yale case 07-044

september 26, 2007

A Note on the Competitor Perspective

Sharon Oster1 Joel Podolny 2

Consider the following eight managerial decisions: In the late 1960s , Herb Kohler, grandson of the founder of Kohler Co., then a modest sized Midwestern producer of relatively undifferentiated bathroom fixtures, decided to combine cutting edge design work and marketing to turn toilets, sinks and bathtubs into luxury consumer durables, i.e. the Bold Look of Kohler. In 1991 Tom Krens, then Executive Director of the Guggenheim Museum, engineered a partnership with the Spanish government to bring a branch of the Guggenheim to the 3 Basque town of Bilbao. By 2006, he had formed similar partnerships and expanded the Guggenheim brand from its original NY and Venice roots to Las Vegas, Bilbao, and Berlin with plans on the table for Abu Dhabi. In the mid-1990s, Charlotte Beers, CEO of the advertising agency Ogilvy and Mather, guided the companys introduction of what came to be known as a Brandprint, a methodology through which Ogilvy and Mather helped their clients to identify the essence of a strong emotional connection that their customers would have for their products and services. In 2000, Pepsi Cola paid $370 million to acquire SoBe, a small Connecticut based manufacturer of vitamin infused teas and juices. SoBe had earlier been in talks with Coke, and one of Pepsis distributors commented on the SoBe deal, Its great to see Pepsi pre-empt Coke. In 2000, JetBlue introduced in-flight satellite TV on its fleet of Airbus A320s, enabling passengers to watch a large number of channels on a personal screen affixed to the seatback in front of them. In October 2005, the U.S. Department of Housing and Urban Development (HUD) opened up an Academy to train advocates, lawyers, investigators, and other interested parties in the prevention and elimination of housing discrimination. In June, 2006, DaimlerChrysler introduced its new minicar, SmartForTwo, to the US market with a modest sticker price of $15,000. The new minicar, designed for city driving, was engineered to get 60 miles per gallon. All of these strategic decisions were made with the sole objective of providing a product or service to some group of individuals that would be perceived as superior to the products or services currently on offer. Business people will refer to this as creating value. (You want to make some money; go create some value.) Moreover, as we see from the examples of the Guggenheim Museum and HUD, the concept of value creation need not be restricted to the world of business. The viability of all organizations, regardless of sector, hinges on their ability to create value. If the

Guggenheim hopes to receive funding from donors and ticket purchases from audiences, then the Guggenheim must present works that the donors and audiences want to see in places that the donors and audiences wish to see the work displayed. If HUD is to continue to receive funding for its academy, then the lawmakers that fund HUD must find value in HUDs activities. However, while value creation may be a necessary condition for organizational viability, it is not sufficient. To survive, an organization must be able to capture the value that it creates. We use the term value capture to refer to an organizations ability to secure resources (usually financial) in exchange for the value that the organization has created. The abilities to both create and capture value are the central 4 strategic tasks of any organization. In the rest of this note, we will explore the way in which other agents in an organizations environment influence these abilities.

What is Value and How is it Created and Captured?

Value Creation In economic terms, the value of a good or service is the difference between the consumers willingness to pay for the product or service and the total production costs of the product or service. For most private goods, the willingness to pay is considered at the level of a single consumer and is measured by the price that consumer will pay to obtain the good or service. However for many nonprofits, the goods or services produced simultaneously generate a stream of benefits for multiple audiences and these benefits will need to be summed up to come up with the value created. Thus when Warner Brothers produced the new Superman movie we measure the gross value created by looking to the combined willingness to pay of all of the patrons of the movie, both at the theatre and later in other forms. By contrast, when the Metropolitan Museum mounts a Rauschenberg exhibit, we measure benefits of that exhibit not only by the willingness to pay of those who see the show, but by the value to art historians from the historical record of the exhibit, and to art lovers who obtain value from the exposure of the public to the exhibition. The latter set of benefits may be somewhat harder to measure than the benefits from the Superman movie, but the principle to be applied in thinking about value is the same. How does an organization create new value? Working with either an existing product or service or in developing a new offering, the firm must either find a way to increase individuals willingness to pay for the product over earlier versions or substitutes, or to produce the product more cheaply. Broadly speaking the first strategy is described as differentiation, while the latter as cost-based. For Kohler, the firm made a judgment that it was possible to design, brand and market bathroom fixtures in such a way that people would value them more than the simple, white fixtures that were the norm. Traditionally, bathroom fixtures had been marketed to the trade; the plumbers and home contractors who were happy to install homogenous and inexpensive fixtures into homes. Kohlers differentiation strategy required the firm to rethink the identity of the buyer, to learn to sell directly to consumers and to have those consumers apply pressure to plumbers to pull the product through the trade. Pioneering this differentiation strategy took a leap of faith as well as some hard-edged analysis. In some industries, differentiation is a way of life and the issue becomes one of seeing a new basis for the differentiation. In the already differentiated airline industry, Jet Blue made the judgment that air passengers would value a new feature, individualized TV viewing. On the other hand, the SoBe acquisition appears to be more of a cost-based strategy, with Pepsi seeing ways to use its network to reduce production and distribution costs for the SoBe brand. As a general matter, managers need to think hard about whether they can create value with one or the other strategy. What is the role of other agents when an organization thinks about value creation? At the simplest level, of course, managers must take into account the alternative products offered by competitive firms when they try to assess the value of their own new or changed offerings. An individuals willingness to pay for an organizations product depends on what other, similar products are out there and at what price. But it 2 a note on the competitor perspective

is also the case that the underlying value to consumers of a product and service is often affected by actions of players outside the firm who produce complements to the new product. Difficult situations arise when the market for a key complement is as yet underdeveloped and a firm must anticipate the pace of that market. For example, Burst was a small innovative firm with a technology for delivering bursts of video content over the internet, a technology designed to smooth real time video delivery. Its value to consumers depended critically on the amount of broadband penetration, and yet Burst itself did not deliver broadband. In the end, the failure of broadband to penetrate quickly doomed Bursts business model. For Krens Bilbao venture to create value depended in part on the willingness of the Spanish government to subsidize other tourist-related infrastructure in the Basque region, very little of which existed at the time the museum was built. In some cases, the complements to an organizations products are not individual products but broad social trends. For Kohler, the growth of larger homes with lavish lifestyle-type bathrooms clearly complemented the introduction of increasingly expansive bathroom fixtures. Broadened interest in travel to less well-known places is a complement to the Bilbao venture. These examples suggest that even in the value creation piece of the puzzle, learning how to anticipate the actions of others in your environment will be very important. Some further thought about the examples pinpoints an important difference among them. In these examples, it is evident that the actions of other agents play a role in how an organization can create value. Understanding whether and how these agents can be influenced is of great importance. Burst was a very small player in the world of broadband; its ability to influence adoption in that market was limited. While he had little effect on the overall travel market, Krens likely had much more control over the complementary actions of the Spanish government. Once Krens realized the importance of the tourist infrastructure to his success, he could either contract with the government for the provision of needed facilities or refashion his partnership contract so that the infrastructure mattered less. On the other hand, Kohler likely had little effect on stimulating the development of the McMansion, though one might argue that their innovations had some marginal effect on bathroom size. In general, understanding who matters for value creation, and how, helps a firm determine the risks of its strategy and in some cases, allows the firm to either hedge against the risks or even change the conditions to obviate the risk. In sum, the competitor perspective prompts the manager to ask:

Who in my environment affects the potential value that my actions could create and how do I anticipate and possibly influence their behavior?
In the value creation process, how do we figure out which agents matter and how they matter? To answer this question well, broad thinking is important. Increasingly the agents that matter are global in scope, and include governmental and nonprofit organizations along side of the traditional corporate competitors. As we have already seen, the way these agents matter also needs to be analyzed broadly. Agents can be both complementors as well as competitors. In the world of technology, complementors are especially important, and we might well see times in which a firm actually wants an increase in the number of competitors because that increase will stimulate further development of key complements. Once we identify the organizations that potentially influence the value creation process, we can turn to forecasting and influencing their behavior. Before we take this next step, however, we briefly explore the value capture piece of our analysis. Value Capture Often times, when deciding about whether to take some action - a repositioning/branding, an acquisition, a new entry, a pricing move - managers will worry much more about how they can create value than about how they can capture the value that they create. But both are important; it is easy to come up with 3 a note on the competitor perspective

examples of organizations that make strategic moves in which they are unable to capture the value that they create. For example, news organizations have had a very difficult time figuring out how to capture the value that they are able to create through the online distribution of content. Some, like the Wall Street Journal, have subscription services. Others, like the New York Times, were charging for premium content until recently. Still others, like the Boston Globe, are offering their content for free and hoping to earn revenues from advertisers who value the number of people who view ads on the Globes website. At the current time, it is not clear the degree to which any of these models will allow news organizations to capture the most value that they are creating. Overall, creating value, while a necessary condition to making money, is not a sufficient one. One of the major reasons that organizations have difficulty capturing the value that they create is the presence of competitors or potential competitors, eager to imitate strategic moves that enhance the flow of resources to the organization. As firms try to implement new strategies, they typically face some risk that other firms will take imitative actions. If, in fact, airline passengers value the ability to watch satellite television on their flights, JetBlue needs to worry about whether existing or potential new competitors will be able to make a similar improvement to their own fleet. If competitors are able to imitate, then this new source of value will no longer be a reason for airline passengers to choose JetBlue. Value will have been created, in that many airline passengers will have an enhanced trip, but all of the value will go to those consumers rather than to the firms that thought of the idea and installed the equipment. In a service business, like advertising, imitation by other firms is made easier by the fact that it is hard for a firm to credibly claim that it is able to do something that its competitors can not. If Ogilvy and Mathers clients see value in the Brandprint, then Sachi & Sachi, one of Ogilvy and Mathers primary competitors, ought to be able to offer something very similar. Thus, we see that it is imitation that often prevents firms from capturing the value they created. This focus on imitation helps us to recognize the key role of time, for as time passes, imitation becomes more likely. Almost every firm that introduces a new product has that market space to itself for at least a short period of time. To do well, the firm needs to be either the only or the best organization selling a good or service for a sustained period, a period long enough to pay off the investment costs of the new development and reward the investors for risks taken. Accordingly, for business people and for those who study competition, an important concept is sustainability: How can an organization not only create value but hold on to that value, over a long period of time, in the face of competitive pressures? The issue of sustainability is clear in the cases of Kohler, Ogilvy and Mather, and JetBlue, but it is even looms in the background for a strategic decision like that taken by the Guggenheim. If it is beneficial to the Guggenheim to set up satellite museums in other locales, then it should be equally true for other art museums to do so, and the Guggenheim may soon find itself having to offer terms of trade for satellite locations that are not very favorable. Here the role of the Competitor Perspective is also clear, for it is in anticipating the actions of other players and potentially influencing those actions that organizations begin to discover which strategies have the greatest potential to sustain value capture. What prevents organizations in general from copying successful strategies? Sometimes ownership of underlying assets plays a role. The Guggenheims art collection allows it to form museum partnerships that Disney could not copy. Sometimes organizations that move early create brand loyalty that makes their strategies hard to match; Kohler may be in this position. Sometimes competitors will engage in non-market tactics to prevent an organization from capturing the value that it is trying to create. In satellite broadcast, regulatory control created by the public sector limits new entry. As we can see, a central concern for an organization is whether the competitive advantage that allows it to have a more valuable product and/or a lower cost than its rivals will be sustainable over time. This discussion allows us to articulate the second key question that we ask in considering the competitor perspective. Just as we asked about value creation, we can ask an analogous question about value capture:

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Who in my environment affects my ability to capture the value that my actions create and how do I anticipate and possibly influence their behavior?
Are value creation and capture extensible? In several of the examples we began our discussion with, the strategic moves underway involved product extensions. For Krens, the move was a geographic one: taking the museum to a new country. For Pepsi, the move was a product line shift: taking its expertise to a new type of beverage. In both cases, the organizations clearly believed that the competitive advantage they had developed in one area would translate into value creation and capture in another area. For most firms that want to grow over time, the natural aging of markets pushes managers to explore new territory. To make these moves requires a very deep understanding of the fit between the talents of the firm in its traditional business and the needs of the new market. In the area of competitive strategy, we ask in these situations whether competitive advantage is extensible. Some of the hardest managerial questions in the area of extensibility involve that of cultural fit. Most firms can see relatively easily whether the technology that they control or the assets that they own can be used in another product area. Determining whether the organizational structure, processes, and values of the firm fit with the needs of a new product line or a new geographical area is much more difficult. When the U.S. banking industry underwent significant deregulation in the 1980s and 1990s, the largest U.S. banks tried to take advantage of their scale economies to offer loans to small businesses that had traditionally been served by smaller, independent banks. However, the scale economies were contingent on the large banks adhering to formal standardized processes that were not appropriate for the nonstandardized balance sheets of these smaller businesses. If one looks at the IT consulting space, one sees a number of product-centered firms, like Microsoft, HP or Oracle, trying to enter the market for enterprise solutions, where they design and implement systemwide solutions for large corporations. If a firms values and routines are grounded in product innovation, then the firms employees may become more focused on the technology itself than on the client results that the technology is supposed to enable. They may downplay implementation issues associated with the technology, like being sensitive to metrics or information that must be continually be tracked as the client moves to the new system. In some cases, the client may lose customers or fail to conform to regulatory standards because the system provider fails to understand their needs. This is not to say that it is impossible for product-focused firms to build successful service business. Lou Gerstner is widely credited with transforming IBM from a product culture to a service culture, but the transition is not to be taken for granted. As a final example, it is worth thinking about the characteristics of a business school that make it more or less able to shift to a multidisciplinary curriculum. Size is clearly a disadvantage because it raises the coordination costs significantly. Large business schools need to devote considerable resources to coordinating behavior within groups; a teaching group for a course in a business school that admits 600 to 900 students per year will often be comprised of 5 to 10 people. It can be difficult for such a group to coordinate among itself; however, if that group then needs to coordinate with groups from other disciplines, then the coordination challenges are significantly magnified. A savvy manager is aware of how a competitors structures, processes, and values places constrains on the competitors effectiveness in a particular niche. This consideration of constraints on competitor action provides a natural segue to a more general consideration of how one anticipates and influences the behavior of those in ones environment.

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Anticipating and Influencing the Behavior of Others

Note in the approach to strategic management that we have outlined here as we have explored value creation and capture, we are not beginning by asking: Who are my competitors? Or, who are my complementors? Instead we take the position that organizations in the environment can simultaneously help create value for me and threaten my ability to capture that value. In the earlier Kohler example, American Standard might well have played a role in its advertising and product distribution in convincing consumers to re-think bathroom fixtures ( thus increasing the value creation in Kohlers own move) even as their actions made it harder for Kohler to capture value. For DaimlerChrysler, hybrid cars compete for energy-conscious customers but also help push governments to change the rules of competition in ways that help this whole category of car in their battle with other automobile manufacturers. We have begun our analysis at a more fundamental level, by focusing not on putting players in fixed roles but in tracing the way individual players whether they be other firms in the same industry, firms in different industries, government organizations, non-government organizations, suppliers, or buyers - can assist in the process of value creation and value capture. Some of these players may affect value creation and capture through market action; some of the players may affect value creation and capture through non-market behavior. More importantly, the relationships among the players are fluid. When Greenpeace mounted a campaign against Shell for disposing of an oil platform by sinking it and caused a huge public outcry in Europe against Shell, they affected Shells ability to capture some of the value that it created. While Shell was hurt by Greenpeace, BP worked with Greenpeace in a way that benefited both organizations. In making the judgment that their actions would indeed create value that the organization could in turn capture, managers at each of the eight organizations we described at the beginning of this memo, were in turn making judgments about what the other organizations in their environment would do. For Herb Kohler, the question was not only whether consumers could be convinced that bathrooms were not just utilitarian cubicles, but whether American Standard, a long time rival, would be able to jump on the luxury bandwagon if it turned out to be a profitable. If so, Kohlers profit margins on these high end fixtures would likely shrink. As it happened, brand awareness is a slow growing, long lived asset in the bathroom business. In the early 1980s American Standard and Kohler were more or less neck and neck in brand awareness measures. By 2002, after twenty or more years of targeting end users, the Kohler brand 5 awareness index was almost twice that of American Standard. In the case of the Pepsi acquisition, earlier interest by Coca-Cola in SoBe clearly played a role in building Pepsis enthusiasm for the deal. However, to make the acquisition work would also require cooperation from Pepsis traditional distributors as they moved into a new demographic segment. Daimler Chrysler was making a bet not only about the American consumer, but about the likely actions of government in energy conservation policy, and the inertia of American producers to respond. Furthermore, the company set SmartForTwos price with an eye to prices set by other auto makers on similar models. Krens was making a judgment that the Spanish government would see gains from cooperation in terms of economic development from a partnership and would help create an institutional infrastructure that would facilitate increased tourism in the area to support the museums attendance goals. In each of these cases, the wisdom of the organizations strategic moves hinged on actions of other agents, each of which had some capacity to affect either the value creation process or the value capture process. The issue of sustainability of value capture is fundamentally a dynamic question. To see if their ideas can stand the test of time requires managers to anticipate the future actions of other players, both inside the market and outside. What tools can we offer to help managers do this? Here too, a broad perspective is important. Game theory is one aid, focusing as it does on developing more formal tools for anticipating rival actions. But organizations are run by people who bring their cultural lenses and behavioral biases to the choices they make. All organizations and their leaders are prone to become inert around particular practices or decisions, and this inertia will affect what the organization will or will not do. 6 a note on the competitor perspective

A manager can also learn much about what competing organization will or wont do by looking at their incentives. Even within the relatively easy to observe mutual fund industry, we find evidence that the investment choices reflect the incentives of the individual managers in a firm.6 A recent comment by John Reed, CEO of Citigroup, speaks volumes about his view of how the individual influences strategic moves: In the old days, I would have said it was capital, history, the name of the bank. Garbageits about the guy at the top. I am very much a process person, a builder. Sandy Weil is an acquirerTotally different. Even remembering the tendency of individuals to overstate their own centrality, the comment is an interesting one. Similar comments have been made about the role that Krens business background (he has a Yale MBA) played in driving the Guggenheims expansion. A study by Scott Morton and Podolny shows that the owners of wineries personally value the quality of their wine even if they are not able to make as much money in the higher quality segments; in effect, the owners consume quality and in the process end up crowding the higher end of the quality spectrum relative to the lower quality end.7 Clearly a first step in anticipating actions is to understand the cultural, legal and organizational context in which other agents in your environment operate. This context provides insight into both motivation and constraints. Thus, as we look at both value creation and value capture, we note the centrality of context. The political infrastructure, legal rules, market dynamics and internal characteristics of the organizations we focus on all help to determine the opportunities and constraints that condition strategic choices.

Conclusion
To summarize, the competitor perspective requires the manager, first, to be aware of how her organization creates and captures value and, second, anticipate how other organizations can and will impact on the extent of that value creation and capture. Anticipating the actions of those other organizations, in turn, depends on identifying those features of the organizations and of the legal and political environment that constrain the choice set for action and then predicting the organizations best move given that restricted choice set. Exhibit 1 provides a visual summary of the Value Creation/Value Capture dynamic of an organization, identifying the key outside influence agents that affect this dynamic. The competitor perspective encourages us to focus on the players inside each of the influence boxes, understand their objectives and constraints, and forecast their behavior, recognizing the feedback loops from our own behavior to theirs. As we indicated earlier, value created comes from the difference between the willingness to pay for a good or service and the opportunity costs of its production. As we see in the exhibit, the willingness to pay is influenced most importantly by two sets of actors: the producers of substitutes and the producers of complements. In its pricing, product design, marketing, and overall differentiation strategy, the organization must take into account the inventory of substitute products and then try to mute the influence of those products. The organization must consider not only the substitutes available now, but the adaptations the producers of those substitutes may be able to make in response to its own offerings. In thinking through the value proposition for its consumers, complements also play a role. Here too, the organizations task is to understand the motives and choices and the players in this box and figure out if and how those players can be influenced. There are players that affect the cost side of the value creation piece as well. An organizations production process is inevitably and importantly influenced by the rules and customs of the society in which it is embedded. Rules govern not only the labor relations of a firm but its relationship to the environment, its access to capital and its obligations to its community. Again, the organization needs to have a fundamental understanding of the players inside this box and some sense of their own role in the evolution of rules. Finally, suppliers to the organization play a role in facilitating value creation. As 7 a note on the competitor perspective

supplier power increases, more of any value created migrates to suppliers, causing the opportunity costs of the good or service under study to rise as value moves to the value creation/capture diagram of the supplier industry. Turn now to the value capture piece of the diagram. The total amount of value that can be captured is bound by value created. As the diagram suggests, the typical organization captures only a portion of the value it creates. Some part normally goes to consumers of the new or improved good or service. As the boxes suggest, the fraction of value captured depends on the strength and actions of competitors in entering the market and thus reducing the price the organization can charge, and on the bottom side, on rivals who imitate production strategies of an organization, reducing the organizations cost advantage. Here too the organization requires an understanding of rival motives and possibilities, and an awareness of how their own actions influence the ability of rivals to reduce value capture. In Exhibit 1, we have drawn each of the boxes representing the key influence agents the same size. But these influence agents clearly play larger or smaller roles in particular industries, operating at specific times in their life cycle. Thinking about the key drivers of an industry is, in large measure, an exercise of thinking about which of the influence boxes plays the most important role at any given time. The classic exercise of analyzing the opportunities and threats of an organization similarly requires one to think about the influence agents

This note has been developed for pedagogical purposes. It is not intended to furnish primary data, serve as an endorsement of the organizations in question, or illustrate either effective or ineffective management techniques or strategies. Copyright 2007 Yale University. All rights reserved. Reprinted with permission of Yale University School of Management. To order copies of this material or to receive permission to reprint any or all of this document, please contact the Yale SOM Case Study Research Team, 135 Prospect Street, PO Box 208200, New Haven, CT 06520.

Endnotes
1

Frederic D. Wolfe Professor of Management and Entrepreneurship & Director of the Program on Social Enterprise Dean & William S. Beinecke Professor of Management

2 3

Bradley, Kim. The Deal of the Century Opening of the Guggenheim Museum Bilbao, Art in America, July 1997.

It is difficult to find the original invocation of the distinction between value capture and value creation in the study of markets. The distinction is now widespread, and it has a number of antecedents in the study of markets, such as the theory of rents (Ricardo, Sorensen) or Stiglers conception of competition. A modern treatment of value capture and creation in the Strategy field is Brandenberg and Stuart, Value Based Business Strategy, JEMS, Spring 1996, 5-24.
5 6

Information provided from the Kohler Company.

Chevalier, Judith and Ellison, Glenn, Are Some Mutual Fund Managers Better than Others? Cross-Sectional Patterns in Behavior and Performance, Journal of Finance, June, 1999. Scott Morton, Fiona, and Podolny, Joel, Love or Money? The Effects of Owner Motivation in the California Wine Industry, Journal of Industrial Economics , 50:4:431-456, 2002.

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Exhibit 1: Competitor/Complementor Pressures on Value Creation and Capture

Organizational Characteristics of Complementors

Actions of Private and Public Complementors

Willingness to Pay
Organizational Characteristics of Substitutes Actions of Producers of Substitutes

Focal Organization Characteristics

Actions of Focal Organization

Value Created

Supplier Characteristics

Supplier Actions

Opportunity Costs of Resources

Entry Decisions of Rivals

Value Captured

Organizational Characteristics of Rivals

Actions of Focal Organization

Production Decisions of Rivals

Public Rules of Production

Note: Value captured is portion of value created with the portion affected by rival entry and rival imitation of production strategies.

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