Strategic discontinuities: when being good may not be enough - strategic business planning

Business Horizons, July-August, 1990 by Henry H. Beam

Strategic Discontinuities: When Being Good May Not Be Enough

A decade ago few would have predicted that by 1990 Apple, Compaq, and Microsoft would be the success stories of the computer industry, not IBM. Similarly, few would have thought that Sears, the world's largest retailer for over half a century, would be struggling for survival while two relative newcomers, Kmart and Wal-Mart, would be on their way to overtaking Sears. Yet that is exactly what has happened.

Sears and IBM are classic examples of what happens when a successful firm is confronted by a strategic discontinuity, a special type of challenge to corporate strategy that can render a successful strategy ineffective. It occurs when a firm is faced with a competitor that has found a better way to provide the same goods or services, usually using a different way to compete.

WAYS TO COMPETE

There are three basic ways to compete: on the basis of delivery (including convenience), quality (including service), or price. Commodities and undifferentiated products (beer, gasoline, sugar) tend to sell on the basis of price. Brand name products (automobiles, clothing, food) sell on the basis of perceived quality and the promise of the manufacturer to stand behind the product. IBM and Caterpillar (construction machinery) are legendary for providing support for their customers worldwide. Advertising can be used to make an inherently undifferentiated product into a brand name, such as Coca-Cola soft drinks, Heinz ketchup, or Morton salt. Delivery becomes important when the customer wants the product right away (fast food, instant printing) and does not mind paying a premium price for the prompt service. McDonald's is known the world over for its quick service, and has sold over 70 billion hamburgers as a result.

Profit margins, or return on sales, are closely related to the basis of competition used. When an item is a commodity, profit margins are low (less than 3 percent) and profitability is attained through high volume, as at self-serve gas stations or grocery stores. When an item has brand name associated with it, acceptable profitability can be attained with medium margins (3 to 8 percent) and medium volume. This is particularly true of products that undergo periodic model changes or product improvement, such as automobiles, pharmaceutical products, or television sets. Advertising is used extensively to convince the customer that he or she is buying a Buick or a Taurus, not merely basic transportation. Convenience items (snack foods, Post-it note pads) are usually sold in small amounts so the customer does not mind paying a premium price. Here high margins compensate for low volume. This is also true of large, one-of-a-kind projects (the space shuttle, new buildings) where on-time completion according to specifications is often more important than price.

Figure 1 shows a nine-cell matrix dawn with profit margins on the vertical axis and volume on the horizontal axis. The three basic ways to compete - delivery/convenience, quality/service, and price - and their associated normal profit margins plot along the diagonal from upper left to lower right. The product of profit margin and volume in each of these positions provides adequate levels of profitability to sustain a business. Most firms that have been successful for many years fall naturally into one of these three positions.

The three cells beneath the diagonal line in Figure 1 should be avoided. They represent situations where profitability is too low to sustain a business. The brokerage industry and the air transport industry (both now deregulated) fall into the low-margin/medium-volume cell. Volume can be gained by reducing prices (price wars), but overall profitability is still unsatisfactory. Profit margins in the air transport industry as a whole averaged less than 1 percent from 1984 to 1989, a dismal performance. Many small businesses fail because they are unable to break out of the low-volume/low-profit cell, the worst of all situations.

GAINING TEMPORARY ADVANTAGE

Figure 1 also shows how desirable it would be to compete at a point above the diagonal, since this would result in increased profitability, either through increased margins, increased volume, or both. Two of America's most successful companies, Sears and IBM, found ways to do that for sustained periods of time. But both struggled throughout the 1980s to maintain their leadership positions.

Sears

Long the dominant American retailing firm, Sears could have chosen to compete almost exclusively on price years ago. It forsook this option for one it perceived to be more profitable: put the Sears brand name on its products, advertise that brand name, and charge a higher price. Sears used this strategy to develop a large base of loyal customers who associated the Sears brand name with value in everything from screwdrivers to shirts. Sears sought to maintain the medium margins associated with brand name merchandise and still develop the high volume usually associated with items that sell primarily on the basis of price. For more than 50 years Sears was very successful in competing at the position to the right of the diagonal line shown in Figure 2. Its average profit margins of 5 percent were about 50 percent higher than the industry average.