Surviving Business’s Least Understood Competitive Upheavals Assignment.
Two of the most intense competitive wars in modern business history are being waged simultaneously today — both centered in the United States, but already spreading to Europe and beyond. General Motors and Ford, once global leaders in automobile manufacturing but now unprofitable and losing market share, seem helpless to defend their home markets against intruders like Toyota and Nissan. Among airlines, household names like United and US Airways have been driven into bankruptcy by intruders once viewed as niche carriers, such as Southwest Airlines. In both cases, struggling incumbents offer the same explanations: weakened industry demand, excessive labor costs, legacy pension
obligations, and rising oil prices. Surviving Business’s Least Understood Competitive Upheavals Assignment.
But these standard explanations are misleading. In the 1990s, incumbents like GM, Ford, United, and US
Air (now US Airways) were already losing market share and money whenever they faced the intruders directly.
Only rising markets elsewhere kept them profitable.
Today, even if their employment costs were equalized, their pension obligations were lifted, and crude oil prices returned to $28 per barrel, they would still have higher costs and lower quality than their new competitors.
The real explanation is format invasion. Every business has a format — its own distinctive way of organizing the many activities involved in delivering its product or service. Incumbents suffer (as GM, Ford, United, and
US Airways have suffered) when intruders enter their markets wielding new types of business formats. These
new ways of assembling commonplace assets deliver familiar goods and services at massively lower cost, often 20 to 40 percent lower, while maintaining or improving quality. The traditional market leaders fail to recognize
the power and potential of their competitors’ new for-
mats. They cling instead to their old familiar formats,
and gradually but inevitably lose ground to the new ones. Surviving Business’s Least Understood Competitive Upheavals Assignment.
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Some business observers credit technological innovation as being the most critical factor in transforming
an industry. But successful new formats do not rely on
new or proprietary technology. Indeed, incumbents
often have broader and deeper technological capabilities
than intruders. Instead, new formats achieve their massive cost advantage by changing several of the business’s main functions at once, often reaching backward to include suppliers or forward to include distributors.
These changes are tightly interlinked: The new format “works” only when it’s adopted as a whole, which makes
the transition to a new format daunting for incumbents.
Other observers equate market development and
growth with a “killer app” — a new feature or hit product,
like the Chrysler minivan,
the Apple iPod, or Pfizer’s
Viagra. Hence the frenetic
chase for the new feature
or hit product that will
open the wallets of an
existing market segment or
galvanize a new one. But a new business format has little to do with innovative features
or technological novelty. Rather,
massively lower cost is the killer app in many markets —
as companies as diverse as Dell, Inditex (Zara) apparel,
Countrywide Financial, Nucor, Wal-Mart, and Charles
Schwab, as well as Toyota and Southwest Airlines, have
shown. Toyota’s lean manufacturing methods, which
ruthlessly eliminated the waste in its production systems, led to costs far below those of the Big Three
Detroit automakers. Southwest’s point-to-point format
for air travel vastly reduced the ground and flight costs
inherent in the “hub-and-spoke” format of the airline
industry’s established leaders. In recent decades, intruders wielding new business formats have trounced traditional incumbents across a wide range of industries:
personal-computer manufacturing, car care, mortgage
lending, stock brokerage, steel, and many varieties of
retailing, from groceries to books to gasoline. Surviving Business’s Least Understood Competitive Upheavals Assignment.
An effective format invasion throws open for question the prevailing operating assumptions of an industry.
Consider, for example, two recent format invasions in
the European gasoline retail sector. The predominant
format for the past several decades was the large, self-
service gas station combined with a convenience store,
which had supplanted the older format of small, full-
service gas stations with repair bays. Jet, now a sub-
sidiary of ConocoPhillips, has entered the Scandinavian
market with a wholly new format: a completely un-
attended gas station. Effectively, it is a giant vending
machine. By eliminating the station manager, cashiers,
and other support costs, the new stations require only
half as much margin per liter of gas to earn an attractive
return. They can offer an almost unbeatable combination of low prices and convenient locations.
Meanwhile, in the United
Kingdom and France, grocery
chains have initiated a different
kind of format invasion in the
same sector, moving aggressively
into gasoline, leveraging their
existing stores and infrastructure to sell gasoline at much
lower costs and prices. Gasoline is just one more product for a grocery chain, whose entire motor fuel department need be only a handful of people, compared with the hundreds employed by the old- format oil companies to support similar market share levels. Surviving Business’s Least Understood Competitive Upheavals Assignment.
Both new formats are coming to the United States. Grocers, general merchandisers, and warehouse clubs have all begun offering gasoline, many of them using unattended operations like Jet’s. They now serve about 10 percent of the U.S. national gasoline market, and much more in some markets, notably Texas. It remains unclear which variant of these new formats will win, with the answer likely varying by local market. But one thing seems clear: The traditional format is losing, and will continue to lose.
It may seem remarkable that this pattern recurs so
often. Yet that’s the reality of format invasions. Highly
sophisticated incumbent companies, with years of experience and strong market positions, ignore and resist a
new format’s opportunities to reduce cost, while upstart new entrants embrace and exploit them. Intruders wielding new business formats in just this way have shattered
traditional competitors across a wide swath of industries,
in countries ranging from the United States to France to
Japan. As a result, companies championing new business
formats are among the largest creators of shareholder
value. Conversely, incumbent companies’ failure to
respond effectively accounts for a great deal of share-
holder value destruction. (See Exhibit 1.)
The pattern continues. New format invasions seem
to be occurring now in industries as diverse as fashion
apparel, commercial aircraft, and wireless communica-
tions. And (investors, take note) we see many established
companies responding to format invasions with the
same tactics that have failed other incumbents before.
But there is good news for executives of established
companies. Format invasions are not overnight suc-
cesses; there is time to respond. And incumbents need
not be losers. Established companies in large industries
— armed as they are with substantial assets, intellectual
capital, and customer relationships — can defeat the
invasions and emerge as winners, if they recognize:
• Where new formats come from
• How new formats take over a market
• Why incumbent companies so often fail to
respond to new formats
• How to take advantage of a new format.
Birth: Reconceiving Costs
Over time, an industry’s prevailing format becomes a
victim of its own accomplishments. The quest within
one company to earn a premium or bring down costs in
targeted activities succeeds — and is then copied across
the industry. Competitors may become less distinct, in
both features and performance, and the category com-
moditizes. Growth may slow, but the industry can carry
on in a state of equilibrium for quite a long time.
Then an innovative new format appears. One day,
somebody reexamines the activities common across the
industry and discovers or develops a completely new
way of performing them. Quite often, this new pattern
involves a focus on activities that the industry’s leading
companies had not noticed, much less singled out for
attention. But by focusing on these overlooked factors,
the innovator finds ways to configure or reconfigure the
company’s assets, people, and processes to greatly reduce
the activities’ costs.
Southwest Airlines provides a famous contempo-
rary example. Once in the air, Southwest is no more effi-
cient than its traditional competitors. But Southwest
was the first airline to focus its institutional attention on
the least interesting part of aviation: the time an airplane
sits at the gate. By dramatically reducing that turn-
around time and ruthlessly applying the same logic to
all its operations, Southwest developed a 40 percent or
greater cost advantage that its old-format competitors
seem helpless to meet. (See “Airline Invasions:
‘Barbarians’ at the Gates,” page 9.)
For a not-so-famous example, take Inditex, the
European apparel maker best known for its major brand,
Zara. In the mid-1990s, European fashion apparel was
dominated by specialty brands that put out new lines of
clothing each season, hoping to catch the eye of trend-
conscious consumers. These firms were on a relentless
treadmill, designing, sourcing, and distributing product
for each season on an eight- to 12-month cycle.
Although this was highly profitable if a firm’s seasonal
offering “hit the market” — selling a good proportion of
product at full retail price — such good seasons were
invariably interspersed with weaker ones, when much of
Bertrand Shelton
(shelton_bert@bah.com) is a
vice president in Booz Allen
Hamilton’s San Francisco
office. He has advised leading
petroleum, financial-services,
aerospace, and consumer
goods companies in North
America, Europe, and Japan.
He focuses on helping com-
panies facing market disconti-
nuities, such as format
invasions, technology shifts,
and deregulation.
Thomas Hansson
(hansson_tom@bah.com) is a
vice president in Booz Allen
Hamilton’s Los Angeles office.
He focuses on new business
development, growth, mergers
and acquisitions, and pricing
issues for a variety of corpo-
rate sectors, and has written
extensively on new operating
models and business formats
in the global airline industry.
Nicholas Hodson
(hodson_nicholas@bah.com)
is a vice president with Booz
Allen Hamilton in San
Francisco. He has advised
companies in Europe and the
United States in the retailing,
fashion apparel, petroleum,
wireless, and aerospace indus-
tries on issues including
organization design, strategy-
based transformation, and the product sold only at heavy markdowns. Since all
players had essentially identical business formats, they
competed to reduce manufacturing costs by sourcing
from China, India, and other low-cost locales. Surviving Business’s Least Understood Competitive Upheavals Assignment.
Zara took a wholly different approach. Management realized that the biggest cost in fashion apparel is
not in production and distribution (fabric, cutting,
stitching, shipping, etc.) but in the margin forgone in
marked-down sales of unpopular product. As a result,
Zara created a business format capable of delivering a
design from sketch to shelf in six weeks or less, allowing
its designers and merchants to observe trends and
respond rapidly, rather than making educated guesses
about what customers might want eight months in the
future. This approach has its costs: Zara’s manufacturing
facilities are located in relatively high-cost Spain. Surviving Business’s Least Understood Competitive Upheavals Assignment.
However, Zara sells around 80 percent of its product at
full price, twice the percentage most competitors
achieve. Confident that its product portfolio is mostly
“hits,” Zara can price its product profitably at about
25 percent less than competing brands. The resulting
extraordinary sales volumes have generated very attractive returns, fueling rapid expansion.
New formats often migrate; they jump across
categories, customer segments, and geographies. Sam
Walton borrowed Wal-Mart’s supercenter concept —
general merchandise plus food — from France’s hyper-
markets. Toys “R” Us transported the self-serve super-
market from groceries to toys. Southwest Airlines start-
ed in 1971 as an intrastate airline in Texas. Surviving Business’s Least Understood Competitive Upheavals Assignment.Only in the
last 10 to 15 years did Southwest break out from being
a short-haul regional player to become a national force
— and only within the past five to 10 years have airlines
such as Ryanair and JetBlue successfully carried the
Southwest format into markets without a similar point-
to-point competitor.
Takeover: Capturing Demand
Time and time again, intruders in a wide variety of
industries around the world have used the same tactics
successfully to invade and take over existing markets.
Invasions typically occur in four stages:
Exhibit 1: Shareholder Return for New-Format Intruders vs. Old-Format Incumbents
60%
50%
40%
30%
20%
10%
0%
–10%
Source B oz Allen Hamilton; CompuStat
C p d d P t p A
B thl h
N
C p q
D ll
Ci it City
B t B y
A i
S th t
L
H D p t
P i W bb
Ch l S h b
teel
985–199
rsonal
om ters
991–2001
nsumer
ectron cs
994–2004
Airl nes
994–2004
me
Improvement
982–199
Reta
ro ra
987–1997
The shareholder impact of format invasion. Each pair of format battle contenders contrasts an incumbent on the left bar with an
intruder on the right, during the peak decade of conflict in that industry.
Stage I — Equilibrium. At the outset, incumbent-
format firms serve their entire market. These firms play
by variations on the same business rules, using largely
the same approaches to product design, production, and
marketing. Of course, each has its own slight distinctions in features, amenities, and pricing, and one or
another company may tweak those to gain a temporary
advantage. Surviving Business’s Least Understood Competitive Upheavals Assignment.But these aren’t decisive, since each player
quickly imitates the others’ worthwhile improvements.
This period can last for decades. U.S. supermarkets
replaced neighborhood stores as the main purveyors of
groceries in the 1950s. They lived in quiet equilibrium
until Wal-Mart and the warehouse clubs finally invaded
their markets with new formats in the 1990s.
Stage II — Intrusion. Most markets
have a considerable amount of price-
sensitive demand hanging around —
both customers willing to change
suppliers for a discount (“penny
switchers”) and noncustomers willing
to start buying if prices fall low enough.
For a new-format intruder, these customers represent a very attractive startup
market. They don’t value “frills”; they
prefer a bare-bones offering at a lower
price, and they don’t have much loyalty
to incumbent brands. So the intruder tailors its initial offering to
their preferences, stripping out amenities that the new format could otherwise
provide, to reduce costs still further. Surviving Business’s Least Understood Competitive Upheavals Assignment.
Capturing these customers requires a careful pricing
strategy. They don’t look just for a good price, but for
the absolute best price, gravitating elsewhere if the price
goes even modestly higher. A successful intruder exploits
this pattern, translating its cost advantage into prices
at the very bottom of the market. These prices attract
customers in extraordinary volume that more than com-
pensates for the margin lost in the discount. Thus, a
relatively low price, near the market bottom, is not as
profitable as the lowest price at the market bottom. In
the early stages of invasion, this phenomenon works to
the advantage of the lowest-cost intruders.
At the same time, even price-sensitive customers
know the difference between “bare bones” and “shoddy.”
They’re naturally suspicious that a below-market price
reflects inferior product quality or poor service. So a typical successful intruder works hard to build and maintain a reputation for candor, no-frills quality, reliability,
and excellent customer service. It secures its relationship
with customers through the openness of its menu and
the clarity of its choices. The tendency of a new format
to improve its product’s quality and consistency helps
establish that reputation.
Stage III — Expansion. The extraordinary profits
that flow from the new format’s huge cost advantage
nurture rapid expansion: double-digit growth at margins
hitherto unheard of in the industry. Format innovations
aren’t usually patentable technologies, so additional
entrants soon emerge, imitating the new format. They
would naturally prefer to compete against the old-format
players than to compete against one another, so these
imitators target market segments — customers, products, or geographies —
into which the new format hasn’t
yet penetrated. A free-for-all
ensues, as the new-format intruders race to occupy as much
market “space” as they can.
Old-format incumbents may
try to meet the intruders’ low prices.
But that seldom lasts long, since the incumbents labor under two disadvantages: the
significantly higher costs inherent in the old
format, and the broader amenity set they
have customarily offered. So they typically
redefine their target market upward, forsaking
the price-driven customers now flocking to
the intruders. There is a tempting but ultimately
shortsighted rationale for abandoning these customers:
Many of them are new to the category, “so we never
actually lost them.” Surviving Business’s Least Understood Competitive Upheavals Assignment.
Retreating up-market relieves the incumbents’
immediate pressures, but only postpones the problem.
As the new format proliferates, it further erodes the old-
format players’ business, draining away their volume and
depressing their prices. Their financial returns deterio-
rate, and investment in the old format gradually ceases.
The recent flurry of activity among European air-
lines nicely illustrates this expansion phase. Ryanair,
easyJet, and a plethora of other new-format competitors
have piled into the European air-travel market. They
expanded far more rapidly than their acknowledged
model, Southwest, did in the U.S., precisely because the
U.S. example demonstrated how much potential the
new format has.
The intensifying financial pressures on old-format
European carriers already have eliminated some
(Swissair, Sabena) and encouraged others to merge
(KLM with Air France). Yet some of these incumbents
remain convinced that the new-format upstarts are “for
backpackers, not for businesspeople” and “cannot
extend into long-haul markets” — as one executive at a
traditional European airline told us quite recently.
Stage IV — Consolidation. The new-format players
continue to expand, broadening their target market
beyond price-sensitive customers. Adding amenities
without giving up the new format’s cost advantages
becomes their next challenge; if they surmount it, they
become very attractive to mainstream customers.
As the mainstream fills up with new-format players,
competition among them pushes prices down toward
the new format’s long-run level, reducing their margins
to more “normal” levels. At that point, the remaining
traditional-format players must crumble, or retreat into
minor niches. Surviving Business’s Least Understood Competitive Upheavals Assignment.Meanwhile, the toughening environment
gradually forces the new-format players to switch their
attention from expansion to grinding competition
among themselves — through incremental efficiencies,
differentiated amenities, or intensified sales campaigns
— with better performers acquiring weaker ones. Even-
tually, equilibrium is reestablished and the new business
format dominates the market.
Incumbents: Misperceiving the Threat
We have found no cases in which an incumbent
responded to a new business format successfully without
essentially adopting it. It’s true that many incumbents
survive for quite some time in the face of a format inva-
sion; they prune product lines, retrench operations, and
scale back investment (if only because the business is
generating less cash than it previously did). But none
prosper over the long run unless they adopt the new for-
mat. No economically sound alternative seems to exist.
Why do incumbents so consistently fail to recognize
this, and let the intruders take away their markets?
Two classic misperceptions lie behind this common
development. First, incumbents often mistakenly
ascribe the new format’s cost advantage to better factor
prices, such as lower wages and benefits for employees or
lower prices paid to suppliers. That explanation, despite
being attractively straightforward, misses the central
point — that the new format uses fewer resources, rather
than merely paying less for those it uses.
This misperception sets incumbents on a path of
fruitless confrontation with unions and suppliers. They
reason that if their competitors got better factor prices, it
was because they themselves hadn’t been “tough” enough.
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Automakers, supermarkets (under pressure from Wal-
Mart), and traditional airlines provide ready examples of
old-format players distracted by these confrontations.
Second, incumbents often confuse the intruders
with “value” or “budget” companies. In their view, the
“value” company is making a niche play, appealing
to the most price-conscious customers in its market. Surviving Business’s Least Understood Competitive Upheavals Assignment.
A “value” make of automobile is smaller, with a less-
powerful engine and fewer extra features than a main-
stream car, and thus carries a lower price tag. Similarly,
a “value” department store offers no-frills products and
fewer services and amenities than a mainstream store in
the same market, at a lower price point. But these
“value” companies rely on the same traditional business
format as their mainstream competitors: They all face
the same menu of trade-offs between amenities and
price. The “value” companies just make different choices
from that menu — choices attuned to the price-conscious customers they’ve tar-
geted. These traditional-format
“value” competitors don’t threat-
en the market’s mainstream tra-
ditional companies.
In contrast, new-format
companies create a different and
better menu for themselves by
operating in strikingly new ways
that slice out slabs of cost. (See
Exhibit 2.) The new format can
deliver either a high or low level
of features and amenities less
expensively than the old format.
Format invaders thus represent a
long-term threat to the main-
stream traditional companies in
the sector, unlike other companies that merely pitch their
offerings at the “value” end of the market. Surviving Business’s Least Understood Competitive Upheavals Assignment.
This misperception fatally weakens the incumbents’ efforts
to counter the new-format intruders at each stage in the cycle. Surviving Business’s Least Understood Competitive Upheavals Assignment.Early on, seeing the
intruders as simple “value” companies, the incumbents
may try competing head-to-head against them with a “value” offering of their own, providing lower features and amenities at a lower price, but still based on the old format. Examples include General Motors’ Vega, an early (1970s) response to low-end import cars, and the lower-priced “value” subsidiaries of mainstream airlines.
Of course, the incumbents’ “value” offerings can’t truly meet the intruders’ pricing head-to-head: Their
cost disadvantage forces them to seek some premium above the intruders’ price. But that misses the central point of the intruders’ entry tactics — that price-sensitive customers respond to prices at the market bottom,
not near it. Near-bottom pricing causes the incumbents
to give up margin without commanding much volume.
So the incumbents’ “value” offerings quickly fail.
Later, the same misperception leads incumbents to believe they can retreat up-market safely, since they believe the new-format intruders can’t follow. But in fact, the intruders have no such limitation — their new format can combine high features or amenities with low
costs. Toyota’s lean business format produces the top-
of-the-line Lexus as well as the entry-level Corolla.
Similarly, Target and Wal-Mart use the same extraordi-
narily efficient business format; Target has merely cho-
sen to focus it on customers and merchandise that are
farther upscale than Wal-Mart’s.
Conversely, incumbents often reject the notion of
adopting the new format on the grounds that doing so
would require abandoning their up-market feature and
amenity offering, and thus cause an unthinkable revenue loss. They fail to see a major opportunity: that the
company can combine high features and amenities with the
new format’s low costs. There is a realistic opportunity, for
instance, for a traditional airline to continue providing
high levels of service while adopting Southwest’s more
efficient production model. (In Exhibit 2, the traditional airline could move down the dotted line to the
new format with mainstream features.)
This confusion also seems to underlie Harvard
Business School Professor Clayton Christensen’s well-
known views on format competition. Professor
Christensen argues that innovative products and business formats (or “value networks,” as he calls them)
begin life underperforming the requirements of a market’s core customers. Later, as the intruder’s performance
Exhibit 2: Strategic Options for Old and New Formats
So ce Booz Allen Ham on
Low FEATURE/AMEN TY LEVEL High
COST LEVEL Low High
Traditional orma ’s
ade-off ne “menu”)
New orma ’s t ade-off
ne “menu”)
New format with
mainstream featu es
Entry point
Mainstream
Incumbent
Intruder
Value/budget. Surviving Business’s Least Understood Competitive Upheavals Assignment.
A format battlefield, showing costs and feature options for two competing companies (such
as United or Continental versus Southwest or JetBlue). The old-format incumbent is typically
found in the high-cost/amenity quadrant, at upper right, and may provide a less expensive
“value/budget” offering (Shuttle-by-United or CalLite). But the new-format intruder will
always have lower costs. Incumbents can adopt their own version of the new format (the
dotted oval), with mainstream features that the intruder may not have introduced.
features strategy & competition improves, it gains the ability to enter the incumbents’
core markets. Whatever the merits of this view with
respect to technological innovations such as improved
disk drives, it does not apply to new business formats.
The choice of business format and the choice of amenity level are largely independent of each other. Most
format innovations indeed appear at the low end of the
market, but this is only because that represents the simplest and most expedient route for the intruder to monetize its innovation.
When a new-format intruder offers more features
and amenities than its traditional competitors do, they
will not necessarily be the same mix. The new format
makes some amenities easier and some harder to
provide, so the intruders do what any seller would do:
accentuate their advantages. Airline passengers, for
example, may wait a bit longer for connecting flights on
Southwest, but they get nonstop flights more frequently.
Retail customers may drive a bit
farther to shop at a “big box”
store, but they can choose
from a broader variety of
goods. In any case, these
differences tend to be mod-
est; the new format’s lower
costs and prices swamp any differences in its amenity mix.
Late in the cycle, as new-for-
mat intruders take ever more
market share, the increasingly
strapped incumbents often start to merge. From one
perspective, these mergers appear inevitable and beneficial: Old-format companies face a contracting market,
which simply cannot support as many of them as it did
before (even if the overall market remains robust). However, the traditional companies often expect more from this kind of industry consolidation than it can provide.
Too often, they view consolidation as a real fix, rather than seeing it correctly as another step in their decline.
This is because they view their collective overcapacity as the problem, rather than recognizing it as a symptom of the format invasion. Surviving Business’s Least Understood Competitive Upheavals Assignment.
The Incumbent’s Opportunity
Some incumbents have responded successfully to a format invasion. When they do, the results are extraordinarily profitable. We’ve looked at several companies that
took on a format invasion successfully, and at several
others that more or less tried but failed. Nothing we’ve
seen indicates that the companies that made a successful
transition to a new format had any greater depth of technical, financial, or operational resources than the peers
they left behind. Nor did we find
that they had “less to lose” by
giving up the old format.
But the winners adhered to a
few basic principles, while
avoiding some clear pitfalls.
The experience of Best
Buy and Circuit City over the
past decade comes close to being a controlled experiment on this point. At the
outset, nothing about Best Buy’s market position or format distinguished it from Circuit
City. If anything, Circuit City had more resources with which to innovate. But Best Buy identified and acted upon an opportunity where Circuit City did not.
Best Buy’s low-cost, self-service
electronics retail format, prompted by a tornado,
was an unexpected wild success. Surviving Business’s Least Understood Competitive Upheavals Assignment.
strategy+business issue 40
In 1980, Circuit City was a rapidly growing electronics retailer, with a better format than traditional TV
dealers. Customers viewed floor samples, made their selection — usually with help from a commissioned salesperson — and paid for the merchandise. They then took their receipt to a separate pick-up window, near the store exit, to collect their purchases. Many other retailers copied this format, including a small but successful
electronics chain named Sound of Music, based near
Minneapolis.
Then, in 1981, a Sound of Music store in Roseville,
Minn., was hit by a tornado, forcing managers to hold a
clearance sale with the inventory stacked on the sales
floor. It was an unexpectedly wild success. Through this
random event, company founder Richard Schulze discovered that a discount, no-frills, self-serve value proposition could be both very attractive to customers and
very profitable for the company. After a couple of years
of experimentation, Mr. Schulze opened his first ware-
house-style, truly self-serve superstore in 1983, changing
the company’s name to Best Buy at the same time. The
following year Mr. Schulze, sensing his new format’s cost
advantage over the incumbent leader, Circuit City (still
thriving at that time), committed his company to a
“won’t be undersold” pricing policy. Mr. Schulze continued to adjust the new format during the next few years;
in 1989, he launched a “grab and go” store, with salaried
rather than commissioned salespeople. Surviving Business’s Least Understood Competitive Upheavals Assignment.
Between 1994 and 2004, Best Buy gradually
eclipsed Circuit City — earning a compound total
shareholder return of 28 percent per year while Circuit
City managed just 8 percent (despite a rapidly expand-
ing market for consumer electronics). Circuit City lost
market leadership in the sector beginning in 1997, but
continues to follow its old format strategy. By now, it’s a
troubled company.
Companies that successfully survive a format inva-
sion seem to have four common attributes:
1. Successful incumbents start with a clear and accu-
rate vision of how the new format works for their competi-
tors — how it serves customers adequately at much lower
cost. Undeniably, that’s hard work. A new format focuses
on unfamiliar aspects of the business; an accurate vision
must grasp what that new focus is. But the new format
Airline Invasions: “Barbarians” at the Gates
One of today’s harshest format inva-
sions is roiling the airline business. An
alternative business format — low-
cost carriers with a point-to-point
production model, exemplified by
Southwest, Ryanair, and JetBlue — is
challenging the traditional “hub-and-
spoke” format of incumbents. The
challengers have designed their oper-
ations around the relatively simple
requirements of moving passengers
directly from one city to another. The
hub-and-spoke incumbents, in con-
trast, are configured to provide effec-
tive passenger connections and to
maximize revenue from their net-
works. The challengers build volume
through price-led market stimulation
of their point-to-point routes, creating
passenger connections as a by-prod-
uct. The incumbents build volume by
offering synchronized services “from
anywhere to everywhere.” Surviving Business’s Least Understood Competitive Upheavals Assignment.
The cost differences are huge: The
challengers have a 40 to 50 percent
cost advantage, a result of 20 to 30
percent higher utilization of aircraft
and crew, more than twice the ground
personnel productivity, and less than
half the overhead cost per enplaned
passenger. Critically, this is not the
result of unionization or differences
in pay scales. Southwest Airlines, for
example, is unionized; with stock
options and benefits factored in, it
pays its employees more than many of
the U.S. hub-and-spoke carriers.
Neither can the cost differences be
attributed to bare-bones and low-
quality service. Although challengers
like Southwest and Ryanair began by
attracting price-sensitive customers
traveling short distances, they have
steadily extended their service offer-
ings. They now feature longer flights,
connections for passengers and bag-
gage, and better on-board services
(JetBlue has 24-channel TV screens
for each passenger). As a result, chal-
lengers have doubled their share of
U.S. domestic passengers, to 30 per-
cent today from 15 percent in 1992.
(European discounters are rapidly
moving along the same path.)
In his book Seeing What’s Next:
Using the Theories of Innovation to
Predict Industry Change (Harvard
Business School Press, 2004), Clayton
Christensen questions the ability of
these new-format airlines to replace
the hub-and-spoke incumbents. While
conceding that low barriers to entry
make them a continual threat to
incumbents’ profitability, he adds,
“Because there is not asymmetric
motivation, disruptive discounters differs from the traditional format in so many ways —
spread across so many parts of the business yet knitted
so closely together — that it’s hard to see. The successful companies don’t just assemble a factual, detailed view
of the new format; they fit those details into a realistic
overall picture.
2. Successful incumbents undertake the new format as
an integrated whole, recognizing its tightly interlinked
nature. Too often, incumbents experiment halfheartedly
with imitating a new format, layering bits and pieces of
it onto their existing business. They modify just one ele-
ment of their traditional business at a time, or they make
a modification but don’t pursue its implications through
the rest of the business. Few companies have an appetite
for making a flying leap to a whole new operating model
— which is another way of explaining why so few
incumbents make the transition to a new format. But
the alternative — piecemeal adoption — just won’t pro-
duce results. Surviving Business’s Least Understood Competitive Upheavals Assignment.
ORDER A CUSTOM-WRITTEN, PLAGIARISM-FREE PAPER HERE
3. Successful incumbents adapt the new format in ways
that don’t compromise its cost advantages. They provide a
basic-level offer that meets the intruders’ bottom-level
prices profitably at the basic amenity level. This reclaims
the bottom-of-market volume that they would other-
wise forfeit to the new-format competitor. To this, they
may add products or services with more features or
amenities than the intruder has yet offered. They resist
the temptation to blend the new format with the tradi-
tional format — an approach usually justified as “we’re
doing it, but our way.” That approach rarely succeeds.
After all, the new format moved away from the old to
achieve some specific objectives; it’s hard to move back
without compromising them. These blends often fritter
away much of the new format’s cost advantage without
any decisive offsetting gain in customer appeal.
4. Successful incumbents make the new format their
core business, not a side offering. Assuming that a competitor’s new format has already proved itself in the
marketplace, execution is needed. Launching a side experiment signals that management sees the new format
as a niche offering, with no bridge to changing the core
business. It’s easy for an organization to get excited at the
outset about an experiment and invest a lot of energy in
it (“Finally, we are actually doing something about the
unlikely to transform the industry.”
But we see a different pattern emerging. Having capitalized on the recent
cyclical downturn in airline travel to
gain market share, the challengers
are permanently changing the pricing
level in the industry, and are poised to
become the dominant format. Today,
some 80 percent of U.S. domestic passenger trips occur between cities that
can comfortably support nonstop
service. For the traditional hub-and-
spoke airlines, there is no place left
to hide.
The incumbents have responded by
cutting costs, increasing efficiency,
and adapting selected elements of
the low-cost carrier model, such as
“smoothing out” (more effectively
scheduling arrivals and departures) at
hubs. They have also created smaller
“airlines within airlines,” such as
Shuttle-by-United (and, recently, Ted),
Continental’s CalLite, and US Airways’
MetroJet. However, their costs are too
high to allow them to compete in the
low-fare market, because they retain
significant elements of the hub-and-
spoke business format. Overall, the
incumbents’ countermeasures have
had little effect, because their basic
business format — the fundamental
cause of their cost disadvantage —
remains largely unchanged. Surviving Business’s Least Understood Competitive Upheavals Assignment.
The only viable strategy for the
major hub-and-spoke airlines is to
adopt the essential elements of the
point-to-point production model as
quickly as possible. This does not
mean eliminating first-class service,
on-board food, frequent-flyer lounges,
or even connections. In fact, reducing
service levels might well be counter-
productive, as the challengers will
gradually add these service features
without losing their fundamental
cost advantage. Instead, it means
adopting the challengers’ scheduling
approaches and ground-operations
concepts, and simplifying overhead
structures accordingly, reflecting the
fact that the vast majority of passen-
gers really only want to travel between
points A and B. This will involve mas-
sive transformation programs — com-
pletely redesigning how operations
are carried out and displacing tens of
thousand of workers. The new format,
however, could save the larger incum-
bents billions per year in costs and
allow them to compete effectively in
the new equilibrium that will emerge
as the new business format replaces
the old one. Surviving Business’s Least Understood Competitive Upheavals Assignment.
—B.S., T.H., N.H.
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strategy+business issue 40
new format threat”), but it’s ultimately ineffectual.
The story of the Home Depot format invasion of
the 1980s, and the response by Lowe’s Companies Inc.
in the 1990s, shows how an incumbent company can
come successfully to terms with a new format. Traditionally, Lowe’s sold construction materials, mainly to
professional homebuilders, through an extensive chain
of small full-service outlets. In 1982, Home Depot
introduced “big box” retailing in a “home improvement
center” format: a much larger store (90,000 square feet
versus 15,000 for a Lowe’s outlet) with dramatically
lower unit operating costs, due mainly to the labor savings from scale and self-service. The new format spread
rapidly and profitably, displacing traditional-format competitors — largely hardware and building supply stores.
Throughout the 1980s, Lowe’s struggled to
respond, trying to blend its traditional format with the
new home improvement center. The company built
larger stores (25,000 square feet) and modified its offer-
ings and layout to accommodate both professionals and
consumers. It didn’t work. By 1988, Lowe’s had fallen
behind Home Depot in size, profitability, and share-
holder returns. (See Exhibit 1, page 4.)
At that point, almost a full decade after the birth of
Home Depot’s format, Lowe’s finally recognized the
new format’s power. In 1989, the company built an
experimental home improvement center. In 1992, management committed to the format and started converting to new stores rapidly. (See Exhibit 3.) Since then, the
profitability, growth, and shareholder returns of Lowe’s
have exceeded those of Home Depot.
Strategy for Survival
Format invasions seem almost certain to continue,
probably with increasing frequency, as ideas for new for-
mats flow ever more easily across industry and regional
boundaries. The lessons for established companies in
those markets seem clear. Surviving Business’s Least Understood Competitive Upheavals Assignment.
• Scan your markets regularly for format invaders.
Whenever a competitor — especially a new entrant —
starts gaining market share by offering familiar products
at below-market prices, suspect the possibility of a for-
mat invasion. If the new format continues growing,
what will you do? Look askance at assumptions that the
new format will apply only to some “value” niche. In
particular, question any plans or actions that would for-
feit down-market segments.
• Understand the competitor’s new format thor-
oughly, including the full potential of its cost and quality
advantages. Recognize that its “logic” will likely be unfa-
miliar, so aim to see it on its own terms. In particular,
resist the temptation to assume that the intruder’s suc-
Exhibit 3: The Evolution of Lowe’s Retail Format
Total Annual Shareholder Return
800
700
600
500
400
300
200
100
Sour owe’s annual reports; Booz Allen Hamilton analysis
N b f St
99
23
99
28
99
36
99
51
99 99
74
99 99
81
99 999
99 04
01
08
ear
vera e Store Si
ft in thousands
60
50
40
30
20
10
me ot Lowes
54
15
82 99
60
50
40
30
20
10
me ot Lowes
20
32
99 2002
raditional
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cess depends simply on lower factor prices, selling below
costs, or other measures you could never emulate (even
if these elements are truly in the picture somewhere).
Then, translate that understanding into a forecast of the
new format’s likely success over the next five to 10 years.
Caution: Incumbents often unconsciously water down
these forecasts on grounds of “realism.” With a new for-
mat, forecasting extraordinary growth is realism.
• Approach the new format as an opportunity. At this
point, you’re likely well ahead of most incumbents fac-
ing a successful new-format competitor. So you now
have a significant opportunity to grow and profit at your
traditional competitors’ expense. In a mature market,
the new format may well be the best opportunity avail-
able to your company. Make an assessment of its poten-
tial; then (if warranted) focus the company on seizing it. Surviving Business’s Least Understood Competitive Upheavals Assignment.
• Design your moves from the market back. A prac-
tical plan for exploiting the new format does not start
from your company’s current position. Rather, it starts
by asking, How could we imitate our most successful
new-format competitor, with parity offerings, parity
costs, and parity prices leading to growth and profits
equalling theirs? (You won’t necessarily implement this
parity plan, but it forces your company’s thinking away
from its traditional format and toward the new one.)
• Be cautious in adding features and amenities.
They may well be justified to build market share by
appealing to mainstream customers, but that will hap-
pen only if they reinforce the new format’s core advantages. (That’s one reason why understanding the new
format thoroughly is important.) A test: Does your
new plan include a bare-bones offering that profitably
matches your new-format competitors head-to-head
on price and features? (If it doesn’t, then your design
has probably slipped away toward a less profitable
“blended” format.) Surviving Business’s Least Understood Competitive Upheavals Assignment.
• Make the new format your mainstream business.
It’s natural to field-test a new business format before
committing to it wholeheartedly. But experimentation
and niche marketing can become ends in themselves.
Any plan for a test should define a successful outcome
and the rollout plan that will follow, carrying the new
format into the heart of your business.
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• Don’t get distracted by merger possibilities.
Against the backdrop of a format invasion, combinations
among traditional competitors present the illusion of
progress. Unfortunately, because the combined incum-
bent remains fundamentally disadvantaged, the merged
company’s greater scale seldom provides enough benefits
to offset the burdens of an old format. (However, a com-
pany that has adopted the new format successfully may
find it worthwhile to acquire other old-format compa-
nies and bring them through the same transition.)
As for the two biggest format invasions going on
right now, we don’t know whether the incumbent
automakers or airlines will survive or succumb. Some
may well retain industry leadership, growing their busi-
nesses and delivering attractive shareholder returns over
the long term. If so, they will do it by finally adopting
and adapting the superior new formats that have over-
taken them — the formats that enabled the Southwest
Airlines and Toyotas of the world to succeed and pros-
per in the same economic and market conditions in
which the old formats proved to be uncompetitive. +
Reprint No. 05305
Resources
Clayton M. Christensen, Scott D. Anthony, and Erik A. Roth, Seeing
What’s Next: Using the Theories of Innovation to Predict Industry Change
(Harvard Business School Press, 2004): A theory of disruptive success that
partly, but not completely, meshes with the format invasion concept.
Jeff Ferry, “Flextronics: Staying Real in a Virtual World,” s+b, Winter
2004, www.strategy-business.com/press/article/04408: A Singaporean
contract manufacturer emulates Toyota’s innovations.
Victoria Griffith, “Welcome to Tesco, Your Glocal Superstore,” s+b, First
Quarter 2002, www.strategy-business.com/press/article/11670: Of the s+b
retail case studies, the most relevant format-renewal example. Surviving Business’s Least Understood Competitive Upheavals Assignment.
Tom Hansson, Jürgen Ringbeck, and Markus Franke, “Flight for Survival:
A New Business Model for the Airline Industry,” s+b, Summer 2003,
www.strategy-business.com/press/article/21966: More detailed view of the
airline format invasion and its cost consequences.
Art Kleiner, “The Next Wave of Format,” Deeper News, 2001,
www.well.com/user/art/formats.pdf: Manifesto about Internet and media
formats as socially created, not technological, innovations.
William Leach, Land of Desire: Merchants, Power, and the Rise of a New
American Culture (Vintage, 1993): Early 20th-century format invasions
among department stores, fashion merchandisers, and investment banks.
Chuck Lucier, “Herb Kelleher: The Thought Leader Interview,” s+b,
Summer 2004, www.strategy-business.com/press/article/04212: The
cofounder of Southwest Airlines explains the strategy underlying his
airline’s cost advantage.
Costas Markides and Paul Geroski, “Colonizers and Consolidators: The
Two Cultures of Corporate Strategy,” s+b, Fall 2003, www.strategy-
business.com/press/article/03306: Cultural change for enabling resilience
among incumbents.
James Womack and Daniel T. Jones, Lean Solutions: How Producers and
Customers Achieve Mutual Value and Create Wealth (Simon & Schuster,
2005): Wholesale Toyota-inspired manufacturing and service redesign. Surviving Business’s Least Understood Competitive Upheavals Assignment.