The Carrot and the Stick: Leveraging Strategic Control for Growth

Jack Welch once said about Vanderbilt and all great executives: “They have the ability to see around corners.” At the start of the Civil War, Vanderbilt realized that a transcontinental railroad could slash coast-to-coast travel times by a matter of months. As a result of this vision, he sold virtually all of his shipping interests in order to invest in railroads. By the end of the war, his vision had resulted in a railroad empire that was worth the equivalent of $75 billion today.

However, he was soon challenged for being “soft” when he was pushed by rival rail companies during tough negotiations. He fought back, looking for a key strategic control point to leverage against his rivals. Since he owned the only rail bridge in and out of New York City (the Hudson River Bridge, pictured in figure 1.1), he owned the gateway to the country’s largest port. Without access to the bridge, every other railroad would be effectively shut out of New York City.1

Vanderbilt, like many after him, realized that he owned a crucial strategic control point, one where all rail traffic flowed between a crucial port in New York City and the rest of the country. The Hudson River Bridge was that strategic control point.

Accordingly, after Vanderbilt’s rivals failed to give him the deal he wanted, he cut off the bridge to them and then famously asserted, “We’re going to watch them bleed ...” Vanderbilt single-handedly created a blockade around the nation’s busiest port and the rest of the country (long before many of today’s antitrust laws were created). When a rival railroad, New York Central, started to “bleed” and shares fell precipitously on the New York Stock Exchange, Vanderbilt bought up every share he could and, in just a few days, took control of the rival railroad. He eventually went on to own 40 percent of the nation’s rail lines and built Grand Central Depot (now Grand Central Station, the largest building in New York at the time) to bring together his three new lines: the Harlem, Hudson, and NY Central.

A few decades later, John D. Rockefeller knew that he needed leverage when he was faced with a coordinated effort to raise passage rates for shipping oil out of Standard Oil refineries in and around Cleveland; the railroad companies owned the lines (a classic strategic control point) and he needed to transport his oil. Consequently, he decided he needed an alternative and thus built a network of oil pipelines to circumvent the need to transport via rail. Rockefeller knew that he would be squeezed for higher rates by the railroads that owned the only viable way to transport oil – unless he could break this control point. His pipeline enabled him to work around an existing point of strategic control – although it took him years to construct it.

DEFINITION: STRATEGIC CONTROL POINT

A strategic control point is a part of a market that, if controlled by one party, can be used to leverage power elsewhere; this can be throughout the supply chain, in a related business, or even in an unrelated market. A classic example might include patented intellectual property or the supply of a critical input in the supply chain. By controlling the supply of a critical input, for example, a firm may be able to extract extraordinary margins in other parts of the supply chain or across other industries as a result.

We will see that a common theme of successful companies today (e.g., Alphabet, Apple, Amazon, Alibaba) is not just that they exert the power derived from owning a point of strategic control but that they have the foresight to own the point of strategic control in the first place. This affords them the ability to exert pressure on an as-needed basis later on – much as Vanderbilt did during the Industrial Revolution. Remember this as we work through the book. You will discover that a plan to leverage strategic control, through various methods, is one of the key components of successful strategies in today’s environment.

We will develop the concept more fully throughout the book; as we proceed, you will find that there are many different potential sources of strategic control. We divide them into six main sources:3

In this chapter, we delve into the details of how to spot, access, and utilize points of strategic control. In order to illustrate how this plays out in practice, we will begin by presenting examples of each of these six main sources of strategic control.

Distribution is perhaps one of the most common sources of strategic control; lock up distribution and it can be exceedingly difficult for someone else to gain access to the market.

The story of Vanderbilt – and how the Hudson River Bridge afforded him a stranglehold on the transport of goods during the Industrial Revolution – is a classic example of how distribution and market access can be used as a strategic control point. The ownership of the bridge out of Manhattan enabled Vanderbilt to control the terms of shipping in and out of the nation’s busiest port because access to New York went across his bridge.

Some more recent examples include eyewear, men’s razors, taxi cabs, and shelf space at DIY (Do It Yourself) retail, each of which is being or has been disrupted in recent years (the stories of how each of these industries is being disrupted today are told later in the book):

• The market for eyewear. One major supplier of eyeglasses and sunglasses controls multiple brand names and owns most retail distribution outlets throughout much of the world. Prior to a 2017 merger that brought the two largest players together, Milan-based Luxottica owned more than 8,000 retail locations in over 150 countries and had a dominant 50 percent market share in sunglasses. French company Essilor owned 45 percent of the prescription lenses market and 15 percent of the sunglasses market in 2015. In January 2017, the two companies announced that they were merging (the merger was approved by U.S. and EU regulators in March of 2018). The combined entity now owns over 50 percent of the prescription eyewear and over 65 percent of the sunglasses market. Add in the only other significant player, Safilo, with a 14 percent market share in sunglasses and a 3.7 percent market share in prescription lenses, and the two companies own a staggering percentage of the retail eyewear market with tight retail distribution control. Significant new competitive entry through retail distribution would be exceedingly difficult and certainly fought tooth-and-nail.4

• Men’s razors. Gillette’s and Schick’s traditional dominance of the men’s shaver market is another classic example. Gillette alone had over a 70 percent market share as recently as 2010, and they routinely introduced relatively minor product variants to occupy most of the available retail shelf space.5 Entering the market with a new razor with an additional blade and pushing behemoth Gillette off pre-existing allocated shelf space has been exceedingly difficult for any potential new entrant over the years. Who truly needs the fifth, sixth, or seventh blade anyway?

• Taxi cabs. The monopoly traditionally afforded to taxi cabs by local municipalities vis-à-vis the medallion program (a system whereby a vehicle needs a “medallion,” often posted on the vehicle itself, in order to legally operate a taxi cab under local jurisdiction) is yet another example. In cities like New York and San Francisco, the right to own and operate a taxi cab has been historically tightly regulated by local governments. For example, in New York, the medallion program began in 1937 when the supply of taxi cabs was significantly greater than demand. Medallions in New York were selling for $2,500 in 1947 and peaked in 2013 at a hefty price tag of $1.3 million. A limited number of medallions were approved by the City of New York, and competition – at least prior to ride-sharing companies such as Uber and Lyft – was prohibited. This was obviously a very strong point of strategic control.6

• Windows, faucets. In DIY (Do It Yourself) “big box” retail (e.g., Lowe’s, Home Depot, Menards), Anderson and Pella dominate windows, while Kohler, Moen, and Delta dominate faucet shelf space. Combined, Kohler, Moen, Delta, and American Standard own a 78 percent market share in the United States in the construction market.7 In retail, shelf space allocation is almost everything, and manufacturers routinely pay “slotting allowances” (paying to get on the shelf) and are required to guarantee sales performance (known as “failure fees”).

The list of companies that have successfully locked up distribution and precluded entry by rivals is long and varied. Examples ranging from Microsoft’s inclusion of Internet Explorer as a feature “tied” to its Windows operating system to Vanderbilt’s bridge have been covered in depth in antitrust-law classes and business school MBA classes. The use of distribution as a “stick” (under the advice of legal counsel) for excluding competition via distribution can be viewed with admiration (in some business classes) or as a risky and potentially illegal strategy (in some antitrust-law classes).

• Distribution is an area where companies can gain strategic advantage (e.g., Luxottica, Moen, or Delta) or be strategically disadvantaged, but it is also an area ripe for disruption.

• Later in the book, we will discuss strategies for dislodging distribution-based sources of strategic control.

• The identification of strategies for overcoming a rival’s distribution-based point of strategic control can often be the difference between success and failure in many industries today.

Source 2a. Information: Hardware/Software (Today’s Version of Give Away the Razor to Sell the Razor Blades)

Information as a Source of Strategic Control: The Battle for Data – in the Wind and the Cloud

Windmill technology has dramatically improved over the past few decades. For example, GE has developed blades and rotors that sense the wind direction and adjust a windmill’s tilt/shift in order to optimize its ability to catch the wind. In addition, many windmill “farms” (i.e., groups of windmills in close proximity) optimize the way they work together, since one windmill’s direction and tilt affects the downwind performance of the other windmills. Thus, a group of windmills, operating together, is more efficient than individual windmills operating separately; as a result, when one windmill fails, the efficiency of the entire farm can be adversely affected.

Industry leaders (e.g., GE and Siemens) have developed their own optimization and monitoring services that use the data coming off the windmills to send performance data to the cloud and, using this data, remotely monitor performance and proactively do repairs to maximize windmill uptime. However, the market for windmills is fragmented, with a few large players and a series of smaller players – many of whom are lower-cost manufacturers from Asia who do not have the scale and/or capabilities to develop and maintain such services.

In response to GE’s and Siemens’s control of this space, a few ingenious companies are in the process of installing – for free – sensors in both new and existing (i.e., retrofitted) windmills. These sensors (see figure 1.2) monitor motor vibration and temperature so that they can predict motor failure before it happens. The data are broadcast to the cloud in real time, and predictive failure analytics are conducted on the data. Once a motor’s spec goes out of tolerance zones, a team is dispatched to “repair” the motor before it fails – not only to maximize the “up time” of the windmill but also to provide peak efficiency for the entire farm (see figure 1.3). This can enable the smaller players to compete effectively with the larger firms; for example, for smaller Chinese manufacturers trying to compete with GE and Siemens, being able to provide this service is often the difference between making the sale and losing it.9

So, how do you make money by installing sensors for free? The key is to own exclusive access to the data generated via the sensors and leverage it by selling higher-margin maintenance contracts back to windmill manufacturers (for newly built windmills) and to farm owners (for retrofitted, existing windmills). In order to understand how and why this works, note that the smaller players are more than willing to allow the sensors to be installed, to grant access to the data, and to pay for higher margin maintenance, since they can’t efficiently do this themselves (due to their size and scale). Further, they gain the ability to compete with the GEs and Siemenses of the world on services, while simultaneously maintaining their cost advantages. In doing so, they can eliminate downtime to at or near zero by offloading this to the sensor supplier. Therefore, it’s a win-win arrangement for all parties.

DEFINITIONS: IOT, INTEROPERABILITY, AND THE CLOUD

In this example, it is worth noting that the ability to remotely monitor a device and allow different parts of the value chain to “interoperate” (here, sensors that allow remote monitoring to make all windmills on a farm collectively more efficient) is often referred to as IoT (internet of things) interoperability. This is just a fancy term for enabling parts of a firm’s supply or value chain to work together by connecting different parts via the internet. We use the term “IoT interoperability” here, but note that this simply means that a device (e.g., a windmill) is connected to the internet (e.g., via sensors on a windmill) and sends data to a central data facility (i.e., the cloud).

This is the modern-day equivalent of the “give away the razor to sell the razor blades” story. Today, the razor equivalent (the sensors) is of value because of the (i) ability to monitor motor performance remotely via the cloud, (ii) ability of the system (“the farm”) to interoperate, and (iii) ability of failure mode analysis to predict failure before it happens. Indeed, in today’s world, it is often beneficial to give away the hardware but own the data. Data is the new currency and often the point of strategic control in many industries.

Source 2b. Information More Generally (Ownership of / Access to Information, and Privacy Concerns)

Wearables and the Internet Access Wars: Why the Battle for the Last Foot between You and Your Internet Is So Valuable

There is a battle raging that most of us don’t know about: the battle to “own” our internet connections. Whatever company owns the data coming off a device (e.g., a smartphone, router, or interconnected machines on a factory floor) will own a huge point of strategic control in future competitive value chains – within and across industries.

In order to illustrate this point, think back to the story of Google and the Latin American insurance executive (in the introduction). What enabled Google to “extort” (according to the executive) margins from the insurance company? Google controlled information on driver position, speed, and acceleration via a device and internet connection associated with each of the insurer’s insured drivers. Thus, by owning the connection and the key app (i.e., Google Maps and the Android OS), Google has access to all of the information generated via the vast majority of smartphones in this region: with 88 percent of the worldwide smartphone operating system installed base in calendar year 2018, the Android operating system provides a treasure trove of data for Google to leverage.11

In today’s interconnected world, the control of information is often an important point of strategic control. Hence, there is an enormous global battle for ownership of the connections of internet users; this is why Google is in the router business with its Google Wifi (formerly OnHub) system and is launching balloons and satellites (via its Skybox acquisition).12 Google, AT&T, and Nokia are focused on fiber-optic cables and “5G” terrestrial high-speed transmission methods; and Airbus and OneWeb have a joint venture to build a high-capacity satellite factory to churn out as many as fifteen low earth orbit (LEO) satellites a week. Google doesn’t want to be in the router business, and Airbus isn’t looking to be in the satellite business; however, they realize that the company that “owns” your connection also owns and/or has access to the information coming from you, such as where you are, how you drive, what you buy, what you say (e.g., political and social views), what you do, and how often you move. The possibilities for leveraging this information via relationships with insurance companies, healthcare providers, plumbers, service technicians, and so on, are almost limitless.

Now, in order to understand why this is so important – and why the CEOs of Microsoft and Alphabet have both commented recently on the importance of “seamless” interactions with the information we need – let’s examine the future consumer world.

The next big technology, the Internet of Things, will embed sensors in our appliances, electronic devices, and our clothing. These will be connected to the Internet via Wi-Fi, Bluetooth, or mobile-phone technology. They will gather extensive data about us and upload it to central storage facilities managed by technology companies. Google’s Nest home thermostat already monitors our daily movements to optimize the temperature in our homes. In the process, Google learns all about our lifestyles and habits. Our smart TV’s will watch us to see if we want to change channels – and learn which shows we like and how attentively we watch them. Our refrigerator will keep track of what we eat so it can order more food – and know our dietary weaknesses.13

There is one thing in particular that any of these IoT-enabled (always-on connectivity to the internet) “wearable” technologies (e.g., the capabilities of our phones built into a pair of glasses, contact lenses, a watch, or on our sleeves)14 will need to work: seamless, ultra-high-speed broadband internet connection. Thus, our internet devices will need to work in our homes, on the street, in stores, on rooftops – all seamlessly and without disruption from wireless source to wireless source. Much like the insurance executive in Latin America, key players today realize that if they have access to all of the information coming off always-on, ubiquitous, internet connections, their ability to leverage this information throughout multiple value chains is enormous. Indeed, if I were to own all of the available information about you (e.g., what you do, buy, and think), I could use this to extract margins from banking, insurance, video content, telecommunications, advertising, and so on.

In the internet space, there are multiple forms of provision – and multiple companies vying to win the war for your information. In 2018, Google, Apple, Cisco, Oracle, and Microsoft were collectively sitting on almost three-quarters of a trillion U.S. dollars in cash, and the battle thus involves significant war chests (to wage and win the war). Table 1.1 summarizes the key players in internet provision as of late 2019.15

If one entity (e.g., Google) were to dominate the ISP space, incorporate internet access into wearable devices (e.g., for Google this is now their Pixel offering, but this will eventually be new devices such as glasses, watches, contact lenses, or virtual reality devices), and bundle it with a current suite of offerings, the bundled suite would be exceedingly difficult to compete against.16 The primary reason is the fact that the ISP, phone, or wearable unit does not have to be profitable in its own right, since the real money is in what the data (e.g., locations) will allow us to do, most of this generated via devices and various apps. Much like the old “give away the razor to sell the razor blades” strategy, the primary ISP providers can subsidize internet provision and the wearable device to sell and/or use the data.

There are countless companies that would pay dearly to understand every move we make. In principle, if you provide internet access and devices to consumers at substantially discounted prices, you then have access to the full set of information generated via the consumers’ devices (e.g., you know how much they move, where they are, and what they buy). You then have the ability to sell services (e.g., targeted advertising) based on this information about customers at supra-normal profits. Conversely, potential competitors who provide only a subset of the offerings generally do not have the ability to cross-subsidize their offerings with margins from services based on the data.17 Thus, they are at a key competitive disadvantage.

Think through all of the offerings that Google has put together over the years (e.g., Gmail, Google Maps [indoor as well as outdoor], the Android operating system, Chrome, and Google television [i.e., YouTube TV]). They haven’t simply been amassing a set of disparate offerings; they have been covering the entire range of offerings that connect to the central node (i.e., the internet connection). Think of it this way – with this connection and all of the offerings, you may not need your ISP, wireless cellphone carrier, cable or satellite provider, or even your bank anymore – in the latter case, thanks to Google Wallet.

In short, the key to the next generation of communication and information devices is the internet connection that is combined with the services; this is the strategic control point, Vanderbilt’s Hudson River Bridge in today’s business environment.

This last point illustrates what is truly different about the business environment of today – and what is discussed throughout this book. In the past, points of strategic control were leveraged within an industry and across that industry’s value chain (again, as with Vanderbilt’s Hudson River Bridge). Today, industries are often interconnected in ways we have never seen before. For example, Google, a search engine company, can leverage internet provision advantages into strengths in multiple, diverse markets, from television and movie content provision to mobile phones and mapping. Also, Amazon’s infrastructure enables it to leverage its initial forays (into publishing and book selling) into Amazon Marketplace, data services, cloud computing, and local services. Thus, companies that succeed today recognize that strategic advantage is no longer about leveraging across an industry but about leveraging across industries.

Privacy and Winning Business Models in the Future: Now, I can imagine that many are reading this and thinking: What about privacy? What about the public outcry after Facebook’s Cambridge Analytica scandal? What about recent regulations to restrict what companies can do with our data such as GDPR (the General Data Protection Regulation 2016/679 – a regulation in EU law on data protection and privacy for all individuals in the EU, but which effectively extends to most large multinational corporations)?

These are all fair concerns, and outright selling of data – or a lack of transparency in how your data are used – is just bad business. Selling of data is most likely going to be a subject of debate and further restrictions. Any business model that is based on selling of data is one likely to be in peril as privacy debates move ahead around the globe.

This is, however, exactly the central point of many of the examples in this book. Models where the use of advanced analytics provides a “better mousetrap” will likely win. Giving away sensors on windmills to provide more efficient maintenance; helping insurance companies pare risks by identifying risky drivers; providing targeted and more effective ads without being “creepy” – these are examples of strategies that benefit all parties.

The Profit Motive: One should always keep in mind that companies are in the business of making money – in fact, they have a fiduciary responsibility to their shareholders to do so. This leads to a logical question: Would you be willing to pay $29.99 a month for Facebook? Or Instagram? No? How about $8.99? If these companies weren’t able to monetize the data, you would need to be charged for the service they provide. You can’t have it both ways – you don’t want them to use your data, but you don’t want to pay for the service. The real question is how much of your privacy are you willing to give up to get something for free? Companies use your data to provide a service and make money on that (not sell your data to third parties) or you have to pay for the service.18

Moving forward, we are currently in the “wild west” of data ownership – a situation that will have repercussions for many years to come. Contracts must be written now with foresight. For example, monetizing owning the temperature and vibration data that come off windmills requires that contracts written for sensor installation today grant exclusive access to data rights for many years into the future. In fact, that’s all that’s needed. Think of it this way – in the windmill sensor example, no agreement for maintenance services needed to be written into the contract for sensor installation. Service agreements often involve contentious negotiations focusing on low cost and, for a provider of the services, should be avoided at all cost. By having the only stipulation for no-cost sensor installation be that the sensor installer owns all the data coming off the sensors (on the face of it, quite reasonable), the installer sets up a market where they are the preferred maintenance provider for the length of the contract, since they can keep the windmills operating more efficiently at lower cost. This is accomplished at no cost to the windmill owner/operator – and usually with little resistance, since it is costless to them. Brilliant.

The type of business model that will prevail moving forward is clear. Choose one where you collect data and then sell the data and you will face significant headwinds through GDPR and analogous initiatives. However, choose one where you build a better mousetrap by using the data to provide a better service, and you will win nearly every time.

The Potential Role of “Net Neutrality” as a Point of Strategic Control: Finally, relevant to this discussion is the concept of “Net Neutrality,” an Obama-era rule that states that all internet traffic should be treated equally. This essentially means that a company like AT&T, which bought Time Warner, can’t favor their own content over competitors’ content. The Trump administration overturned this rule in June 2018, but the overturn has not been in effect as of the time of the writing of this book. Many suits are currently challenging the Obama-era rule, but the U.S. Supreme Court has recently announced that it would not take up challenges to it. If the Net Neutrality rule goes away, the idea that “if you control the internet, you control the content delivered to the customers” will be even more powerful. The fight is still ongoing, with many suits hanging in court while individual states are starting to create their own rules. It is important to note, however, that the absence of Net Neutrality rules will make all that is suggested here even more relevant.

• Just as Vanderbilt recognized that all rail traffic went through the Hudson River Bridge in New York after the Civil War, Google recognizes that all of your activities run through whatever hardware or software you have that allows you to access the internet from wherever you are located.

• This hub (i.e., your internet provider) is the strategic control point that connects multiple industries, can yield substantial competitive advantages, and lets Google and/or others leverage the data coming off that connection.

• Similarly, by placing sensors on devices such as windmills, other companies are able to own a key point of strategic control – data – and leverage it for strategic advantage.

• In the wake of privacy concerns raised by events like the Facebook Cambridge Analytica scandal and in the wake of regulations such as GDPR, how the data are used and the opportunities to utilize potential points of strategic control will look much more like the windmill example than like the outright sale of the data (as with Cambridge Analytica).

• Business models that entail monetizing data need to have foresight. Just like Vanderbilt, who needed to have the foresight to own the bridge in the first place in order to utilize it as a strategic control point, companies need to have the foresight to build data-exclusive arrangements into future contracts.

The use of strategic control is by no means limited to high- technology markets. In fact, it tends to be even more prevalent in old-line industries such as manufacturing, building, and construction. There are numerous examples of this, of course, but one classic and recent example involves production capacity and how it can create short- to intermediate-run control points.

I recently worked with a firm selling a line of popular household goods that had a difficult problem to solve. The company – call them “Cornell,” after my alma mater – sold a high-end line of consumer products in China.19 The products had huge margins; they were also somewhat difficult to manufacture to a high standard, and worldwide production was limited. Their contract producer, let’s call them “Ace,” incorporated in France, produced about 80 percent of their world’s supply.

In late 2017, Cornell realized that they had a problem. Ace had just been bought out in a private equity deal. The timeline for a typical private equity acquisition is for the private equity firm that buys a company to sell it within three to five years at a profit after growing the business a multiple of at least three to five times current earnings. Hence, the new owners had to grow – and grow fast. Moreover, Ace was supplying 80 percent of Cornell’s key product line for the lucrative, high-end market in China. This constituted 50 percent of Ace’s production capacity; the other 50 percent was dedicated to their own production – a rival but somewhat lower-quality product that was also being sold to the Chinese market.

If you feel something tickle at the back of your neck, a warning of something disconcerting, it is well founded – if you were Cornell, this should be extraordinarily disconcerting. Having your sole supplier be a key (lower-priced) competitor in a highly profitable market is most definitely not a situation you would want to create for yourself. Worse yet, Cornell had few alternative supply options: it had shut down its U.S. plant a number of years ago, and companies in Japan (7 percent) and Korea (13 percent) made up the rest of its supply. However, these suppliers had little ability to expand output; even if they could, they could not consistently produce the level of quality needed to meet the high-end Chinese market demands. Worse yet, a “Made in France” label carries much more weight in China than do “Made in Japan,” “Made in Korea,” and “Made in China” labels.

So, in summary, Cornell had no credible alternative supply (at least in sufficient quality and quantity), and their contract producer (Ace) had a competing product in an expanding Chinese market. Further, the supplier had just recently been purchased by a private equity shop that had a mandate to grow significantly within a three-to-five-year time horizon. It didn’t take a rocket scientist to figure out that Ace would take advantage of their unique production capability in this area, their unique strategic control point. If Ace were to cut off Cornell’s supply, it would take a minimum of two to three years for Cornell to develop alternative supply capabilities or build its own plant. Therefore, a credible strategy for Ace would be to:

1 cut off Cornell’s supply (although there is a contract in place, enforcing the contract in French and international courts would be exceedingly difficult, expensive, time-consuming, and distracting), and/or

3 flood the market in China with Ace’s own brand – decimating Cornell’s lucrative business in China.

Worse yet, Cornell would have few alternatives available. As with Vanderbilt’s bridge, Ace owned a key strategic control point, namely production capacity and – vis-à-vis the private equity acquisition – the newfound imperative to use the strategic control point (production capacity) in this market. Indeed, because of Ace’s ability to sell its production capacity in China, cutting off supply to Cornell would be not only a feasible but also a credible threat.

So, what did Ace do? It threatened to pull production entirely and demanded more favorable terms; specifically, if Cornell didn’t make it worth their while to continue producing for them, they would decimate their market. Thus, Ace was exerting its power inside this point of strategic control to increase prices significantly – much like when Vanderbilt closed the bridge to Manhattan.

In a later chapter, we will discuss how game theory can be successfully employed to address this difficult dilemma. This will illustrate how it can be possible to free yourself from a strategic control point that is owned by someone else. For now, however, it is simply important to understand how production capacity, in this industry, was the point of strategic control and how Ace was able to exert control in the value chain to significantly increase margin – much as Google did to the Latin American insurance executive and Vanderbilt did many years ago in New York!

• Thinking ahead far enough is crucial – indeed, think ahead so that you (like Cornell) are not in the position to be squeezed by someone else who owns a key point of strategic control.

• Strategic control points are not limited to high-tech markets – production capacity, patents, process IP, and related tools can be used just as effectively in “traditional” and “low-tech” industries.

Sometimes, firms need to be concerned about defensive moves, such as what would happen if part of a market is – or could be – controlled by others. For example, Owens Corning is a Fortune 500 company that develops, manufactures, and markets insulation, roofing, and fiberglass composites. Based in Toledo, Ohio, Owens Corning posted 2018 sales of $7.1 billion and employs about 19,000 people in thirty-seven countries.20 They manufacture various lines of building-related products that use glass fiber as a base, ranging from composites (e.g., tubing used in outdoor furniture, fiberglass pipe, etc.) to asphalt roofing shingles to insulation. They are a leading manufacturer of roofing shingles, competing against a couple of other large manufacturers, including one owned by Berkshire Hathaway’s Johns Manville.

During the process of manufacturing asphalt shingles, a fiberglass mat forms a base (and adds weather protection and fire resistance); asphalt holds the granules on the shingle (and protects the roof from water); and colorful mineral granules (made of crushed stone and/or recycled glass granules) help reflect the sun’s rays and add a bit of style to the roof. At the end of the process, a heat-activated adhesive strip bonds the shingles into a single, watertight unit. A few years ago, after walking through a Competitive and Capabilities Map exercise (to be discussed in detail later in this book), Owens Corning became concerned that the granules on the shingles (a key ingredient in roofing shingles) were largely controlled by a third party – and it was the only major roofing manufacturer not vertically integrated into granules. This, of course, set them up to be frozen out of shingles if the granule supply was restricted in some way, which raised a number of red flags – especially since one of the major granules suppliers was a competitor (Johns Manville). Strategically, Johns Manville had the potential to exert its capabilities in an area of strategic control by significantly raising prices on granules – or freezing Owens Corning out entirely.

This led Owens Corning to integrate and develop granule- production capabilities as a purely defensive play – and a smart one at that. This anecdote illustrates how an analysis of strategic control points can reveal potential areas where strategic control by someone else can have negative consequences for your firm; therefore, paying attention to potential areas of “negative strategic control” is prudent. Sometimes this can mean the difference between continuing to compete and succeed in a market – and being frozen out.

• Remain aware of potential competitor ownership of key strategic control points.

• The ability to think ahead far enough is crucial; make sure that you don’t put yourself in a position to be squeezed by someone else’s ownership of a key point of strategic control.

• Strategic control points are not limited to high-tech markets – also, certain strategic control points (e.g., production capacity, patents, and process IP) can be used just as effectively in “traditional” and “low-tech” industries.

Imagine two scenarios. First, imagine that you have always dreamed of (and recently saved for) a shiny new car. You are at the dealer’s and have agreed upon a great price. You shake the salesperson’s hand and are passed off to the finance manager to finalize the deal, “do the paperwork,” and arrange financing. We’ve all been there. Of course, in the meantime, various transactions, checks, and processing activities are going on behind the scenes. Second, imagine a friend is stranded in Europe and you are trying to get cash to her quickly; however, through the traditional banking system, you have limited options. Wiring money would be quickest, but this could take a day or more and is expensive (banks need to “talk” to each other, confirm available funds, and transfer and reconcile accounts across banking intermediaries). The transfer of funds involves a variety of ledger checks, transaction fees, and processing rigidities built into a complex international banking and regulatory system.

Banking transactions have involved similar systems for more than a century. Traditional banks have built a platform based primarily upon their vast number of customers, the trust that exists in the banking system (due largely to regulations), and the ability of the banks to deal with the federal government in compliance areas. Indeed, the fundamental foundation of our banking system is trust. This trust (between banks and their customers) took centuries to build and is supported by stringent banking regulations and, in the United States, $250,000 in federal deposit insurance (FDIC), as well as the full backing of the U.S. government and the Federal Reserve.

This trust is also built upon a complex reconciliation process. For example, banks keep their records in proprietary systems. So, how do we know that the records with one bank are consistent with those of another bank? These records are checked and reconciled by multiple, trusted third parties. Traditionally, if I wanted to send money to someone in another country, the following would need to be done: (i) I would go to my bank (and inform someone at the bank of my intention); (ii) the bank would send the request to the country’s central bank; (iii) the central bank would talk to the associated European country’s central bank, which would communicate with the associated local bank; and (iv) the friend could then pick up his money. The whole process could take from days to weeks.

Traditional banks effectively utilize the regulatory system (vis-à-vis the FDIC) as well as related trust as a strategic control point. You and I can’t simply open a bank; doing so involves following a specific and well-regulated process. However, let’s consider today’s new and innovative environment. Banks and financial services firms are being pressured by financial technology start-ups (i.e., “Fintech”) on technology initiatives such as the following:

1 “Peer-to-peer” (P2P) money transfer that is instantaneous, done over an app on your phone, and much easier than having to hand over cash or write a check (e.g., I can transfer money to you directly through organizations like Lending Club or Venmo). Non-bank institutions have successfully been making inroads in P2P lending via new technologies that have made P2P fund transactions quick and easy.

2 Beyond P2P lending, Fintech start-ups have been developing “distributed ledger” or “blockchain” technology in an attempt to “open up” the banking system to non-banks. Blockchain is an open (or public time-stamped) ledger that, because of its specific time sequencing, can be accessed quickly, securely, and at exceedingly low cost. Transfers can be processed and verified almost instantly, without risk of fraud, because each transaction is verified (or denied) based on unique time sequencing, which is presented across an openly available ledger. The main benefits are its quick processing (a transaction that used to take days or weeks can be verified and enacted in seconds), its low (near-zero) cost, and, in theory, its ability to eliminate fraudulent transactions. Traditional banks are quite concerned, since many Fintech start-ups seek to eliminate the fees that are the revenue streams for banks.

Thus, Fintech start-ups have been making progress in P2P lending; however, they face regulatory hurdles due to their utilization of the “distributed ledger” blockchain technology to lower transaction costs and speed transaction clearing times. If you were a large “traditional” bank, what might you do to leverage your strategic control points and keep Fintech competitors at bay? Banks are indeed smart; accordingly, there are two very different yet parallel paths that they are taking; their choice of one versus the other depends on how vulnerable they are and how tightly they can exert existing points of strategic control:

Path 1 (Utilizing Coopetition): Traditional banks have typically been losing ground to start-ups in peer-to-peer (P2P) lending; hence, in this domain, they are cooperating by “opening up” their systems and data to competitors (i.e., Fintech start-ups). One way that big banks are leveraging the power of Silicon Valley is by sharing application programming interface (API) protocols with start-ups and thus allowing access to their proprietary data and leveraging the innovations of Fintech start-ups. By offering open APIs, banks have become back-end platforms; furthermore, third-party developers are creating innovative apps for customers (to access the bank data). Apps are increasingly important to banks because of the prevalence of mobile phones and mobile banking and commerce needs. Therefore, banks are opening APIs to Fintech start-ups in order to “cooperate” in areas where (i) barriers are low and (ii) Fintech start-ups are already making inroads.

Path 2 (Leveraging Strategic Control): On the other hand, banks have advantages that the Fintech start-ups do not: well-established trust and government backing (e.g., via FDIC guarantees). Accordingly, they are vigorously protecting traditional banking operations (e.g., traditional accounts and commercial and mortgage lending) outside of P2P settings. For example, in the area of blockchain, Bank of America filed fifteen patent applications just last year (and intends to file twenty more); Goldman Sachs is developing SETLCoin, its own blockchain-based currency for post-trade settlements; and banks are also creating their own digital currencies (e.g., Citibank with its CitiCoin and Bank of New York Mellon with its BKoins) – all while vigorously protecting their core assets.

Further, banks have a history of working together: indeed, fifty of the world’s leading banks have joined a consortium that is spearheading the application of distributed ledger technology and “smart contracts.” For example, R3CEV is leading this consortium with the mission to save money, decrease transactional errors, and significantly increase settlement speeds. In terms of scalability, Visa, Citibank, and the NASDAQ-backed chain.com can process tens of thousands of transactions per second, an impressive feat – especially when compared to Visa’s capacity of 65,000 transactions per second.

One thing is certain: all banking products will be digitized before long. However, this is an industry that is still based on trust. Thus, all else being equal, the brand equity of incumbent banks will win. Furthermore, traditional banks have a long history of protecting their core assets vis-à-vis key points of strategic control: trust and the regulatory backing of the government.

We can summarize IP and Regulatory Market Access-based strategic control points as follows:

• The ownership of strategic control points by incumbent banks includes the regulatory process, which results in confidence and trust.

• Fintech start-ups have made inroads in P2P lending; as a result, banks have been cooperating by opening their APIs to technology start-ups.

• Since banks notably make money via transactions, they will use Fintech start-ups to develop the back end of new systems; however, they will fiercely protect the part of the business that utilizes their competencies in existing areas of strategic control points – namely through trust via federal FDIC protection.

• Key strategic lessons for incumbent banks (and other industries) include the following:

1. Leverage existing capabilities by cooperating with potential competitors in the areas where you are most vulnerable (e.g., P2P).

2. Fiercely protect key margin areas when you have points of strategic control that are sustainable (e.g., traditional banking versus start-up, blockchain-based initiatives), while simultaneously developing your own capabilities in these areas.

Perhaps the best – and most dramatic – example of a strategic control point is that of Softsoap®, the liquid hand soap that we use to wash our hands. William Sheppard of New York was granted a patent for “Improved Liquid Soap” in 1865. His invention was a good one and had many practical uses;21 however, it did not make its way into people’s homes until much later (like many inventions). In 1980, the Minnetonka Corporation started offering “Crème Soap on Tap” through boutique distributors. The product was a success, and the corporation decided to follow up with a similar product for mass retail sale. There was a decision during the launch to package the product in a distinctive-looking pump bottle; however, retailing is intensely competitive, with requirements to get on the shelves (“slotting allowance”) and performance guarantees (“failure fees”) once on the shelves – both tough barriers to overcome for a small manufacturer that could potentially face overwhelming competition. For example, industry giants such as P&G, Johnson & Johnson, and Unilever could easily attempt to imitate its success. However, Minnetonka believed that if it had a ten- to twelve-month head start, it could build up enough brand presence and shelf-space allocation that it would be able to maintain at least a one-third market share – even after the “big boys” entered. So, how could it do this? The answer again is via strategic control points.

In this instance, Minnetonka decided to buy up the world’s supply of plastic pumps! Consequently, if any of the major manufacturers wanted to enter the liquid soap market, they would have to wait until the supply built up again – or build their own factories to make the pumps. This process would take close to a year – roughly the amount of time that Minnetonka needed to build distribution, shelf allocation, and a brand presence! In this instance, pump manufacturing was a classic strategic control point (i.e., a part of the supply chain that, if controlled, could enable Softsoap® to gain a differential competitive advantage in the key part of the market – retail – that it was pursuing). Note that there may or may not be a profitable business in pump manufacturing; however, controlling that part of the supply chain was key in this circumstance. And, as they say, the rest is history – just as with Vanderbilt and the Hudson River Bridge.

We can summarize key manufacturing component-based strategic control points as follows:

• Look beyond your immediate industry for strategic control. Minnetonka and Softsoap® was not in the pump business; however, the pump was a necessary component and in short supply at the time. Often, a point of strategic control involves building capabilities in unrelated markets.

• The ownership of points of strategic control is often temporary. Today, markets move at light speed; therefore, the key to owning points of strategic control is often keeping rivals at bay while you develop your next strategic move and/or market opportunity.

Based on all of these potential sources of strategic control, there are a few fundamental points to keep in mind as you read through this book and as you think through your own industries and applications. These points are crucial to understanding how to use the “Stick” part of the “Carrot and the Stick.”

1 Strategic control points are not binary. There is a continuum – from being a commodity on one end to exercising complete control (e.g., you own a patent) on the other. Think of strategic control as being weak or strong (versus simply existing or not existing).

2 Strategic control points are market- and industry-based; competencies are firm-based. This is one of the points that companies confuse the most. Points of control exist because of a unique aspect in a market; thus, they are market-driven. For example, a raw material or form of data may be scarce and can thus only be accessed by one entity at a time. In this circumstance, a firm should strive to have unique competencies in an area of a market with a strategic control point. For example, if satellite transmission is important to an offering because it enables real-time updating of data (which is pivotal to the success of an offering) and there is limited satellite bandwidth for transmission, this could create a type of strategic control point because of the lack of satellite transmission bandwidth. If you are the only one with competencies in this area (i.e., you are the only one with access to the satellite capabilities), then you should be able to extract supernormal margins. Thus, this strategic control point is created by a lack of satellite transmission capabilities in the market. In sum, you should ideally strive to have unique, essential capabilities in underserved areas of markets (where a component is in short supply). This will be a key part of the analysis when the Competitive and Capabilities Maps are developed and discussed later in this book.

3 Strategic control points can only be implemented in contexts that generate something of value to the customer. If something isn’t important to the customer, there is no extra margin to be leveraged if no one is willing to pay for it; it must be important to the customer. Nevertheless, customer demand is not the sole criterion. For example, salt may be important to customers; however, it is not in short supply and is generally thought to be a commodity with no point of strategic control.

4 Strategic control points must be rivalrous in nature. If my owning a point of strategic control doesn’t preclude you from also owning it, how can it be a point of control?

5 If everything is a point of strategic control, nothing is; if everyone has competencies in an area of strategic control, it is not a point of strategic control. This should be self-evident; a strategic control point involves a limited supply and/or capability. If everyone has capabilities in a certain area, there is no unique capability (i.e., for extracting margins).

6 Employing points of strategic control can (and should) be used in conjunction with other strategic approaches. In The End of Competitive Advantage, Rita McGrath wrote that modern-day competitive advantages are “transient” since markets move so quickly. She argued that the transient nature of competitive advantage means that we need to move faster to stay ahead of competition. Since markets do move much more quickly today, finding and leveraging strategic control points can help firms hold onto competitive advantages that much longer; indeed, while competitors fight to break the stranglehold you have on the market, you can be moving onto the next market opportunity correlated with your current strategic control point – hoping to be one step ahead of the competition. Further, unique agreements with suppliers and others, as Adam Brandenburger and Barry Nalebuff argue, can potentially provide you with capabilities that are in short supply in an area of strategic control. Find these opportunities and you’re firing on all cylinders – and creating a network for long-term success.22

7 Today’s applications are all about the broader ecosystem (“Think platforms, not products; ecosystems, not platforms”). Along these same lines, companies that succeed over time are able to leverage strategic control points in one market and apply them to other markets and other market opportunities. Amazon has been a master at this via leveraging their platform to generate Amazon Marketplace, cloud services, and Amazon Web Services (Amazon AWS).

The issues at the heart of this book shed important light on current conversations about breaking up big technology companies such as Facebook, Alphabet, Amazon, and others, many of whom have successfully employed the strategies presented in this book. The use of strategic control points and the competitive dynamics between those that hold points of strategic control and those that attempt to disrupt them go to the heart of this debate. This book makes no value judgments on technology firms – or any others, for that matter. What the book does address are (i) the strategies that lead to market dominance today – whether for Amazon and Alphabet or a smaller firm competing for its survival, and (ii) strategies that can be employed to fight back when someone else owns key points of strategic control. Knowing how to develop dominant strategies as you build your business across multiple, interconnected markets and knowing how to disrupt those that dominate is often the key to success in today’s environment. It is also the key to rational, intelligent debates about the role of antitrust policy today.23

Choosing When NOT to Compete: Find Parts of the Value Chain with Profit and/or Margin Opportunities (“Pools”) and Points of Strategic Control – or Exit as Quickly as Possible

When I work with companies, I find that it is important, early on, to map out the relevant industry value chains associated with the company. We look for profit or margin opportunities (sometimes referred to as “pools”) arising in the value chain (e.g., due to things like a lack of competition or entry barriers at one stage of the value chain), and points of strategic control, and we often discuss ways to align incentives. These conversations can result in concrete and constructive conversations about the company’s relative position in the market. However, occasionally, when we work through a detailed value chain, we don’t find a margin opportunity or a point of strategic control, which inevitably leads me to ask: “Why are you in this business?” Three times in the last couple of years, it has led to a divestiture – one in solar, one in windows, and one in the chemical space. You need to ask the tough questions and then make the tough calls.

In closing, it is important to note that finding points of strategic control is rarely as “easy” and simple as was the case in the Softsoap® or Vanderbilt Hudson River Bridge examples. Indeed, finding points of control is usually considerably subtler and more complex. Further, it is important to note that it can (i) involve owning the entire value chain (back to front) and leveraging this across industries (as Amazon has done); (ii) lead you to conclude that there are no points of strategic control in your market at all; and/or (iii) sometimes warn you of impending danger from those already holding points of strategic control. This book is about how to find the important strategic control points and what to do if you don’t have them or another firm has them – and how to leverage them across multiple industries (which is often the key to success in today’s markets).

To be clear, the basic concept of a strategic control point is not new; indeed, the concept was clearly recognized by Vanderbilt and others. However, a detailed treatment of how, why, and when the use of strategic control points can be advantageous doesn’t exist (e.g., for one of the rare discussions, see the three-page coverage in Slywotzky and Morrison’s The Profit Zone, cited in note 3 above). More importantly, there has been no recognition of what is unique about today’s business environment and, particularly, the fact that strategic control points can be leveraged across industries, at light speed, and in ways we have never seen before.

• The business of a strategic control point may or may not be profitable in its own right. Don’t require it to be its own profit center. For example, buying up the world’s supply of pumps in the Softsoap® example wasn’t profitable on its own, but it enabled the Minnetonka corporation to build its Softsoap® business.

• Gaining control over the part of the value chain with strategic control enables greater value extraction at other points in the value chain.

• A strategic control point provides the basis for a sustainable competitive advantage; thus, it should not be temporary or fleeting unless the objective is short term in nature (as in the Softsoap® example).

• There can be more than one strategic control point. Alternatively, there may not be any.

• Strategic control points are not binary (i.e., there is a continuum from low to high).

• Strategic control is market- or industry-based, not firm based. You try to have unique capabilities in one area of the market that, if controlled, allows for disproportionate margin attainment.

• Strategic control points must be “rivalrous” in nature; if everyone has capabilities in an area of strategic control, it isn’t a strategic control point.

• A strategic control point must result in something that is important to the customer. After all, if a strategic control point doesn’t help generate something that the customer truly needs or wants, who cares?

• Nevertheless, it can’t just be about this. For example, salt is important to the customer; however, it is just a commodity, since many can produce and deliver salt to the market.

• Often, a valuable question to ask is: “If one of my competitors gained control of this strategic control point, what would this do to my business?” If the impact would be negative, it may be important to form a defensive strategy.

• Is the investment commensurate with the rate of return? Sometimes, the investment in the strategic control point can be prohibitively expensive, and hence it may not make sense to compete in this market. Decisions of this sort are crucial to success.

3 An original source dates back to Adrian J. Slywotzky’s and David J. Morrison’s The Profit Zone: How Strategic Business Design Will Lead You to Tomorrow’s Profits (New York: Crown Business Press, 1997). They cover this in a mere three pages, but it is an important concept that is extended beyond a single market here. The key is to leverage points of strategic control across markets. For an excellent and prophetic look at strategic control in the context of investment in information across the extended enterprise, see Benn Konsynski, “Strategic Control in the Extended Enterprise,” IBM Systems Journal, 32 (1), January 1993, 111–42.

7 The most recent year for which data are available is 2015. Source: Hanley Wood, “Faucets Used the Most by Construction Firms in the United States in 2015,” Statista – The Statistics Portal, Statista, www.statista.com/statistics/307423/most-used-faucets-brands-in-the-us/. Accessed 12 March 2019.

10 Source: author. Unless otherwise noted figures have been provided by the author, throughout.

13 Source: Vivek Wadhwa, “When Your Scale Talks to Your Refrigerator: The Internet of Things,” 14 March 2016: http://wadhwa.com/articles/, accessed on 18 March 2019, and used by permission of Vivek Wadhwa.

16 In principle, this act of tying is one that Microsoft faced with the U.S. and EU action vis-à-vis its Internet Explorer. Legal issues are discussed later in this book.

18 Alternatively, some have argued, that since Facebook (for example) earns $34.86 a month in revenue for each user in the United States and Canada, you should be paid for using Facebook. The argument is an interesting one, with merit. Source: Statista, “Facebook’s Average Revenue per User as of 4th Quarter 2018, by Region (in U.S. dollars).” In Statista - The Statistics Portal. Retrieved 29 June 2019, from: https://www.statista.com/statistics/251328/facebooks-average-revenue-per-user-by-region/.

19 The names of the companies, the industry, and the numbers have been changed to disguise the industry and firms involved.

22 Rita Gunther McGrath, The End of Competitive Advantage: How to Keep Your Strategy Moving as Fast as Your Business (Boston: Harvard Business School Press, 2013); Adam M. Brandenburger and Barry J. Nalebuff, Co-opetition: A Revolution Mindset That Combines Competition and Cooperation: The Game Theory Strategy That’s Changing the Game of Business (New York: Doubleday Business, 1996).

23 For an interesting and rigorous, albeit controversial, take on this question, see Lina M. Khan, “Amazon’s Antitrust Paradox,” Yale Law Journal, 126 (3) (2016): 709–805. Available at: https://digitalcommons.law.yale.edu/ylj/vol126/iss3/3.

Terrestrial	Non-Terrestrial	Key Players
Fiber interlaced with Wi-Fi		Google, AT&T, Verizon
	Satellite	SpaceX
		OneWeb Satellites
		Blue Origin
5G (chips)		Intel, Qualcomm, Huawei
5G (network)		Nokia, AT&T, Verizon
		Google
	Drones	Airbus
	LEO Balloons	Google
Tier 1 “backbone” providers	Traditional	CenturyLink, Cogent, GTT,
	Tier 1 ISP	Telia, NTT, Tata, T1 Sparkle