MARKETS & COMPETITION
“A horse never runs so fast as when he has other horses to catch up and outpace.”
– Ovid, Roman Poet
At Stanford, I fell in love with the parallels of capitalism and evolution. The underlying force of both capitalism and evolution is competition for scarce resources. With evolution, it is in the form of survival of the fittest and natural selection, as all living things compete against each other for food, shelter, and land in the pursuit of the survival and proliferation of the species.
In the case of capitalism, competition is in the form of companies competing against each other for customers, employees, ideas, and materials in the pursuit of survival and growth. Capitalism is a human construct that has created incredible value for society. Of course, it isn’t perfect and does have some limitations, such as the focus on short-term gains that often create long-term societal externalities, which are costs that must be accounted for by society, such as pollution, deforestation, disease, and other maladies that will have to be paid by future generations.
We’re going to fly through the fundamentals of most introductory microeconomics classes. The theory behind markets and competition is critical for strategic leaders to understand, for every company competes in some market(s) against some form of competition.
What are markets and competition?
Competition is the energy source of evolution, capitalism, and markets. Competition for scarce resources, customers, ideas, capital, talent, and climbing the ladder, feed the engines of innovation, growth, and creative destruction.
Competition is the collective action of individuals and organizations pursuing gain against each other. There are many ways to define the gain, including value, profit, customers, prestige, competitive advantage, resources, talent, market share, etc.
A market is created when parties exchange goods in the form of products, services, resources, or information in exchange for currency, barter, or something of value. Typically a market involves buyers (customers) and sellers (competitors). The collective purchasing behavior of all buyers creates a demand curve which plots out how much demand there is for a particular good at different prices.
Demand curves are typically downward sloping, meaning at high prices there are fewer buyers and demand for the good, but as the price drops more buyers would come into the market and increase demand for the good. On the flip side, suppliers create a supply curve, which can be created by plotting how much quantity of a particular good suppliers will offer to buyers at different prices. Supply curves are upward sloping, meaning at low prices for a good, there typically aren’t a lot of sellers able to produce and supply the good at a low enough cost to make a profit, but as the price of the good goes up, more sellers will be able and willing to supply the market with the good, while making a profit. The intersection of the demand curve and supply curve is typically the equilibrium price of the market, where at a given price the quantity of a good demanded by buyers equals the quantity of the good suppliers are willing to supply.
Now, here is where things get personal for strategic leaders; markets constantly evolve. We live in an ever-changing dynamic world, where demand curves evolve and shift due to changes in tastes and preferences, needs, incomes, substitutes, advertising and adoption curves. And, supply curves evolve and shift due to competitors’ ability to drive down costs and increase value through innovation, technology, better design, and other structural improvements. As demand and supply curves evolve and shift, prices, total demand, and the number and volume of suppliers can quickly transform the competitive dynamics of a market. Below is a representation of shifts in demand and supply curves, and the corresponding shifts in the equilibrium between quantity and price.
Market theory is not perfect, given we live in an imperfect world. Not everything behaves according to supply, demand and equilibrium prices but 80% of it does happen probably 80% of the time in the real world. And, the important takeaways for strategic leaders hold true, which include:
Constantly drive down your costs
Underlying supply curves are aggregate “cost curves” of competitors, and at a given market price the difference between the price and the cost to supply at that price is profit (a bit oversimplified, but we’ll let it be). The competitors that are the best at constantly driving down costs or increasing value (benefits/costs) will be able to either keep those cost savings as profit or change the dynamics of the supply curve to their benefit. Regardless, whoever wins the cost and value game typically has the option to evolve the game and the market to their benefit, when they desire, typically in the form of lower prices or more customer value for the same price.
Always be paranoid
As Andy Grove, the previous CEO of Intel, always preached “Only the paranoid survive.” Complacency is the death knell of organizations. The minute you feel like you are on top, you’ve got a big lead, that no one can catch you, is the minute you need never to think that way again, dig even deeper, and execute ever more flawlessly. At Goal Zero, while we were the clear leaders in the portable solar power solutions market, I realized that we were way, way behind the leader in an adjacent market that could quickly jump into our market. By seeing a potential competitor way ahead on a lot of dimensions, it energized and focused the team in a way that is difficult when you have the mindset of being the clear leader.
Use competition everywhere
Competition is one of the most used tools of strategic leaders, whether it is in sourcing partners, benchmarking teams, negotiating deals, crowdsourcing projects, or creating healthy and friendly internal competition among team members. Utilize competition to get the most out of people and partners. At McKinsey, there is a virtual “free market” for projects. Partners with new projects have to find consultants that are a good fit for the project and vice versa. Great partners always had a lot of demand for their projects and can get their pick of consultants, while strong consultants are in high demand, and can pick their projects and partners. At Sports Authority, we benchmarked individual, team and store productivity and customer service metrics against other stores, to tap into the competitive nature of store managers and associates to improve and be the best. Figure out how to create mini-markets in your company.
Watch out for massive disruptions to markets
You have to continually watch out for disruptions to a market, whether from technology, innovation, or structural changes. As an example, ecommerce has disrupted traditional retail with a lower cost structure and better capital efficiency. Now, we are in the next step of the ecommerce disruption, with China factories shipping directly to consumers, the peer-to-peer economy, Alexa-enabled buying, “Internet of Things” (IoT) replenishment, on-demand manufacturing, 3D printing, etc. If you aren’t figuring out how to leverage digital and next-gen technology to change the customer value equation and experience, some competitor is doing it for you.
Create sustainable competitive differentiation
The way to drive long-term disproportionate profit and growth is to de-commoditize your market and build sustainable competitive differentiation into your business and value proposition, with the eight sources of competitive advantage being scale, intellectual capital, proprietary information, brand loyalty, network effect, innovation, locked-up supply, and location.
Consolidation changes the game
While most companies operate in more-or-less a “perfect market” with lots of buyers and sellers, the nirvana is to get to a monopoly (markets with only one supplier) or oligopoly (markets with typically 2 to 3 core suppliers). Monopolies and oligopolies operate under more favorable market dynamics and often make much more profit, because they can drive down costs through economies of scale, and influence the quantity supplied and the price to their favor. These are the main reason why you often see mature markets consolidate overtime to 2-3 main players.
If you can, create or own a market
Some of the largest value-creating organizations and business models are the ones that create and own a market, which is called a market maker strategy. You only have to look as far as eBay or Amazon to see the power of creating and owning a market. The beauty of a market is the network effect of growth, as the market grows with more buyers and sellers, the value of the market grows since if you are a buyer, you want to go to the market with the most amount of sellers, and if you are a seller you want to go to the market with the most amount of buyers.
A great example of a market maker strategy is Google. In the late 90s, while Google had a great search algorithm, it was Adwords (ad-buying platform) that created the lion share of value for Google. Adwords is an advertising platform that is a market for “words” or search terms, where advertisers bid to advertise on particular search terms on Google search. Before Adwords, if you wanted to advertise online, or in a magazine, newspaper, or TV, you paid a set CPM (i.e., cost per thousand impressions) which was set and negotiated by the publisher.
What Google did with Adwords changed the paradigm. Instead of setting a CPM to advertise on Google search terms, Google created individual markets between search terms and buyers wanting to advertise with those search terms. In creating a market where the search terms were the supply and buyers bid on and set the price of a Cost Per Click (i.e., CPC) for each search term, Google was able to maximize the potential revenue from search terms. If you’re a lawyer that wants to advertise on Google when someone searches for mesothelioma (i.e., terrible cancer that is caused by asbestos) you’ll have to pay upwards of $200 for every click. While, if you are running a shoe store, you’ll pay around $2 for every click if you want to advertise when someone searches for running shoes. The ability to let the buyers create the market-clearing price for a search term that costs Google almost nothing is a pretty profitable market maker strategy.