• Strategy
  • McKinsey & Co.

Extreme Competition

The forces of globalization, technology, and economic liberalization are combining to make life harder than ever for established companies.

At the heart of this managerial challenge is the age-old trade-off between margins and market share. When does it make sense to hold prices steady in the face of new competition or to reduce them in the interest of holding the customer base? Will reducing them now provide a more secure long-term competitive position? The answers, we believe, vary even within different product segments of the same company. A leading telco, for example, has followed distinct pricing strategies in different segments of its core business — “margin maximizing” in some, “share maximizing” in others. These pricing decisions are always carefully thought through in the context of broader industry transitions. By striking a careful balance between near-term profitability and longer-term strategic positioning, this company has enjoyed strong performance in both profitability and share prices.

Costs too are an important factor in transition economics. Building lower-cost positions earlier and more radically than seems necessary almost always pays off. Moreover, a healthy cost structure provides the headroom needed to cut prices or to invest in innovative products and business models should the market require them. When an incumbent transforms its cost structure, a deep understanding of the attacker’s business model should inform the way it does so. Take, for example, the attacker Southwest Airlines: the enhanced productivity that comes from eight takeoffs and landings per aircraft daily (as opposed to the usual four or five) enables the airline to generate up to 40 percent more revenue per aircraft a day than a traditional carrier does. Had major US airlines recognized the significance of this productivity advantage a decade ago — and of course hindsight is always 20-20 — would they have been quicker to rethink their business models?

No part of the cost structure should escape scrutiny; radically cheaper alternatives are often possible for “below-the-line” expenses such as R&D and selling, general, and administrative costs. Software engineering and the development of pharmaceuticals are but two of the knowledge-intensive undertakings to which Western companies have successfully brought the power of Indian talent — and its lower costs.

Fight Aggregation with Disaggregation. As powerful forces of aggregation and integration reshape entire industries and create a raft of unlikely new competitors, supply chains — for physical as well as knowledge work — are fragmenting and specialized new players are forming around each link. Every incumbent should reexamine its product portfolios, customer segments, and geographies in this light and treat them less homogeneously by looking for the sharp edges where its value proposition is more attractive or the competition less intense.

Scale advantages may push some companies in the other direction, toward the further aggregation of markets, but we believe that most will benefit by creating more differentiated value propositions to serve microsegments. Production processes may often be uniform, but markets rarely are. Disaggregation helps to expose value propositions that are stuck in the middle — dangerous territory when most markets are clustering around either high excitement (Apple computers, Porsche cars) or high value and productivity (Dell computers, Toyota cars).

Discuss

Your email address will not be published. Required fields are marked *