the first, you step away from some of your existing business, stop trying to be all things to all customers, and focus on achieving some capability that no other company in the industry can match. Chances are, this will mean building on your existing strengths. It wasn’t enough to save Volvo from being acquired, but it could save your company if you are far enough ahead. The second track is simply to do what every other company does — but do it better, faster, and more effectively.

The Supercompetitors’ Pie

This dynamic is named after a hypothesis put forth by Northwestern University’s Kellogg School of Management faculty members N. Thomas Hubbard, Paul Leinwand, and Cesare Mainardi (“The New Supercompetitors,” s+b, Autumn 2014). They predicted that most industries would soon be carved up by the companies with the most distinctive value propositions and the capabilities to match. Businesses that could set themselves apart in pivotal ways — for instance, by their product design, supply chain scale, or manufacturing efficiency — would become supercompetitors, able to shape their “slice” of the customer market to their advantage. Leinwand and Mainardi put this concept at the center of their PwC- and Strategy-sponsored book, Strategy That Works (Harvard Business Review Press, 2016).

Industries caught up in this dynamic tend to get sliced into a few specialized domains, often consolidating through MA until there are only a few major companies in each. Competing on capabilities is effective for these companies because it allows them to focus on one or two specialized domains where they have the prowess they need to shape the category. For example, many consumer packaged goods companies have jettisoned products and services that don’t fit with their capabilities. The businesses they end up with — Procter Gamble’s personal care and cleaning products, Kraft’s meats and cheeses — are often much more narrowly focused than what they had before, but also more able to dominate the market.

One of the most radical such transitions is occurring in the aerospace and defense (AD) industry. These companies were once in a system where they all played the same game: tailoring their products to meet the requirements of large weapons programs that were the priorities of the biggest, wealthiest defense customers, such as the U.S. armed forces. Now those priorities are shifting. The Pentagon, for example, is focusing its attention on more flexible, lower-cost high tech. This change has, in turn, galvanized a spate of new technologically adept and agile competitors able to quickly provide small, customized solutions that are out of the reach of traditional AD contractors.

Going into direct competition with high-tech companies would be a mistake for AD contractors, which generally lack the necessary breadth and depth of talent to support the continuous technological advances needed to develop products that are wedded to the information value chain. U.S. AD companies employ fewer than one in every 150 engineers with expertise in autonomous systems, secure communications, artificial intelligence, and machine learning. And defense companies spend far less on RD (2.2 percent of revenues on average) than do most U.S. technology companies (7.6 percent of revenues on average). For these reasons, defense companies are not going to out-hire Amazon in cloud services or Google, Microsoft, or Facebook in data science and analytics.

But AD outfits have a huge advantage over technology firms in their special relationship with defense departments around the world. After years of doing business with the military, defense contractors have learned the secrets of navigating the halls of the Pentagon, for example, and have become fluent in the language and expectations of the top brass. And unlike most relatively young technology companies, AD organizations are used to the extended lead times, delays, intellectual property rules, and elbow rubbing that are typical of a long-term defense contract.

Thus, AD companies are increasingly seeking to carve up the sector by targeting selective weapons niches. Some companies are specializing in sensor-equipped tracking devices, others in vehicles for difficult terrain, still others in weapons with artificial intelligence, and others in the cyberwarfare slice. Fewer companies than before are specializing in maintaining the major weapons of conventional defense contracting.

Airlines are also carving up their industry. The decisive battle for the future of the airline industry over the next five to 10 years will be fought over which airlines cater to which type of customer, with the right capabilities. If you are a family of four on the way to a resort with skis, a car seat, eight bags, and toys, and are in need of a lot of entertainment during the trip, one or two airlines will provide a package that addresses all of these needs, including help getting through security and on and off the plane. If you are a businessperson, you might travel on a different airline altogether — one that specializes in all-business-class amenities. And if you simply want cheap, practical, point-to-point transportation, you’ll fly a no-frills airline oriented to that purpose.

The Dominating Platform

The final dynamic is the Dominating Platform. In this dynamic, the industry is already disrupted, and now the competitors must figure out how to assert a role for themselves using a new common technological platform. In this category, there is often just one supercompetitor, keeping itself dominant by continually improving its capabilities, without any real competition — at least not yet. Microsoft’s Windows operating system, Google’s search engine, and Amazon’s “everything online” retail experience are all renowned cases of the Dominating Platform. These companies will remain in control until someone comes along with a more disruptive technology.

Indeed, a battle for platform domination is still going on in the music business. As we noted above, iTunes controlled the industry for about a decade; it was a powerful Dominating Platform. Then Spotify overtook Apple in both revenue and subscribers. But Spotify has not created a fully Dominating Platform, in part because streaming audio is a relatively open architecture with fewer barriers to entry than downloaded music had. Consequently, Spotify is battling with Amazon, Apple, Pandora, and many other music sources — along with some popular musicians including Taylor Swift and Adele — for platform control. This sector may ultimately fall into the Table Stakes Game dynamic instead.

You don’t have to be a producer of high-tech products to be in an industry where a Dominating Platform dynamic is in play. Consider commercial transportation, the business of container ships, freight trains, and trucking fleets. This industry has been dramatically disrupted since the early 2010s. Yesterday’s established logistics companies have been beset by new high-tech entrants slicing off bits and pieces of their business, offering speed and flexibility — and more value — to customers at an attractive cost. There is, in effect, a new “open source” logistics platform, and gaining leadership in this sector by gaining control of the platform is essential.

Financial services is another industry struggling with platform domination. Dozens of specialized products have been launched by startup financial technology (fintech) companies providing loans, credit, mobile payments, investment services, and even risk analysis. They are all seeking to develop a ubiquitous infrastructure that other banks and financial-services companies will join. Technology giants like Apple, Google, and Samsung are trying to enter this platform business as well.

In a Dominating Platform dynamic, the best way to thrive is to create a powerful enough platform, or to align with the company that does. Creating a Dominating Platform requires extensive and highly distinctive capabilities. The place to start, therefore, is with a sober assessment of what your company does best and whether it could be the basis of a Dominating Platform. If the answer is yes, channel all your investment into this value proposition, defunding activities that don’t fit, and make alliances with or acquire third-party technology providers that can provide the hardware, software, and apps to support the platform you are building.

Getting Ready for 2017

This coming winter, when we again examine the trends and prospects in critical industries, the need for specialization will no doubt come into sharper focus. We expect that companies will increasingly use technological innovation — big data, connectivity, advanced sensors, apps, and cloud-based hardware and software — to reach individual consumers with customized products. And some companies will rely on MA and internal cultural change to support these efforts. Although all industries have begun to feel the impact of specialization, and some are suffused with it, companies have no shortage of strategic and tactical options for prospering from it.