Keeping Out The Competition

Although all companies strive to develop one form of competitive advantage or another, relatively few are persistently successful over long periods. Innovative activity is almost always followed by waves of imitation and relatively few first movers are able to maintain their initial market position.

Although Tagamet was both revolutionary and one of the best-selling drugs of all time, it was eclipsed by an imitator, Zantac, in an embarrassingly short time. Similarly, companies such as Thorn-EMI, which first developed the CAT scanner, and Xerox, whose Palo Alto research labs developed many of the innovations that created personal computers, failed to generate any lasting success from ideas that have created whole new industries. The simple truth is that most large-scale expenditures designed to create competitive advantage are unlikely to realise a return unless that advantage can be sustained.

 

Economists think about this problem as one of creating, or strategically exploiting, barriers to entry or mobility barriers.

Entry barriers are structural features of a market that enable incumbent companies to raise prices persistently above costs without attracting new entrants (and, therefore, losing market share). Entry barriers protect companies inside a market from imitators in other industries. Mobility barriers, on the other hand, protect incumbents who operate in one part of a market from other established companies who operate in other parts of the same market.

Entry barriers give rise to persistent differences in profits between industries; mobility barriers create persistent differences in profitability within the same market. Although different commentators produce different lists, almost all sources of entry or mobility barriers fall into one of the three following categories: product differentiation advantages, absolute cost advantages, and scale-related advantages.

Product differentiation arises when buyers distinguish the product of one company from that of another and are willing to pay a price premium to get the variant of their choice. Such differences become entry or mobility barriers whenever imitators, whether they be new entrants or companies operating in other niches of the same market, cannot realise the same prices for an otherwise identical product as the incumbent.

On the face of it, it is hard to understand how this might come about since consumers will (surely) always prefer the lower-priced variant of two otherwise identical products. However, if it is costly for consumers to change from purchasing one product to purchasing another, then prices for otherwise identical products can differ for long periods of time.

Economists call costs of this type switching costs and business strategy textbooks are full of suggestions about how companies might try to create switching costs by locking consumers into their product.

Habit formation is an obvious source of switching costs and many marketing campaigns are designed to reinforce the purchasing patterns of existing customers and raise their resistance to change.

Further, many consumers sink costs into gathering information about new products and, once they have made a choice that satisfies them, they are likely to resist making further investments.

Both sources of switching costs are often reinforced by the use of brand names to help consumers quickly find familiar products. The value of these labels depends, of course, on the size of the switching costs that they help to sustain.

Finally, switching costs also arise when consumption involves the purchase of highly specific complementary products that lock consumers into existing purchasing patterns. Buyers of IBM mainframes often found that the large costs of rewriting software and recording data dwarfed price or performance differences that might otherwise have induced them to switch to one of IBM