The Carrot and the Stick: Leveraging Strategic Control for Growth

What can you do if someone else has a unique competency in a point of strategic control? Is it rivalrous or non-rivalrous?

It was the early 1880s and John D. Rockefeller had a problem. While his company, Standard Oil, controlled some 90 percent of U.S. refinery capacity, Cornelius Vanderbilt and Tom Scott (owners of by far the two largest railroads) agreed to make their most significant client, Rockefeller’s Standard Oil Company, pay “going rates” on shipping oil by rail.1 Previously, Rockefeller had received significantly discounted rates, which provided him with a substantial cost advantage (over the few rivals that he did have) and better margins on the oil that he sold. Rockefeller viewed the rate increase as a declaration of war and vowed to find another way. Unfortunately for Rockefeller, rail was the only way to get oil from a number of oil fields to his refineries and was thus a classic strategic control point. When it came to getting his oil from point A to point B, he was “on the outside looking in.”

Rockefeller’s solution was to find his own alternative to the strategic control of the railroads – build a pipeline. Beginning with a majority stake in the Tidewater Pipe Company, his companies laid one and a half miles of pipeline a day, eventually constructing a pipeline that was more than 4,000 miles long – connecting lucrative oil wells across Ohio and Pennsylvania directly to Standard Oil refineries. While it was a huge task that only a Rockefeller, Carnegie, or Vanderbilt could have undertaken at the time, it was also a huge success. The marginal cost of shipping oil to the refinery was now close to zero, and all margins were internalized to Standard Oil. Better yet, Rockefeller had won his war against the railroads by making what was once a critical strategic control point into something that was no longer even a part of the kerosene production value chain. Brilliant.

As a brief aside, it is ironic that once the pipeline was constructed, Rockefeller no longer needed the railroads; however, the railroads increasingly needed his oil as the volume of shipments by rail plummeted at the turn of the century. The railroads had forced him into a corner that pushed him to do something (i.e., construct a pipeline) that led to their own irrelevance.

We now focus on seven potential strategies for overcoming someone else’s strategic control point. Specifically, what do you do when someone else owns that key point of strategic control? – something we refer to as being “on the outside looking in.”

As with Rockefeller’s solution of building a pipeline (the workaround for the stranglehold that the railroads had on oil shipments), there are various strategies for working around points of strategic control that are owned by someone else. We break these down into seven main strategies:

Sometimes you can’t easily access a point of control, and so you need to find a strategy to work effectively around it. Apple, with the success of its iTunes platform, had tied customers to its iTunes, iPod, iPad, and iPhone by pulling all of their music, apps, and information into a single, interconnected platform; given the early development of the App Store, users typically spent hundreds of dollars on apps. Thus, they would have to start all over again if they were to switch from Apple’s iOS and still wanted the same, or similar, apps on their non-iOS-based smartphone. Indeed, for smartphones, the OS (operating system) is incredibly “sticky.” How many of us have faced this same dilemma? You like that new Samsung; however, you have a number of Apple devices and are thus part of the Apple “ecosystem.”

So, let’s examine the strategic options available to Google when they developed a strategy for the Android operating system after purchasing Android, Inc., in 2005:

a. Become an iOS app developer. If you can’t beat them, join them; after all, tough competitors (e.g., Nokia, RIM, Dell, Palm, and Microsoft) had tried to beat Apple at their own game and all had failed – often dramatically.

b. Go it alone and beat Apple at its own game. Move forward based on the belief that it is possible to do this better and more successfully – even with Apple’s iTunes and App Store dominance (and its point of strategic control growing stronger as the iPhone penetration and cumulative spend on existing iOS apps have increased over time).

c. Find a way to bring the collective of the industry together to fight Apple’s iOS strategic control point – of course using the Android OS as the instrument.

Google wisely chose Option C, combined it with incentive alignment (Google gave carriers 30 percent of the Android app store cut), and attempted to develop a viable strategy to “find a release” from Apple’s strategic control. Fred Vogelstein in Dogfight: How Apple and Google Went to War and Started a Revolution, tells the story well:2

But by 2010 it was also clear that Rubin and Android were playing a much more sophisticated game than Apple’s previous competitors. To them the hub wasn’t the laptop or the desktop computer, but the millions of faceless machines running 24-7 in Google’s giant network of server farms – now often referred to as the cloud. Connecting and syncing with a personal computer – the way iTunes was set up – was necessary when devices didn’t have wireless capability or when wireless bandwidth was too slow to be useful. But in 2010 neither was true, prompting Rubin and the Android team to ask, why tether users to one machine when the Wi-Fi and cellular chips inside smartphones are fast enough to let them have access to their content on any machine? Android now wirelessly synced with virtually all mail, contact, and calendar servers – whether stored at Google, Microsoft, or Yahoo!, or at a worker’s company. Music and movies could be downloaded from Amazon in addition to the iTunes store. Spotify and Pandora offered music subscription services for small monthly fees. Developers were scrambling to make sure that all of the programs inside the Apple app store could be found inside the Android app store too. As for all that content trapped inside iTunes, Google and the rest of the software industry were writing programs that made it easier and easier to get it out and uploaded to Google – or anywhere. With many new ways to download and enjoy content on Android devices, the penalty for using a non-Apple device that wouldn’t connect to iTunes was diminished. Freed from this control, users were choosing Android devices in droves. ...

Thus, Google incentivized carriers to adopt, sell, and push Android-based phones via an offer of 30 percent of the cut of associated Android app store sales; as a result, it was able to significantly lessen Apple’s strategic control. As Android adoption grew and as the proliferation strategy of Samsung and others continued to succeed, the position of Google in this space only improved over time.

Google used the lessons discussed earlier by providing a “carrot,” vis-à-vis incentive alignment (by giving 30 percent of Android app store revenue back to the carriers), and a “stick” (finding a way to effectively lesson Apple’s point of strategic control) to fight back against Apple (methods more effective than those used earlier by Dell, Palm, Nokia, RIM, Microsoft, and other very strong players). How can you learn from this? What can you do in your industry?

Finding creative ways to lessen existing points of strategic control is not limited to high-tech solutions. Sometimes you can find low-tech solutions to high-technology problems.

“High-frequency trading” is a fancy name for an automated trading platform – used by large investment banks and institutional investors – that utilizes powerful computers at extremely high speeds. The speed of the trades is crucial, and those trades that are executed from locations closer to Wall Street in lower Manhattan can often have a micro-second(s) advantage on a trade, an advantage that can make a significant financial difference on high-speed, high-volume trading. In fact, locations closer to Wall Street command a real-estate premium, and the popular press has often commented that our financial system is not fair – that institutional investors have an advantage over the average investor like you and me. Michael Lewis addresses this in detail in his 2014 book Flash Boys.3

The star of that book is Brad Katsuyama. Brad started his career at the Royal Bank of Canada (RBC) and help developed a software solution to try to level the playing field. The solution was to put in a delay so that every order was executed on a level playing field: every order placed at the same time would arrive at the same time.

He decided to use this as the basis to start his own exchange, IEX, co-founded in 2012 with Ronan Ryan, to rival the giant NASDAQ and New York Stock Exchange (NYSE). He wanted an exchange where every order was executed fairly. His problem was that RBC owned the software – so his solution was ingenious and “old school.” He built a box, a physical box, with thirty-five miles of fiber optic cable built in. Why thirty-five miles? It turns out that most high-frequency traders were located within a thirty-five-mile radius of Wall Street. Thus, he could put a physical delay into any order so that an order placed in the next building on Wall Street would be processed at the same time as one placed at the same instant somewhere in New Jersey thirty-five miles away. Leveling the playing field, in this case with an old-school, low-tech solution, was his strategy to break the strategic control point held by existing exchanges, NASDAQ and the NYSE (the Securities and Exchange Commission [SEC] approves all exchanges, and their regulatory approval was the key point of strategic control). With the significant pressure on the SEC to approve the “fairer” exchange, IEX was granted approval in June 2016 and began operating in September 2016.4

What is important to note here is that the existing point of strategic control held by NASDAQ and the NYSE (under the auspices of SEC regulatory approval) was overcome only by putting pressure on the SEC to approve a “fairer” exchange, thereby lessening the incumbents’ point of strategic control. And it was achieved with an ingenious, low-tech solution!

Finally, recall the earlier example of placing sensors on windmills; this had a similar impact – namely, to lessen the point of strategic control owned by the two big windmill players, GE and Siemens. In this case, the company was finding a way to help weaken a point of strategic control that was also a barrier to others (e.g., in this case, smaller, Chinese windmill manufacturers), thus presenting firms with an entirely new business model.

The classic strategy for overcoming another firm’s point of strategic control is to take advantage of a rival’s slow reaction to market change; this is something that often happens when a firm becomes addicted to the current revenue of existing products. This approach is classic and one that has been used in more industries than we can count. Indeed, companies often have a “cocaine problem” – not a literal cocaine problem, of course, but a metaphorical one. They are hooked on the drug of their existing business. The classic example is the now clichéd Kodak story. Indeed, Kodak should have owned digital photography; however, it was wedded to its film business, which made it slow to move to the digital world.

Modern-day examples of this include Nokia and BlackBerry. In 2005, BlackBerry (then called RIM [for Research in Motion]) controlled the enterprise smartphone market, and Nokia controlled the handset market. Apple recognized how both firms were slow to change in response to the emerging technologies (e.g., smartphones) that have since come into mass use. Ease of use and design – along with technological improvements – allowed everyday users to browse the internet, send email, and use apps. As with numerous other examples over time, Apple took advantage of Nokia’s addiction to handsets and RIM’s addiction to the corporate enterprise user and recognized that – precisely because of these addictions – these firms would not react quickly enough to a key emerging market (i.e., smartphones for the masses).

A more recent and perhaps more relevant example is that of Olli. Imagine needing a ride home from your favorite watering hole. You might call a taxi (or use Flywheel, Uber, or Lyft); however, there is little room in the existing “transportation” market for other competitors these days – particularly given the cost of vehicles and the regulatory environment. Until now.

Imagine pulling out your smartphone – or your wearable device – and simply saying “Olli, take me home.” Olli comes and picks you up, talks to you on your way home, drops you off at your door, automatically bills your credit card, and sends an email receipt (much like Uber does). The only twist is that Olli is a small, personalized bus that is 3D printed by Local Motors, “powered” by IBM’s Watson, and doesn’t have a driver – it’s fully autonomous. Further, Watson and Olli get to “know” you and your habits – if you want to know how the Giants did that day, just say “Olli, who won today?” Olli would know from your “favorites” list on your ESPN app that the Giants are your favorite baseball team and that they played the Yankees today. Olli would know the score and might even offer words of consolation to you if your team lost.

In fact, the autonomous vehicle market is becoming more and more competitive. If the major firms move into this space quickly, Olli’s market may be small and may not be worth the investment; alternatively, if Local Motors can gain scale with Olli (i.e., before others can transition to a partially driverless world), Olli has a fighting chance. Thus, Olli has a chance to succeed – with the caveat that speed to scale is of the essence. It now has $150 million from Airbus and $1 billion in available funding for Olli customers, secured as of late 2017.5

We are living in the age of disintermediation – when a single player or technology can disrupt a market of 100 years or more.

DEFINITIONS: DISINTERMEDIATION AND CANARY

Disintermediation: a reduction in the use of intermediaries between producers and consumers. In English, this means that we no longer need traditional providers because we can get what we need more directly.

Canary: an African finch with a melodious song, typically having yellowish-green plumage. The canary is popular as a pet bird and has been bred in a variety of colors, especially bright yellow; however, it is also known as the bird that warns of disasters. A canary can be sent down into a mine to warn of dangers. If it returns, it is safe to go in; however, if it doesn’t return, that means the mine is unsafe for humans to enter.

A non-avian type of “canary” is disintermediating a whole host of businesses – from home security and monitoring services to branded smoke detectors. Some of you reading this have a home security system, most – if not all – of you have smoke and carbon monoxide detectors, and many of you have home security cameras and/or indoor air-quality monitors to check for temperature, humidity, and particulates.6

“Canary” is a device that sits in your home and has a camera that can be viewed and monitored remotely, can send pictures or videos of an intruder, and has a whole host of monitoring sensors (e.g., that measure air temperature, humidity levels, and carbon monoxide levels and can sense when a fire has started). Canary can potentially interact with your heating system to automatically turn down the heat – or turn on the dehumidifier. Such a device has the potential to disrupt a myriad of existing businesses, such as home security and monitoring companies like ADT, carbon monoxide and smoke detector brands like Kidde, and testing agencies such as Underwriters Laboratories (UL). This is much of the reason why there is such a fight going on for home-related connectivity (e.g., Alphabet with its Nest division; the Chinese manufacturer Huawei; “Home Hub” competitors like Wink, Z-wave, Zigbee, and Apple’s Home Kit); many players are vying to control your home.

Canary is just one of many offerings that have the potential to disintermediate entire industries, much as Amazon did to traditional retailing many years ago, as Uber has done to taxi cabs, and as Airbnb has done to the traditional hotel business. Disintermediation can be one of the most effective methods of freeing the stranglehold that an owner of a strategic control point may have – witness the fact that large hotel chains controlled the hotel real estate in major cities only to be disintermediated through the internet, and taxi cabs controlled transportation via the medallion system only to be disintermediated by a sharing economy (via Uber). Technology-based disintermediation may now be the most effective and commonly used approach for disrupting markets; however, it’s not the only one. Our economy is being disrupted daily in ways we couldn’t have imagined just a few years ago.

Creative ways around a company’s distribution dominance through disintermediation have become much more prevalent in recent years and extend beyond Canary. There is often a common theme across many of the examples of industries that have been disrupted in recent years: dissatisfaction with the current offerings in that industry (e.g., the high cost of eyeglasses and men’s razors; the poor performance and lack of availability of taxi cabs).

Disintermediate through alternative “points of access.” Warby Parker. Two Wharton students were on a camping trip when one lost a recently purchased – and very expensive – pair of eyeglasses. After much consternation, the pair (pun intended) set out to revolutionize the eyewear industry. On their website, they explain their rationale as follows:

Every idea starts with a problem. Ours was simple: glasses are too expensive ... It turns out there was a simple explanation. The eyewear industry is dominated by a single company that has been able to keep prices artificially high while reaping huge profits from consumers who have no other options ... We started Warby Parker to create an alternative.7

They didn’t attack incumbents directly through traditional retail outlets. Instead, they sold exclusively online, using “pop-up” stores (temporary stores located in prominent locations) and traveling buses to help promote the brand. Their business model is straightforward: a customer picks out five frames online, and Warby Parker FedExes a package with these frames for you to try on at home. You pick out the one you like, order online, and send the package back (prepaid) via FedEx – or send the package back and order a different set of five frames. You can try them on at the location of your choice, with your spouse, partner, or friend to provide feedback (“Did you really choose THAT frame?!”), all at your convenience. The finished product is then delivered in a few days to your home. As a result, online sales of eyewear products in the United States have taken off, and in 2018 Warby Parker was valued at $1.75 billion in a pre-IPO investment of $75 million.8

Disintermediate by sidestepping regulatory authorities. Uber, Lyft, Airbnb. The stories of Uber, Lyft, and Airbnb have been told so many times, there is no need to repeat them here.9 However, one could argue that each of these companies has been able to succeed because they have found ways to circumvent government regulations. Uber was able to “ride share” so that they would not (at least in theory) be subject to medallion restrictions, and Airbnb found a way around regulations that would have required room sharing to be regulated (and taxed) under municipal hotel codes.10

Disintermediate by going online and employing a subscription model. Dollar Shave Club and Harry’s. Dollar Shave Club was founded by Mark Levine and Michael Dubin in 2011 after they met at a party and spoke of their frustrations with the cost of razor blades. There had to be a better way, they argued. Launched online in 2012, their company offered a subscription model with three tiers whereby razors are delivered to your door monthly rather than being purchased at a brick-and-mortar retailer. Five years and more than three million subscribers later, the company was acquired by Unilever for more than $1 billion (from Unilever’s perspective, “If you can’t beat them, join them”). Harry’s, founded in 2013, uses both a direct-delivery and a retail approach to addressing the same concern (the high cost of men’s razors) that prompted the founding of the Dollar Shave Club. Recently, Harry’s has been valued at just under $1 billion.11 Disintermediation through a “judo strategy” (not attacking larger rivals directly) pays – in men’s razors, to the tune of $1 billion!

Disintermediate via a multi-faceted approach to distribution. Globe Union. To overcome traditional distribution brand concentration, Globe Union employs a multi-faceted approach. They use two private branded products, Danze and Gerber, to sell outside of big box retail (these two brands, by design, do not sell to big box stores). Instead, these two brands sell almost exclusively through two-step distribution (distribution to wholesalers to plumbers or builders). In big box, Globe Union’s parent company, Industrial Corporation in Taiwan, manufactures and sells private label products for big box stores, giving them access to both big box (via the private labels) and plumbers/builders (via Gerber and Danze). It also uses Gerber (“the plumber’s brand”) to focus on the service plumber market.12 Thus, via this multi-pronged approach, they are able to compete effectively across multiple traditional distribution channels, enabling them to grow in ways a single-branded/single-channel approach could not.

The classic example is, of course, Rockefeller’s pipeline (as discussed earlier). Rockefeller decided to build an efficient, near-zero-marginal-cost network of pipelines to bypass the existing railroad stranglehold on crude shipments. However, there are analogous, albeit less dramatic, strategies that have worked quite well for other companies over the years. Examples are as varied as payment methods/systems, old-line manufacturing, use of unmanned vehicle technologies, and motorized bicycles in China.

Traditional credit cards as we know them, physical cards that are used at point-of-sale, are increasingly less relevant as the interface of retail payments is evolving – and converging – as in every other industry discussed in this book. In this instance, mobile payments firms such as Square allow a merchant or service provider to accept payments on their phones. Some companies are developing “payments by facial recognition.” Indeed, over time, “virtual” credit cards using certain technologies (e.g., near-field communication, tokenization, and others) will likely make physical cards obsolete. I often joke that I go to Starbucks because I don’t ever have to pay – “I just show them my phone.” I do have to pay, of course, but using the Starbucks app or using Apple Pay, Visa Checkout, Samsung Pay, you-name-it pay – with your smartphone and a thumbprint or your face – is infinitely easier than using a card with a chip. I would even take this one step further and say that once some company has figured out a way to strike a deal with the government to digitize IDs, we will no longer have to carry a wallet. Anything can be done with some sort of scan of a smartphone or, with the launch of Apple’s Watch 4, a watch on your wrist.

Amazon’s Go stores and its Whole Foods acquisition aim to eliminate checkout stands entirely (Walmart has been experimenting with doing away with the checkout stand for years). The idea is that you could just walk out the door, an RFID chip (e.g., a chip on all of the products in your basket) would automatically charge your Amazon previously agreed payment method, and an itemized receipt would be sent to your smartphone. Amazon, with its efficient distribution network, is taking this to another level.

The concept of “building a better mousetrap” to loosen existing points of strategic control applies equally to “old line” industries. As noted earlier in this book, Owens Corning is one of a few national manufacturers of roofing shingles in the United States; however, like other roofing manufacturers, it has an important problem: highly regional, variable demand. As an owner of a house on the ocean in North Carolina, I have experience of this phenomenon. A storm or a hurricane hits, and the demand for roofing shingles surges. For the homeowner, the first qualified roofing contractor who can repair the roof often gets the contract.

Lead and fulfillment are crucial for contractors; the lead is the point of control – as is supply fulfillment, at times. Nationwide and Owens Corning have a unique solution: they use satellite images of roofs to calculate the number of squares of roofing material that might be needed in advance of a storm. Thus, when associated contractors show up at your door, they are ready with not only a secured/ready supply (and an estimate of how many roofing “squares” are needed) but also a preapproved insurance settlement (from Nationwide). Approximately 95 percent of estimates go to contract and result in completion of the job.13

The use of drones/unmanned aerial vehicles (UAVs) in home inspections and mortgage approvals is another example of “building a better mousetrap.” Quality home inspectors are often in short supply in hot markets. Thus, some companies are using drones to do local appraisals, a strategy that can save both time and money and increase the number of appraisals that any one appraiser can complete. Similarly, Indiana Limestone uses drones to try to grow the market in Asia: a customer in Korea, with a budget to spend, can log into an Indiana Limestone server and – literally – fly a drone over a limestone quarry in Indiana; from his or her desk in Korea, this individual can then pick out custom limestone from the quarry.

Still in the unmanned arena, a North Carolina company has an interesting solution to onerous but necessary OSHA requirements. For context, in quarries, vehicles are not allowed to dig in areas with vertical walls higher than six feet (i.e., the height of an average male), to guard against having a wall collapse on a driver. The solution: use an unmanned vehicle to cover the terrain – not only increasing the yield of the quarry but also saving on labor costs. They can now send an unmanned vehicle into the mine, at depths and heights that were not possible previously.

Finally, Chinese company Didi has an ingenious Uber-type app that is available in cities such as Shanghai and Beijing. China, like many other countries today, has a “zero tolerance” alcohol policy. If you drink any amount of alcohol and then drive, you go to jail – and you don’t want to go to a Chinese prison! Thus, the Uber-style app enables you to quickly find a driver who can drive you home; via the app, you can see the drivers’ faces and check their driving records. They actually show up driving a motorized bicycle that folds up and fits in your trunk. After driving your car home for you, the driver then takes his or her bike out of your trunk and drives to the next job. You, however, wake up the next morning, in your bed, and with your car right at home.

Samsung chose an interesting strategy to fight Apple’s stranglehold on not only the mobile phone market but also the entire value chain in mobile devices. Recall the earlier discussion about how Apple – back in the era of Steve Jobs – was able to control its entire value chain. How do you break into this market with the switching costs so high? How did Samsung succeed where others (e.g., Sony Ericsson, Nokia, and BlackBerry) had failed? They imitated and improved the attributes of the Apple lineup.

Of course, Samsung could not have succeeded were it not for Google. Apple’s strategic control point was significantly weakened by Google (e.g., by Google’s Android OS and Google Play). Thus, Google’s “building a better mousetrap” loosened Apple’s strategic control point, thereby presenting an opening for Samsung.

Proliferation, the business strategy of offering numerous variants of the same base product, can have a profound impact on entry success and create significant entry barriers. For example, Richard Schmalensee studied the ready-to-eat (RTE) breakfast cereal market a number of years ago and came to some interesting conclusions.14 Imagine a market opportunity for a repeat purchase product (e.g., a breakfast cereal) with 1,000 customers and no one supplying the market. If you enter first, you have the potential (sometimes referred to as available) market opportunity of 1,000 customers. Next, imagine that a competitor is thinking about entering this market after you already have. This firm would normally expect, on average, a 50 percent market share, since there would be two firms (you and this new entrant) in the market after they entered; in this context, their available market opportunity would be, at most, half (500) of yours when you entered (1,000).

Now, imagine that, after these two firms have entered the market, a third firm is also contemplating entering this market. They naturally might expect at most one-third of the market or about 333 customers (i.e., far less than your original 1,000). Thus, the incentive to enter decreases after more and more firms have entered.

Alternatively, now imagine that, before the second firm has entered, you introduce a total of nine products – each somewhat different from the others – so that your offerings cover every available option in this space. With nine products in the market, each product might, on average, be expected to get one-ninth of the total market. Now, if the aforementioned second entrant decides to enter, this firm might be expected, on average, to get one-tenth of the market (i.e., just 100 customers), since there are now ten products in the market (assuming that all products split the market roughly equally). Taking this one step farther, imagine that you introduced nineteen slightly different products spanning the options in the market. Then, if this firm considers entering the market, it might reasonably expect just one-twentieth of the market (or just 50 customers).

So, we’ve gone from the original new entrant with a market opportunity of 1,000 customers down to just 5 percent (50 customers) as a result of the first firm’s strategy of proliferating the number of offerings in the same market. As incumbent firms “proliferate” their offerings, the motivation to enter for any new firm is reduced. Thus, proliferation can provide significant entry barriers, something that has been confirmed in multiple industries.15

What if there is no way to differentiate your product? What if you are increasingly commoditized and there is no way out? Do you exit the business or are there ways to win even here? Occasionally, when evaluating the value chain in their own – and related – markets, firms find that there are no avenues for strategic control and little in the way of margin opportunities within the market (i.e., a classic “commodity trap”) – a market that should generally be avoided at all costs. However, a few recent developments suggest that some ideas might be worth pursuing before you decide to give up on a market. The first, used by Intel and others to extract higher margins on largely commodity products, is illustrated by an example involving sushi and sushi rice. The second example is one that posits that a marginal advantage can be parlayed into a much bigger one via the right strategy. The key is utilizing the entire value chain – much as Amazon has done over the years. Sometimes owning the value chain back to ront can, in and of itself, give you a point of strategic control that no one can match.

Sushi restaurants and one-way fares – other leverage opportunities. Recent research has pointed out another potential way to extract margins within the value chain – even for commodity or low-value-added products. Imagine the following example: you own a sushi restaurant. You obtain two basic ingredients from key suppliers: 1) sushi rice, a commodity product that can be stockpiled and for which a continuous and regular supply is available; and 2) fish, which is perishable and volatile in terms of its demand (due to often highly unpredictable restaurant traffic flows) and which also requires a fair amount of customization from the supplier. One would think that the margins on the rice (a commodity product) would be small and the margins on the fish would be extremely high. In fact, research16 has uncovered that the margins on the sushi rice were relatively high. Why? Simply because the rice is consistently in demand and can be stored; for this reason, “overpaying” on the rice makes sense for both parties and facilitates contractual supply on the fish (including delivery, customization, and support) that is required on a daily basis.

Can you connect a commodity product to a value-added product so that the steady supply of the value-added product is guaranteed by the supply of the (now higher-margin) commodity product?

This is an interesting twist on the age-old practice of connecting supply issues with customization, perishability, and commoditization. Whenever possible, leverage strengths in one part of the competition to extract better terms in another part of the chain.

Another example illustrates a firm’s advantages associated with owning the value chain back-to-front. Imagine two airlines competing on a given route between City 1 and City 2. Airline A has ten trips a day from City 1 to City 2 and ten trips back. Airline B has only one a day in each direction. So, on average, Airline A has a ten-to-one advantage over Airline B in each direction (since they have ten times as many choices in each direction).17

Question: Under this structure, how can Airline A dramatically increase its advantage in the market?

Answer: Do not allow one-way ticket purchases. If Airline A does not allow one-way ticket purchases and requires customers to purchase round-trip tickets (essentially “bundling” the two one-way tickets), its ten-to-one advantage grows to a hundred-to-one, since there are 100 combinations that you can purchase from Airline A but only one combination that you can purchase from Airline B (as figure 4.2 suggests).18

By changing the rules of engagement, the company has turned a commodity into a strategic advantage. Although it’s often not possible to change a commodity into anything but a commodity, when there is a chance to do so, creative strategies can be effective. The sushi and rice example was derived from Intel’s strategy across customized versus non-customized chips, for example. The airline example is a real one involving a common practice on certain routes.

By way of analogy, Amazon controls its entire value chain back to front. We can’t order from Amazon, arrange delivery from someone else, and pay the seller directly; everything goes through Amazon. Moreover, today they are using what is known as an advanced programming interface (API) as a point of strategic control across platforms. Amazon gives companies an API tunnel to develop an offering to integrate into their systems, and you can run with it; furthermore, the more that is available throughout Amazon’s system, the more they control the value chain. The result is on a par with the airline example – magnifying an advantage that is already there (the whole is greater than the sum of the parts), which is something exceedingly difficult to imitate.

7. Surrender to the curve. Recognize that the only way to compete is to leverage someone else’s point of control.

In extreme cases, the market throws you a curve. For example, Blockbuster had a great business model years ago, renting video-cassettes and then DVDs until other companies (e.g., Redbox and Netflix) came along and made the rental business fiercely price competitive. Also, Netflix had a great business model years ago, distributing DVDs via mail until streaming became mainstream. How then, if you are Netflix, do you address today’s fiercely competitive, mostly commoditized content-streaming market? You surrender to this curve, recognize that it is inevitable, and give in. Focus on other ways to achieve strategic advantage. For Netflix, this means two things: (i) original content that is unique to Netflix and generates a loyal set of viewers/customers, and (ii) analytics so that they appear to know your tastes better than you do and always seem to have the right movies for you.

There’s an old saying: “Find a way.” Good leaders find a way. When it comes to strategic control and you’re on the outside looking in, find a way. Use this to your advantage – sketch out your industry and, if you find yourself “on the outside looking in,” deploy one of these approaches. It’s better to be on the inside looking out!

• Recall the story of Rockefeller’s pipeline – and the stranglehold that the railroads once had on oil shipments. There are often strategies for working around points of strategic control that are owned by someone else (and they are usually less dramatic and costly than the Rockefeller solution).

• As we noted in in the previous chapter, first-mover advantages associated with strategic control can be sustainable and lasting; however, first-mover advantages associated with product attributes are typically ephemeral.

• In the event that you are in a commodity business, the best option may be to exit; however, in the event that you are committed to the market, certain strategies (referred to as tying and bundling) may be effective – albeit subject to antitrust scrutiny.

1 Source: The History Channel’s The Men Who Built America, episode 2, www.history.com.

2 Source for both the quotation and the 30 percent figure used in this section: Fred Vogelstein, Dogfight: How Apple and Google Went to War and Started a Revolution (New York: Farrar, Straus and Giroux, 2013), 141–2.

3 Michael Lewis, Flash Boys: A Wall Street Revolt (New York: W.W. Norton & Company, 2014).

4 The details here on IEX come from numerous personal conversations with IEX executives, including but not limited to Brad Katsuyama, Laurence Latimer, and Gerald Lam, and from their presentation at the Yale School of Management on 19 July 2017.

6 I thank Christian Anschuetz, chief digital officer for UL, LLC, for this example.

10 Thanks to Keith Williams, president and CEO of Underwriters Laboratories, for this observation.

12 Typically, when a service plumber responds to a call from a homeowner with a leaky faucet, he or she arrives with a truck that contains everything required for a repair job (e.g., equipment, tools, and replacement parts) – as well as a few “extras.” One of the biggest sources of revenue for the modern-day plumber is the “upsell”; rather than just doing the repair job, they try to upsell you, for example, to purchase a shiny new faucet to replace the one that your grandfather installed back in 1927. Special thanks are owed to Brian Fiala at Globe Union for his help on clarifying details about the U.S. faucet market.

13 Source: Numerous internal company conversations (original quote from Brian Chambers in 2016, president of Owens Corning, who was recently named as incoming CEO in 2019, replacing Mike Thaman).

14 See Richard Schmalensee, “Entry Deterrence in the Ready-to-Eat Breakfast Cereal Industry,” Bell Journal of Economics 9 (2) (October 1978): 305–27.

15 For further reading on the effects of product-line proliferation, see Barry L. Bayus and William P. Putsis, Jr, “An Empirical Analysis of Firm Product Line Decisions,” Journal of Marketing Research, 38 (1) (February 2001): 110–18; and William P. Putsis, Jr, and Barry L. Bayus, “Product Proliferation: An Empirical Analysis of Product Line Determinants and Market Outcomes,” Marketing Science, 18 (2) (1999): 137–53.

17 This is, of course, assuming all other things are held constant. That is, it may be that the optimal thing for Airline B is to schedule its one flight at the peak travel time; however, if there is excess capacity at other times of the day, the advantage is less than ten to one. There are other nuances that may make the advantage different (versus precisely ten to one), but the essence of the argument made here remains the same.