Competition Demystified Chapter 6: Niche Advantages and the Dilemma of Growth Quiz

I intend to live forever – so far, so good–Steven Wright

Questions on the reading in Chapter 6

Let’s test our comprehension of the reading.

What competitive advantages does Microsoft enjoy in the operating system industry?

Why have “box makers” not been able to establish a competitive advantage over other competitors? Why was the enormous growth in the market for PCs such a problem for Compaq specifically? Did it have any alternatives that might have worked out better than its chosen strategy? Did Apple?

4 responses to “Competition Demystified Chapter 6: Niche Advantages and the Dilemma of Growth Quiz

  1. MSFT had a mix of economies of scale and customer captivity. The economies of scale is obvious since they most of the cost goes into the software and there are no variable costs after that. Customer captivity came from user’s wanting compatibility. Even if MSFT was second or third in operating system quality, the fact that every user was already using windows and office made it undesirable to change.
    I forgot the compaq discusion in the book so I’ll try to answer that later.

  2. Customers were captive due to the strong network effects of the os market. The more users an os has, the greater value it has for application makers (more potential customers); the more applications an os has, the more valuable it is (e.g. iOS vs bb7). This virtuous cycle leads to Networks that ‘tip’ to a single dominant provider. VHS vs beta, blu ray vs hd-DVD, etc.

  3. In contrast to the os market, the box market is a commodity market. The dominant players tend to be companies who have some unique income statement or balance sheet advantage (low cost provider, supply chain dominance, negative working capital, strongest balance sheet, etc) relative to their competitors. But as the market has low barriers to entry (unlike the os market which has high switching costs and thus very steep barriers to entry) the pricing power that a dominant os provider has doesn’t extend to the dominant box seller.

  4. Answer to post on 2-7-2012
    Microsoft: Operating system industry

    What competitive advantages does MSFT benefit from in the operating system industry?

    Supply? Privileged access to crucial inputs? No. Technological advantage? Patents and copy rights, Perhaps.
    Demand? Customer captivity based on habit? Not really. Switching costs? Yes. MSFT benefits from the network effect. They have essentially become the platform OS. Most computer users are trained on a MSFT OS and therefore are comfortable using it. Microsoft has gained a large scale (many users) and as the number of users of the product increased, the value of the product increased to the users. This is the definition of network effect demand advantages. Search costs? Not really. There are other competitors products that can be purchased easily. Microsoft has over 90% share of the OS market (very dominant market position). Most corporations and users would need to be trained on a different OS, which would take time, money and lost productivity for a while. So the benefits of a better operating system would have to be very large and outweigh the costs.

    Economies of scale + customer captivity? Yes. MSFT enjoys 90%+ share of the OS market. This high level of market share combined with network effect demand advantages creates a very strong franchise. Economies of scale are defined as fixed costs per unit declining as unit volume increases. MSFT can spread its fixed R&D and advertising costs over many units. Therefore, it is operating lower on its average cost curve than a potential entrant. THIS is a structural competitive advantage. A competitor would need to introduce a product much better than MSFT AND take market share away. Due to the power of the network effect, this would be very difficult.

    Note: You would need to see the advantages in the numbers over two prior market cycles. This would bake in enough conservative assumptions as well as your own conservatism. You MUST LOOK AT THE NUMBERS FIRST to determine if there’s even any advantages.
    Why have box makers not been able to establish a competitive advantage over other competitors?

    Box makers do not have any supply or demand advantages, or do they? Cost, proprietary technology, privileged access to crucial inputs, experience? All the box makers do (their business) is to assemble the parts into a box. So they wouldn’t have any proprietary parts that go into the box. Note that Gateway did try to vertically integrate. This strategy (of selling products that are reliable for a premium) worked for a while. As technological progress increased, firms began to specialize in the production of the component parts, thus becoming more efficient and perhaps gaining scale advantages in the development of a specific product niche. A company can be run more efficiently for a period of time (i.e. Dell). Dell built product to order vs. carrying inventory and retail strategy, had negative working capital. Were Dell’s high returns (did they have high returns?) sustainable? Did the company benefit from any structural competitive advantages? Dell’s business model was different that competitors. Competitors would need to retool their businesses and this is not a short-term project. In the long-run, competitors can copy Dell’s business model and they have.
    Why was the enormous growth in the market for PCs a problem for Gateway specifically.

    For a period of time, Gateway focused on selling premium products to corporate customers (niche part of the PC industry). Gateway was able to gain EOS advantages with perhaps some very limited customer captivity. We know that growth in a market is not good for companies that benefit from EOS. Why? A company that benefits from EOS + CC is operating lower on its average cost curve. EOS are based on fixed costs relative to the size of the specific market (product or geographic). As the size of the market grows, potential entrants can take a slice of the demand, increasing their output and lowering their average cost position (fixed costs begin to decline). If the market grows large enough, more firms will enter and the spread between the dominant firms lower average costs over entrants will narrow and perhaps be eliminated completely. Compaq’s EOS advantage was eventually eroded away as vertical integration ended up increasing their cost structure relative to more efficient competitors—in the long run. Companies began to specialize in niche aspects of manufacturing the component parts for PCs, and perhaps they gained some EOS advantages there. The technology improved so much that Compaq’s that competitors were offering machines just as good, if not better than Compaq at lower prices. Growth allowed competitors to enter the market and eventually take enough share away from Compaq so as to erode their advantages.
    Did it have an alternative that might have worked better than its chosen strategy?

    Yes, the company did realize that its prices were too high at one point in the 1990s when they were having trouble selling inventory. Note: If a company tries to sell its products, can’t, then cuts its prices 30% and STILL can’t sell, they may have a problem!! Its strategy should have been to operate as efficiently and effectively as possible (since it was a box maker and would not benefit from any structural competitive advantages in the long run). The company tried this strategy and it worked (as the numbers showed). Then management lost sight of their purpose and goals and went on an acquisition binge and the company finally sold itself to HP.

    Did Apple?
    I’ll need to think about that one a bit more.

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