Tag Archives: Competition Demystified

Analysis of Chapter 15 in Competition Demystified: Cooperation

Finally back to work on our study of Competition Demystified: http://wp.me/p1PgpH-Oa

For easier reading here is the PDF:Chapter 15 Cooperation the Dos and Do Nots

Chapter 15: Cooperation: The Dos and Don’ts in Competition Demystified


Describe the “virtuous circle” that Nintendo enjoyed when it dominated the 8-bit games market.

Note: An excellent history of Nintendo and the gaming industry can be found in the book, Game Over: Nintendo’s Battle to Dominate an Industry by David Scheff (Paperback 1993)

The main goal for this chapter is to understand the importance of how industry participants interact and cooperate (or the lack thereof).

What Nintendo had working in its favor was the virtuous circle of network externalities. Once the Nintendo system had established a substantial installed base, more outside software companies wanted to write games for it, which make the console more popular, meaning even more games, and on and on. The virtuous circle extended to retailers as well as game writers. Because retailers were reluctant to carry competing consoles and games, customers could find Nintendo, a great marketing organization, established displays in 10,000 outlets where customers could try out the system and the games. Having dedicated real estate within a retail store is every manufacturer’s dream. Retailers, on the other hand, are generally reluctant to cede control over their primary asset: selling space. As a result, dedicated retail space is only made available to dominant manufacturers. Controlling this space reinforces their dominance, and so on.

What were the major reasons Nintendo’s position as market leader deteriorated?

Despite all these benefits that reinforced its position, including the fact that the efficient configuration for this industry mandated a single console supplier, Nintendo was still vulnerable. Its virtuous circle rested on two advantages that turned out to be less solid than Nintendo assumed. One was the enormous installed base of Nintendo’s console; the other was the cooperative relationship between Nintendo, the game writers, and the retailers.

The first advantage would be wiped out by each new generation of technology. As the chips advanced from 8- to 16-, 32-, 64- 128-, and even 2456-bit processors, the graphical quality and power of the new machine would render the old systems and games obsolete. Nintendo’s installed base of 8-bit machines would not be attractive to either the game writers or the retailers, who sold games primarily of the new systems.

The second advantage, its relationships up and down stream, might then tide Nintendo over until it had built up a dominant installed base of new generation systems, but only provided that the writers and the stores felt they had mutually beneficial relationships with Nintendo. Game writers would then reserve their best next generation games for the introduction of Nintendo systems, and stores would continue to provide Nintendo with unequaled store space. But if Nintendo had bullied these constituencies and grabbed a disproportionate share of industry profits, leaving the writers and retailers waiting for the opportunity to escape Nintendo’s grip, the opposite would happen. The best new generation games would be retained for Nintendo’s grip, and then the opposite would happen. The best new generation games would be retained for Nintendo’s competitors, who would be welcomed by the retailers with shelf space rivaling Nintendo.

Nintendo went from a company with a dominant position in an industry and a high return on capital to one competitor among many with at best ordinary returns on investment, in large part because it did not play well with others. It claimed so much of the industry profit for itself that both developers and retailers were ready to support new consoler markers. Nintendo did not play well with others. It did not share industry returns fairly which eventually cost the company its competitive advantage. If Nintendo had been willing to share the benefits of this organization with the game writers and the retailers, there was no inherent reason why the strategy should not have survived several generations of technology.

Ethyl Corporation

In the lead additive market, what were the four or five major reasons the competitors maintained high profits despite a continually shrinking market?

This case illustrates intelligent cooperation amongst incumbents who maintained exceptional profitability despite the industry’s product was a commodity, demand was guaranteed (based on EPS regulations and pollution) to decline rapidly, there was overcapacity, and there was outside pressure from government agencies and public interest groups.

The managers of companies producing the lead-based additives used to boost octane ratings of gasoline (reduce knocking) were able to work together and share the wealth.

In 1974 there were Ethyl, Dupont, PPG and Nalco who produced around 1 billion pounds of these chemical compounds.  Prospects changed in 1973, when the Environmental Protection Agency issued regulations intended to implement parts of the Clean Air Act of 1970. The regulations were intended to phase out the use of lead-based additives over time.  All new cars starting in 1975 had to be sold with catalytic converters designed to reduce harmful exhaust omission from automobiles but lead based gasoline couldn’t be used with the converters.  The market shrunk to 200 million pounds the year later (1983), and to almost nothing by 1996.

The Structure of the Lead Additive Industry

A small number of chemical companies bought raw materials, especially lead, processed them into two different additives, tetraethyl lead (“TEL”) and tetramethyl lead (“TML”), and sold them to gasoline refiners.

Raw materials accounted for most of the costs of production. All the producers needed to buy lead.  There were no patents. The organization of production into small number of plants—never more than seven—to supply the whole industry suggest that there may have been some economies of scale. But the large plants did not drive out the small ones, indicating that scale economies were limited. And without some customer captivity, economies of scale in themselves do not create a sustained competitive advantage.

However the EPA’s regulatory announcement in 1973 created an insurmountable barrier to entry to protect the four incumbents. What entrant would want to enter a dying business whose product would inevitably become extinct.

By putting the industry on a certain path to extinction, the EPA ensured that the existing firms would have the business to themselves, to profit as best they could during the slow path to disappearance.

Cooperation among Friends

Most of the methods the lead additive producers used were checks on themselves, to make it more difficult to give customers discounts or otherwise to deviate from established prices:

  1. Uniform pricing: by including cost of delivery in the quoted price3, the suppliers prevented themselves from offering a hidden discount with a lower deliver charge.
  2. Advance notice of price changes: when one supplier wanted to change—raise-the list price of the additive, the contracts called for it to give its customers thirty days’ notice, during which time they could order more supply at the existing price.
  3. Most favored nation pricing: this policy assured every customer that it was getting the best price available. It placed suppliers into a strait-jacket, preventing them from offering any special discount to a particular customer on the grounds that they would have to give the same break to everyone.
  4. Joint sourcing and 5. producing: an order placed with one supplier’s plant, depending on location, availability of chemicals, and other practical consideration, like relative productivity. The four manufacturers maintained a settlement system among themselves, netting out all the shipments made for one another and paying only the balances.

Dupont had the largest capacity but trailed Ethyl in production. The two had comparable sales volume. Ethyl brewed more additive than it sold, supplying some of Dupont’s and also PPG’s customers. Joint sourcing eliminated much of the cost differential among the suppliers, who could all take advantage of Ethyl’s efficiency. Taking cost out of the equation removed whatever incentive the low-cost producer might have to gain market share at the expense of the other three firms and minimized overall industry costs and market shares among the four producers was stable.

The stability of market share of sales coupled with joint sourcing led to an unusual rationality in capacity management. Since high cost plants tended to operate at low capacity under joint sourcing they were the plants most likely to be shuttered an overall demand declined. Joint sourcing created an incentive structure that both eliminated excess capacity and closed the least-efficient plants first.  The net result was a strategy to manage capacity in order to minimize overall industry costs.

Even though Ethyl was largely a reseller of chemical made elsewhere, between 1994 and 1996, the additives accounted for 23 percent of the company’s total sales and 63 percent of its profits.  In 1998, after its additive revenues had declined to $117 million, it still made $51 million in operating profits, a 44 percent return.  The rest of the company had operating margins of 11 percent.

Joint producing: the stability of market share of sales coupled with joint sourcing led to an unusual rationality in capacity management.

Christie’s and Sotheby’s Unsuccessful Cooperation

In contrast, the last part of the chapter illustrates Christie’s and Sotheby’s unsuccessful cooperation.

These art auction house which together shared some 90% to 95% of the high-end auction market, should have been able to benefit from economies of scale and significant customer captivity.  Smaller and newer auction houses had made no inroads into their market share for many years. The key to success was restraint on competition which required that they stay out of each other’s way.

With geography an unwieldy knife with which to slice the pie, field specialization—product market niches—remained the obvious choice by which to divide the business. Each auction house could have concentrated on particular periods and types of art.  They could also have selected specialties from the broad range of other objects offered for sale, like antique Persian carpets, jewelry, and clocks and barometric measuring devices from the age of Louis XIV.

If Sotheby’s had become the palace to go for eighteenth century French painting and decorative arts, and Christie’s had emerged as the dominant firm for color field abstraction, then sellers would have had to choose an auction house on the basis of what they were trying to sell. A further advantage of such specialization would have been a significant reduction in overall overhead costs, since substantial duplication of effort would have been eliminated.

The contrast between the histories of Nintendo and the auction houses on the one hand, and the lead-based gasoline additive industry on the other clearly points up the benefits of effective cooperation among firms just as it clearly points up the benefits of effective cooperation among firms. Just as clearly, it underscores the perils of inexpert cooperation that crosses the legality line. A well-formulated strategy will not immediately or solely look to salvation through cooperation. But the story of the lead-based additive industry demonstrates how useful a cooperative perspective can be under the right conditions. The optimum situation is an industry where several firms coexist within well-established barriers.

Updated Links for Competition Demystified and Ethyl Corp (Robotti)

I highly recommend that you go to the links below to read the PDF of this book. But the PDF lacks many of the graphs and tables so essential to the book. The point is to help you with the cases while you order the book–highly recommended–only about $11 to $15. One of the best books on analyzing businesses that I have stumbled upon. Ironically, the book never became popular like Good to Great and other Pop Management books.  Go here for the PDF of the book: Competition_Demystified__A_


For a book review and link to Amazon’s reviews go here:



Robotti’s Investment Thesis of Ethyl Corporation

Yesterday, the case on Ethyl Corporation was provided http://wp.me/p1PgpH-J3. This is a case on managing a declining business (Lead-based Gasoline became outlawed). For more understanding and background I added an investor’s perspective on Ethyl here: Robotti Mention of Ethyl (See page 25)

The above article also has good analysis of Spin-offs. An excellent read. Thanks to a reader’s heads up!

Case Study Analysis of Kiwi Airlines Entry Strategy

Kiwi Airline Case Study

This is an important case for learning about successful and unsuccessful entry strategies.

The Kiwi Case Study was provided:Kiwi Airlines CS

The analysis is here:Chapter 12

On to Kodak Takes on Polaroid (Chapter 13 in Competition Demystified).

Analysis of Fox News: A Fox in the Henhouse-Entry Strategies

Chase after money and security and your heart will never unclench. Care about other people’s approval and you will be their prisoner. Do your own work, then step back. The only path to serenity. Lao Tzu

Fox News Entry Strategy

Questions on Chapter 10 in Competition Demystified and the HBR Case Study of Fox’s Strategy were posted: http://wp.me/p1PgpH-AK

As a review, this case is important to study for how a company enters under barriers to entry. If you can find such a company in the early stages of building a competitive advantage, you can earn huge returns as an investor. It ain’t easy, but one way to start is to study this case. Also, instructive in how incumbents respond. For those who don’t have a digital copy of the book, you can email me at aldridge56@aol.com and write (ONLY) BOOK in the subject line. I will email you the PDF within 24 hours. The PDF lacks the graphs and tables but has the text. I suggest you splurge on the $12 to $13 with shipping for a second-hand book through www.Amazon.com.

My write-up of the case is here:Fox News Case Study on Entry Strategies Chapter 10 of Comp Demyst

Note the subtleties of Murdoch’s entry moves.

Coke and Pepsi’s Uncivil Cola Wars-Case Study Analysis

Money is better than poverty, if only for financial reasons–Woody Allen

Besides understanding economies of scale, the next area you need to master is understanding the prisoner’s dilemma and how companies coexist or compete within barriers to entry.

The case readings were presented here:http://wp.me/p1PgpH-yl

Remember that if the links do not work, then the materials are in a folder in the VALUE VAULT. Simply email Aldridge56@aol.com and request a key.


The case study discussion in a PDF because of financial tables. Go here: http://www.yousendit.com/download/M3BsM25ITmFsMHhESjlVag

 Pepsi and Coke’s Uncivil Wars

Chapter 9 in Competition Demystified: Uncivil Cola Wars: Coke and Pepsi Confront the Prisoner’s Dilemma

What are the sources of competitive advantages in the soda industry?

First we should look at industry structure. The cola companies buy raw materials of sugar, sweeteners and flavorings from many suppliers then they turn the commodities into a branded product which consists of syrup/concentrated combined with water and bottles. The companies are joined at the hip with their bottlers/distributors who then sell to many retail outlets.  Selling bulky and heavy beverages lends itself to regional economies of scale advantages.

The soda companies cannot operate successfully unless their bottlers and distributors are profitable and content whether company-owned or franchised.

The existence of barriers to entry indicates that the incumbents enjoy competitive advantages that potential entrants cannot match. In the soft drink world, the sources of these advantages are easy to identify. First, on the demand side, there is the kind of customer loyalty that network executives, beer brewers and car manufacturers only dream about. People who drink sodas drink them frequently (habit formation), and they relish a constancy of experience that keeps them ordering the same brand, no matter the circumstances.

Both Coke and Pepsi exhibit the presence of barriers to entry and competitive advantage—stable *ROE can be influenced by whether bottlers’ assets are off or on the balance sheet

Second, there are large economies of scale in the soda business both at the concentrate maker and bottler levels. Developing new products and advertising existing ones are fixed costs, unrelated to the number of cases sold. Equally important, the distribution of soda to the consumer benefits from regional scale economies. The more customers there are in a given region, the more economical the distribution. A bottler of Coke, selling the product to 40% to 50% of the soda drinkers in the market area, is going to have lower costs than someone peddling Dr. Pepper to 5% to 56% of the drinkers.

During the “statesmen” era of Pepsi and Coke, what actions did each of the companies take? Why did they help raise profitability?

Note the stability of market share and ROE. ROE dipped in 1980 and 1982 as Pepsi and Coke waged a price war. Yet, market shares did not change as a result of the price war—both companies were worse off. Pepsi gained market share in the late 1970s versus Coke. Coke was slow and clumsy to respond.

Price wars between two elephants in an industry with barriers to entry tend to flatten a lot of grass and make customers happy. They hardly ever result in a dead elephant. Still, there are better and worse ways of initiating a price contest. Coke chose the worst. Coke chose to lower concentrate prices on those regions where its share of the cola market was high (80%) and Pepsi’s low (20 percent). This tactic ensured that for every dollar of revenue Pepsi gave up, Coke would surrender four dollars.

Coke luckily developed New Coke which allowed it to attack Pepsi in its dominant markets in a precise way—minimizing damage to Coke’s profits–and force a truce in the price wars.

They made visible moves to signal the other side that they intended to cooperate. Coca-Cola initiated the new era with a major corporate reorganization. After buying up many of the bottlers and reorganizing the bottler network, it spun off 51% of the company owned bottlers to shareholders in a new entity, Coca-Cola Enterprises, and it loaded up on debt for this corporation. With so much debt to service, Coca-Cola Enterprises had to concentrate on the tangible requirements of cash flow rather than the chimera of gaining great hunks of market share from Pepsi. PepsiCo responded by dropping the Pepsi Challenge, toning down its aggressive advertising and thus signaling that it accepted the truce. Profit margins improved. Operating profit margins went from 10% to 20% for Coca-Cola. Pepsi gain was less dramatic but also substantial.

Both companies focused on ROE rather than market share and sales growth.

The urge to grow, to hammer competitors and drive them out of business, or at least reduce their market share by a meaningful amount, had been a continual source of poor performance for companies that do have competitive advantages and a franchise, but are not content with it.

Chapter 7: Production Advantages Lost, Part 3

All products become toasters in the end

Part 2: http://wp.me/p1PgpH-tC

Part 3: Explain the statement, “No matter how complex and unique products seem at the start, in the long run they are all toasters.”

Though they differ from one to another in functional and design features, one toaster is pretty much like another. But with no barriers to entry here, it is unreasonable to assume that any manufacturer is earning an exceptional return on its toaster assets.

How different is a complicated and expensive piece of network equipment—a router, smart hub, or Lan switch—from a toaster? Initially very different, but ultimately, not so different at all. The success of Cisco in its original business attracted new entrants, most of whom could not put a dent in Cisco’s performance without extensive technical and maintenance support. They were not sophisticated enough to mix and match communication equipment the way families do with household appliances.  Also, the need to develop successive new generations of software and hardware makes fixed costs a permanently large part of total costs, and they are a source of economies of scale. (In contrast, in CD manufacturing, plant, and equipment were a once-and-for-all expense. Economies of scale topped at a two million discs per year plant.) All these factors created competitive advantages for Cisco, and put up barriers to entry in its enterprise-class business.

But it seems clear that those advantages diminish over time. Equipment becomes more reliable and easier to use. Support and service costs decline. Compatibility across company product lines increases as equipment functions become standardized. Research and development costs decline as product lines mature. Customers become more confident in their use of equipment and more willing to try new, lower cost suppliers. Some of these changes have already affected Cisco. The trends identified above will ultimately eliminate Cisco’s competitive advantages entirely.

Technological change can be the enemy of the investor.

Our next study will be Chapter 8 in Competition Demystified.

Chapter 7: Production Advantages Lost Part 2

Part 1: http://wp.me/p1PgpH-ta and the original post on the case study is here: http://wp.me/p1PgpH-r2

Logan James, a huge contributor to this blog, continues his analysis….

Question 2: Why was Cisco able to dominate the router market in the 1980s and 1990s in a way that Philips was not in the compact disc market?

Answer: Cisco’s router and switch products were much more complex than Philips’s compact discs. Cisco’s customers, in the beginning, were businesses, government agencies and universities. These institutions required initial setup of router and switch networks as well as continual service to make sure that the networks were up and functioning properly. If you’re a business that runs a network, imagine what it would be like if your network went down and business essentially stopped? Who would you call? Probably Cisco first. You would also view Cisco as the expert in the router/switch markets and would rely on their advice in regards to servicing the network. If you want to upgrade your network equipment, they’re probably getting the first call. So you have captive customers combined with some economies of scale (maybe in R&D, advertising, manufacturing). Note: Would need to check to see if these advantages show up in the numbers.

Philips sold compact discs, which are not complex. The company was the first mover, like Cisco, but did not benefit from any competitive advantages. Why would a recording studio be captive to one maker of compact discs unless that company had patents protecting its products for a period of time? The purchaser of the CD does not care which company makes the CD, they just want the music. Note that Philips initially targeted a niche part of the music market but planned to take share away from vinyl records in the future.

Note that growth can harm companies that benefit from EOS + CC because it is easier for competitors to enter the market, take demand and achieve minimum efficient scale. Two examples where this did not occur are MSFT and CSCO.

My comments below are repetitive to Logan James but may reinforce concepts pertinent to this case.

Cisco managed to create competitive advantages for itself, which became stronger as its business grew. The advantages of economies of scale never became important for Philips because the CD market was large relevant to the efficient plant size of two million discs per year. Cisco, by contrast, because of the high software content and attendant high fixed costs for its routers, enjoyed economies of scale advantages. It managed this advantage brilliantly.

Cisco prospered by solving a problem that was widely shared. By removing the language barriers between computer systems, Cisco made networking throughout the enterprise a reality. A company that makes life much better for its customers gets handsomely rewarded, provided it can separate itself from competitors offering similar benefits.

Cisco’s market had two elements missing from the CD market–substantial customer captivity and economies of scale. Routers are sophisticated pieces of equipment, a complex fusion of hardware and software. A high level of technological expertise was required to install and maintain the systems, an expertise not widely available except for those customers with large and skilled IT departments. The others relied on Cisco or its competitors (3Com and Wellfeet). As they expanded their own internal networks, they naturally turned first to the vendor whose equipment they already owned, not wanting to incur the risks and costs of developing a relationship with a new supplier. This asymmetry of familiarity was abetted by another feature of routers that made it difficult for customers to switch: the routers themselves were not compatible. Customers were made captive by complexity.

Cisco’s pre-tax return on invested capital during 1990-2000 was 142%!

Cisco moved into the new market of telecommunications service providers. As an entrant into this market, Cisco was without the critical competitive advantages it enjoyed in the enterprise market. It has no captive customers; so far as established customer relationships are concerned, it was the outsider looking in. Without this kind of customer base, Cisco had no economies of scale in distribution or service support. Because Cisco was working on new products for new customers, it had no economies of scale advantages in research and development either.
Part 3: Next Post.

Analysis of Ch. 7 on Production Advantages Lost Part 1

 A reader, Logan, provided a thorough, intelligent analysis of the case study of Philips and Cisco (first mentioned here: http://wp.me/p1PgpH-sL) from Chapter Seven in Competition Demystified below. My comments are in Italics. Please do not hesitate to add your comments if you have additional insights.Question 1: Discuss first mover conditions that Philips might have considered in entering the compact disc and compact disc player markets. Consider: market growth, establishment of standards specs, patents, customer captivity, economies of scale.


First mover conditions:

Will Philips be able to have any sustainable/structural competitive advantages in this industry? Will we be able to develop and maintain any structural competitive advantages? If so, which ones? Proprietary technology? Patents/trademarks? Learning/experience? Demand? Economies of scale + Customer captivity? How sustainable will these advantages be? What will we be able to do in the long run that competitors cannot do?

The market for compact discs could be very large in the future. How large? In several years, perhaps 200 million units will be sold. Will growth in the market be good or bad for Philips? That depends on whether the company will have any structural competitive advantages and how sustainable those advantages are.

Supply: Philips will have no long-term supply based competitive advantages. There are NO patents protecting the CD technology (since it was developed at MIT in the 1950s). We are to assume that any competitors with available funds will enter the market and replicate the technology if they choose. One potential advantage Philips might have is an experience based advantage from being the first mover. We should try to quantify this.

Where was Philips going to make its money in the CD market? None of the record companies like CBS/Sony paid a royalty to Philips for its technology. Quite the opposite, Philips and Sony had to persuade them to take up the new product; they were not about to reduce their returns for the favor. No patents protected the technology. And the large record companies were the only players in the whole industry who were concentrated enough to wield some bargaining power. Philips was NOT in a position to coerce them. 

Perhaps it could prosper as a manufacturers of CDs. As the first mover into the field, might Philips been able to take advantage of its earlier start down the learning curve, producing the discs at a much lower variable cost than companies just beginning to learn the intricacies of achieving high yields by keeping contamination to a minimum. Although experience did help in raising yields and lowered variable costs, it was offset by the disadvantage of being the first to invest in a production line. Here, costs were lower for the latecomer, who did not have to pay the penalty for taking the lead.

The balance between these two forces would depend on how rapidly the market for CDs developed. On balance, then, Philips could expect to benefit from an initial learning curve advantage over new entrants. However, as an entrant gained experience and moved down the learning curve, this advantage would start to shrink and would disappear entirely once the entrant had procured a cumulative volume of 50 million discs. Because it was using later-generation equipment, its capital costs would be lower than Philips’s.

Demand: Demand for the new CD technology is dependent on the acceptance of the new format by the 5 major recording studios. In order for the technology to be a success, a few studios will need to adopt the format and cause the others to follow suit. Will the recording studios be captive to one supplier of CD technology? Habit? No. Switching/Search costs? No. The recording studios are essentially purchasing a commodity product and are not captive to one particular manufacturer of CDs. If Philips is the only game in town, the studios will be forced to use them. Since we know that there are no patents protecting the CD technology, entrants will flood the market (if they can) and at best they will compete based on price and “product differentiation.”

It will cost $25 million and take 18 months to build the first manufacturing line with a capacity of 2 million units. Internal projections show that the costs of equipment and time to manufacture new facilities will decline in the future. Therefore, entrants will have an advantage over the incumbents with older manufacturing facilities. Will higher volume offset the disadvantage of using older technology? In 3 years’ time, it is projected that Philips could be selling 10 million units. Variable cost per CD will be roughly $1.77 vs. $3.00 for an entrant in the 0-5 million unit output range. This is an advantage of $1.23. Using the older equipment, Philips fixed costs per unit at 20% cost of capital and 10 year depreciation will be $2.50 vs. $1.12 for a spread disadvantage of $1.38 per CD. Therefore, higher unit volume will be more than offset by the more efficient and productive new facilities.

Questions: What are the fixed costs relative to the size of the market? Can Philips focus on a niche? If so, which niche? What is the minimum efficient scale? Will competitors take customers and market share away from our company? Why would a recording studio use our products and not potential entrants?

Plants can be efficiently operated at a scale of 2 million units. Given that demand is projected to reach 200 million in the next several years, companies will enter the market since customer captivity is very limited. In order to reach minimum variable costs per unit, a competitor would need to reach 50 million units per year. If Philips could enter the market and CREATE customer captivity, it could potentially control a large enough share of the market to make entrance by competitors prohibitive. But we have observed that customer captivity is going to be VERY limited.

How will the establishment of standards specs impact the industry? If you develop the standard that everyone decides to use AND you have some structural competitive advantage (supply, demand, or EOS+CC) then you can benefit from being the company that manufactures the standard (think MSFT). If competitors can copy the standard and you do not have captive customers or patents, you will be competing on a semi-level playing field (you might have some advantages in terms of know how). Since you are first mover and create a new product, you can benefit in the short-term potentially from learning and experience. Over time, competitors will gain the knowledge and experience (do it themselves or hire your people away) so as to make this advantage dissipate. Question: Apple has created several product categories. In the long-run, how do you assess whether Apple can continue to create new products and that competitors will not catch up?

If the CD market exploded to 200 million or more units per year, then at least some new entrants could rapidly reach a cumulative output of 50 million. It is unlikely that Philips would benefit from customer captivity, since its important customers were the large, sophisticated and powerful major record companies. Thus, Philips ‘s cost advantage would last for less than two years. Paradoxically, the only condition that might sustain Philips’s learning curve would be a SLOWLY growing CD market, so that it would take years before competitors could reach the 50 million cumulative milestones and complete their passage down the learning curve.

From this perspective, the problem with the market for discs was not that it would be too small; it would be TOO LARGE. Even if it had a head start, Philips was not going to sustain an advantage based on being first mover for more than a few years. Unless it achieved some measure of customer captivity, there was no reason to think that Philips could keep current customers from taking their business elsewhere. And since plants could be efficiently operated at a scale of only 2 million discs per year, economies of scale in production would both be a deterrent to entry. Without captive customers., durable production advantages, or relative economies of scale, Philips would benefit from no competitive advantages as a producer of CDs.

It might have been better off if CDs had been restricted to a niche market in which it would have had the field to itself for perhaps five to seven years. During this interim period, it might have been able to earn above average returns, maybe enough to compensate it for its initial development expense.

In the CD market, Philips never had the kind of honeymoon that Cisco enjoyed. It never established customer captivity; its customers were large and sophisticated, and its product did not require significant support. It also never benefited from economies of scale. Distribution and service support for raw, unrecorded CDs accounted for a tiny share of the costs, and while the original development costs may have been high, continuing R&D expenditures were negligible. Learning curve related advantages, Philips’s only remaining hope of competitive advantage, were undermined by the rapid growth CD market, which allowed its competitors also to move quickly down the experience curve. Philips confronted a world without competitive advantage–a “toaster” world.


Part 2 Tomorrow


I will post my answers at the end of this week to the Philips Electronics case study mentioned here: http://wp.me/p1PgpH-r2. Readers feel free to post your analysis.



This blog is slowly being reorganized. This weekend I will post the answers to the questions posed for Chapter 6 in Competition Demystified. Readers have already posted excellent analysis. The readers here far surpass the “professor.”

I will write-up study questions for the funeral case studies. If you don’t have those cases simply email: aldridge56@aol.com with FUNERAL HOMES in the subject line.

And finally, I will have new cases for Chapter 7 and 8 in Competition Demystified next week.  We must move forward.

WHY we study Strategic Logic

Valuation formula:  Earnings next year/(Cost of Capital – Perpetual Growth Rate) = Intrinsic Value.   Or $1 in earnings/(10% – 5%) = $20.00

It takes two minutes to learn how to use the formula but a lifetime to know what to plug into the formula.