Your business is steaming ahead. Vision, hard work, and a focus on quality of service have put you in the driver's seat in a mature market. And then, after years of success, technological disruption upends your operating model.
What to do with your mature organization when competition emerges along dimensions outside of your heretofore successful operation?
This is a classic question faced by many organizations over time. In the early '80s, one answer was enshrined in the now-famous book “The Innovator’s Dilemma” (TID). Now part of the MBA canon, the book made clear that innovations entail necessary destruction of existing market and enterprise practices. So-called “creative destruction,” like controlled demolition of aging buildings for new construction, clears a path for new approaches and increased value.
TID goes on to highlight the difficulty of engaging in creative destruction within a large, long-standing organization, particularly one competing in a mature market. It’s far easier for the startup standing in an empty field, free from the detailed processes and elaborate culture that allow competitive differentiation to build something new. Startups can focus their destructive energies on external structures, while going concerns have to attack the edifice they’re standing in.
Be that as it may, incumbents have only two choices: compete, or lay down arms and exit. TID suggests that incumbents should create teams that work, succeed, and fail like independent startups. This is a reasonable work-around that captures the advantages of startup flexibility, and sector incumbency.
By all means, therefore, it is a strategy to consider carefully.
However, in the case of a highly commoditized market in which a sector incumbent is competing on service and process, this may not be the only or even the best option.
To understand if it is or not, a firm needs to know explicitly and with zealous dedication how it is competing.
Let’s Talk About Tap Water
You’re thirsty. Standing in your kitchen, you are faced with a choice: Take a glass and fill it at your faucet for one penny (as billed by your water company), or pay me a dollar to let you fill it at my faucet.
Assuming no informational asymmetries, you would sagely ignore my offer.
Now, same starting conditions, but instead of your dollar getting you access to the same water you could get for a penny when you pay me, I will deliver the water to you in your living room, wait while you indulge, retrieve the empty glass, wash it, and clean up the kitchen.
Perhaps you’d agree this time, but you would do so not for the water, whose commoditized value you understand, but for the kitchen service and cleaning.
My second offering distinguishes a commoditized product through service quality. With my highly trained and dedicated team, I capture a chunk of the water business.
Let's take this a step further: My water business is humming along, when a Stanford undergrad CS student announces insta-water! A product that allows the user to teleport water from her phone directly into her mouth, ice cold, for 50 cents per 8 oz.
Faced with this competition, does it make sense for me to pour resources into a teleportation and Apple iOS development team? Maybe. But my dedicated team of kitchen scrubbers is ill-equipped to build apps, something that would be instantly clear if I understood that my offering is not water, but service.
Differentiation: The Freshmaker
It’s a familiar cycle: as a market matures, an offering progresses from unique product to commodity. Over time, advantages erode, products face commoditization and profits are squeezed.
Faced with these market conditions, producers may seek new ways to differentiate their product, often through quality of service. Competing on service is easier said than done. It requires alignment of mission, culture, and team.
In this vision for success in commoditized competition, operations can be considered a value-added step, which transforms the original offering. The commoditized product thus becomes an input to a service offering.
To put that a little differently, when a firm differentiates a commodity through service, the firm is in the service business, not the commodity business.
The Wisdom of No
This is a cycle we have seen repeatedly in the entertainment industry. As the means of production have become more accessible through technology, the capex intensive legacy businesses have confronted commoditization of their core offerings.
Post-production houses faced this over the last decade as a glut of houses crowded the market. The boom of post-production resources led to underutilization of equipment. The response from many enterprising professionals was to move up the value chain, to invest their resources into content ownership.
Unfortunately, this didn’t work out well for most companies.
The computing needed for post-production had become a commodity, but the move to compete in a part of the value chain with only marginal synergies did nothing to improve these firms’ competitive positions. Rather than differentiating the commodity, these firms tried to win at a notoriously difficult business (content), in which they had little expertise.
As if, in the water example, they had jumped from water delivery and service to plumbing. Not completely unrelated, but ill-fitting to their organization and the value their firms had to exploit.
What few firms do in these situations is say no. The fallacy of sunk costs and the attractiveness of the business segment often obscure the truth of the economic situation: if a firm cannot differentiate a commodity, the wise choice is to exit the market.
Interestingly, the same clouded reasoning is often applied in reverse, particularly in entertainment. Firms enter a commoditized market as the prices drop, only to discover that they have no way to compete.
Organizations are human endeavors, and therefore they often defy cold logic. So, as a manager and a leader, your first opportunity to differentiate is within yourself. Say no if the situation demands it.