The New Dynamics of Competition

by Michael D. Ryall

Photography: Courtesy of Pace Gallery

Artwork:Tara Donovan, Untitled (Mylar), 2011, Mylar and hot glue, Tara Donovan: Drawings (Pins), Pace Gallery, New York

In his book Innovation and Entrepreneurship, Peter Drucker made this observation about industries that rely on knowledge-based innovation: “For a long time, there is awareness of an innovation about to happen....Then suddenly there is a near-explosion, followed by a few short years of tremendous excitement, tremendous start-up activity, tremendous publicity....Later comes a ‘shakeout,’ which few survive.”

The problem, Drucker argues, is that knowledge-driven innovations are “almost never based on one factor but on the convergence of several different kinds of knowledge.” The initial breakthrough generates a spate of activity, but meaningful progress occurs only after all the pieces are in place.

I cannot attest to the scientific merit of Drucker’s claim, but I consider it to be a remarkably accurate description of the field of strategy. In its early days strategy was a loose affair. Content originated either from commonsense approaches such as SWOT analysis or from frameworks like the Boston Consulting Group’s growth-share matrix. In 1979, however, Michael Porter’s five forces model changed the field forever. It masterfully synthesized the practical implications of economic research on industrial organizations from the 1960s and 1970s. Knowledge-based innovation put strategy on the map as a field of study, virtually overnight. Competitive Strategy, Porter’s practitioner-oriented book, became an enormous success.

Porter’s ideas generated immediate excitement. They prompted interest from researchers in other fields and the establishment of the Strategic Management Society and the peer-reviewed Strategic Management Journal. A flurry of papers made informally reasoned claims about the causes of persistent performance differences across firms. Theories such as the resource-based view, dynamic capabilities, and transaction-cost economics appeared, and an avalanche of empirical work quickly followed. Another seminal concept, though not as popular with practitioners as Porter’s proved to be, came in 1996, when Harvard Business School’s Adam Brandenburger and Harborne Stuart Jr. proposed “value-based business strategy.” That work has bred an extensive body of literature on strategy by mathematical economists.

From that backdrop, a general model of competitive strategy, which I call the value capture model (VCM), has emerged. It uniquely applies the mathematical concept of cooperative game theory to research on business strategy. (“Cooperative” is a misnomer, as the math focuses on competitive dynamics.) As such, the VCM has an explanatory, predictive potential that no other theory of competitive strategy, including Porter’s, can claim. The model is a work in progress, but scholars are starting to use it to explain the dynamics of competition and to identify practical implications for strategic decision making. At the VCM’s core is this axiom: “The value that any party can capture from engaging in transactions with a given set of parties is bounded by the value each of them can add to parties outside the set.”

In this article I will explain the axiom and its implications for how we need to think about strategy.
 
Redefining Competition: From Five Forces to One 
In most industries, a firm, its suppliers, and its customers all have choices about how and with whom they create value. To produce more value, they may change how they engage in transactions with existing suppliers and customers or may switch to other suppliers and customers. Those agents, in turn, have similar alternatives in how they transact with the original firm and with their own suppliers and customers.

That reality suggests a formal definition of competitiveness that applies equally to all the firms, suppliers, and customers in an industry: a tension between the value generated from transactions that a firm undertakes with a given set of agents and the forgone value it could have generated from transactions with other agents. That definition enables you to assign formal identities to the agents involved; to place them in a mathematical game-theory model; and, with given measures of competitive tension, to examine the payoffs from their investments in resources and capabilities. You can also bring big data—from enormous databases that track consumer behavior and spending, stock prices, company accounts, and so on—to bear on this work. No other current theory of strategy offers the ability to model the effect of strategic decisions so precisely or to use data to test hypotheses about what kinds of management processes or investments improve a given firm’s ability to capture value in its industry.

What Is the Theory of Your Firm?

by Todd Zenger

Photography: Courtesy of Pace Gallery

Artwork:Tara Donovan,Untitled, 2008, polyester film

If asked to define strategy, most executives would probably come up with something like this: Strategy involves discovering and targeting attractive markets and then crafting positions that deliver sustained competitive advantage in them. Companies achieve these positions by configuring and arranging resources and activities to provide either unique value to customers or common value at a uniquely low cost. This view of strategy as position remains central in business school curricula around the globe: Valuable positions, protected from imitation and appropriation, provide sustained profit streams.

Unfortunately, investors don’t reward senior managers for simply occupying and defending positions. Equity markets are full of companies with powerful positions and sluggish stock prices. The retail giant Walmart is a case in point. Few people would dispute that it remains a remarkable firm. Its early focus on building a regionally dense network of stores in small towns delivered a strong positional advantage. Complementary choices regarding advertising, pricing, and information technology all continue to support its low-cost and flexibly merchandised stores.
 
Despite this strong position and a successful strategic rollout, Walmart’s equity price has seen little growth for most of the past 12 or 13 years. That’s because the ongoing rollout was anticipated long ago, and investors seek evidence of newly discovered value—value of compounding magnitude. Merely sustaining prior financial returns, even if they are outstanding, does not significantly increase share price; tomorrow’s positive surprises must be worth more than yesterday’s.

Not surprisingly, I consistently advise MBA students that if they’re confronted with a choice between leading a poorly run company and leading a well-run one, they should choose the former. Imagine assuming the reins of GE from Jack Welch in September 2001 with shareholders’ having enjoyed a 40-fold increase in value over the prior two decades. The expectations baked into the share price of a company like that are daunting, to say the least.
 
To make matters worse, attempts to grow often undermine a company’s current market position. As Michael Porter, the leading proponent of strategy as positioning, has argued, “Efforts to grow blur uniqueness, create compromises, reduce fit, and ultimately undermine competitive advantage. In fact, the growth imperative is hazardous to strategy.” Quite simply, the logic of this perspective not only provides little guidance about how to sustain value creation but also discourages growth that might in any way move a company away from its current strategic position. Though it recognizes the dilemma, it offers no real advice beyond “Dig in.”

Essentially, a leader’s most vexing strategic challenge is not how to obtain or sustain competitive advantage—which has been the field of strategy’s primary focus—but, rather, how to keep finding new, unexpected ways to create value. In the following pages I offer what I call the corporate theory, which reveals how a given company can continue to create value. It is more than a strategy, more than a map to a position—it is a guide to the selection of strategies. The better its theory, the more successful an organization will be at recognizing and composing strategic choices that fuel sustained growth in value.

The Greatest Theory Ever Told 
Value creation in all realms, from product development to strategy, involves recombining a large number of existing elements. But picking the right combinations out of a vast array is like being a blind explorer on a rugged mountain range. The strategist cannot see the topography of the surrounding landscape—the true value of various combinations. All he or she can do is try to imagine what it is like. 

Todd Zenger is the Robert and Barbara Frick Professor of Business Strategy at Washington University in St. Louis’s Olin Business School.