By Michael A. Roberto, D.B.A, Bryant University, and four others
Sun Tzu wrote of the importance of analyzing your enemy. This is crucial in business strategy, as well as in the military. Strong businesses put themselves in the shoes of their rivals, to anticipate how those competitors will react, and to help them plot a more effective strategy. Even iconic companies that failed to do this have lost to their competitors.
Failed Business Strategy—Netflix vs. Blockbuster
Let’s think about this in the context of Netflix and Blockbuster. Netflix entered the market in 1999, confronting the incumbent, Blockbuster. Blockbuster had a choice. How hard would they fight this new player, or would they accommodate? How did that play out in the movie-rental business? One important decision that Blockbuster confronted early on was the question of cutting late fees.
This is a transcript from the video series Critical Business Skills for Success. Watch it now, on Wondrium.
Netflix came into the market with a different pricing model: They weren’t charging per movie; they were charging a monthly subscription. Customers paid a certain fixed amount per month and rented as many movies as they wanted. Within that, they didn’t have to return each movie in a prescribed period of time. You could keep the movie for more days than Blockbuster typically allowed for their customers. But to rent more new movies, you eventually had to return what you already had. Netflix imposed a limit, but there were not traditional late fees.
Blockbuster had to decide. Would they cut late fees, which some customers disliked, to compete with Netflix? Netflix was anticipating Blockbusters’ next move. Would the video giant come after them?
It’s interesting to look at the economic motives of Blockbuster. Netflix likely did, based on my conversations with people in the industry. Blockbuster was generating at least $300 million per year in late fees in the early 2000s. In some years, that was more than the total operating profit of the entire company. They were dependent on late-fee revenue for their profitability.
In their first few years, Netflix only had a few hundred thousand subscribers to Blockbuster’s millions of customers. If Blockbuster cuts late fees, they destroy the entire profitability of the firm. But what do they gain by saving a tiny slice of market share? Ultimately, Blockbuster chose to accommodate and kept late fees in place. In their interest to preserve profitability at the time, they ceded a few 100,000 customers to Netflix, rather than try to save a bit of market share and sacrifice their revenue.
Of course, you might say that was shortsighted. What about the long run? What if Netflix starts to grow and grow rapidly? Blockbuster’s projection was that Netflix would not grow that rapidly, that it was a niche player catering to a certain subset of customers, and would never go mainstream. With that expectation, they weren’t willing to eliminate late fees to save that tiny slice of the market.
Blockbuster’s projection was that Netflix would not grow that rapidly, that it was a niche player catering to a certain subset of customers, and that it would never go mainstream.
They were wrong, of course. The decision to cut late fees came years later, after their financials began to turn. The number of customers Netflix had built up and accumulated became so large that the accommodation strategy Blockbuster instituted cost them a great deal of money. Too late, they finally cut late fees.
Learn more about when Netflix met Blockbuster
Avoid a Failing Strategy with Competition — Clorox vs. Procter & Gamble
There’s a few other principles here we can learn about competitors and how they respond to one another. One key for the incumbent is, what signal are they sending to other potential entrants by their behavior today? The focus is not what is the short-term impact on profit, but what is the long-term impact on the competitive dynamic? Do they play nice, or fight? If they fight aggressively, does it deter other entrepreneurs from coming into that market segment?
Think about what you’re trying to do as an incumbent player in these markets. What you’d love to do is take action up front to deter entry before the player even comes in, and therefore, avoid the situation of having to take a huge hit to profits later on. Could you engage in preemptive action?
Several years ago, Clorox and Procter & Gamble were in an interesting competitive situation. Procter & Gamble, maker of laundry detergents like Tide, was thinking about entering the bleach category. This was one area in the laundry detergent aisle that they did not compete in. Clorox was the dominant player. Most Americans use the word Clorox and bleach interchangeably; the brand was the product.
Procter & Gamble’s plan was to test market their new bleach in Portland, Maine. Why Portland Maine? It was far from Clorox’s headquarters in California, it was a small market, and they were all set with a couponing and sampling strategy for introducing their product to test it out.
Clorox caught wind of this. They launched a preemptive attack to deter entry by P&G. They delivered a gallon of bleach to every household in Portland, Maine.
What did Procter & Gamble do? They realized their whole sampling and couponing strategy wouldn’t do much good once every household had an extra bottle of bleach already on hand. Moreover, we just learned that Clorox is going to fight to the death in that market. It wouldn’t be an easy battle.
What did Procter & Gamble do? They realized their whole sampling and couponing strategy wouldn’t much good once every household had an extra bottle of bleach already on hand. Moreover, they learned that Clorox was going to fight to the death in that market. It wouldn’t be an easy battle. They never entered the market; they decided to forsake the bleach category. A preemptive strike that deterred entry turned out to be a very effective business strategy.
As a potential entrant, assess the competitor’s response. Think about the range of factors that might suggest aggressive moves the incumbent makes that could be harmful to you as an entrepreneur. Are you in a slow-growth market? Is this a situation where the incumbent is starving for new customers, where there is no growth, and therefore, they might fight to preserve the customers they already have?
Learn more about industry structure and competitive advantage
Economy of Scale and Failing Business Strategy
In the 1980s, NutraSweet was the dominant player in the aspartame, or artificial sweetener, market. Their biggest customers were Coke and Pepsi. In fact, Coke and Pepsi accounted for almost half of their sales worldwide. As their patents were about to expire, new businesses were looking to enter the market to compete. Holland Sweetener was one of those firms.
How would NutraSweet respond? Would they retaliate aggressively? Holland Sweetener made two big mistakes in their efforts to enter this market. The first was they didn’t fully understand how powerful NutraSweet’s cost advantage was over them.
It turns out there were huge economies of scale in the aspartame market and a substantial learning curve. The cost of producing aspartame had been falling significantly for years and NutraSweet gained more and more experience producing this good.
It was the same basic product. With no cost advantage and no differentiation, they were toast.
And as for huge economies of scale—you only needed a few factories to produce enough aspartame to serve the entire worldwide market. What did this mean for Holland Sweetener? It meant the incumbent could fight, and fight aggressively, because they could bring the price way down and still make money due to their cost advantage. Plus, Holland Sweetener had no other way of differentiating their product. It was the same basic product. With no cost advantage and no differentiation, they were toast.
If they had applied a little game theory to understand NutraSweet’s behavior with respect to Coke and Pepsi, they could have avoided their second mistake. Holland Sweetener counted on Coke and Pepsi shifting some of their volume over. They figured Coke and Pepsi didn’t want to be so dependent on NutraSweet, and that the soda companies would want to shift some of their volume, especially if offered a more attractive price.
Learn more about the battle between NutraSweet and Holland Sweetener
But Coke and Pepsi were caught in a prisoner’s dilemma, as explained by NYU Professor Adam Brandenburger. He said Coke and Pepsi were caught in a situation where it would have been in their interest to switch some volume and get a better price from Holland Sweetener, but neither wanted to move first. Each looked and said, “If we move, will our opponent attack us?” Will Pepsi say to Coke, “You’re changing an ingredient, and it’s changing the taste of your soda.” Maybe that’s not true, but would they try to argue that to the customer? And so, NutraSweet was able to retain those customers. Neither wanted to switch, and Holland Sweetener never made money in the artificial sweetener market.
Common Questions About Failed Business Strategy
Businesses can fail due to indifference from the public, a change in the market, or an inability to effectively respond to competition.
Big companies usually fail due to inadequate leadership, inability to listen to customers and give them what they want, and failure of long-term planning.
To avoid failure, businesses should not minimize their competition. In the case of Netflix, even though they were a much smaller company at the start, they still posed a legitimate threat to Blockbuster.
If your company is failing, you should go back to the drawing board and ask employees and customers for input.