The Carrot and the Stick: Leveraging Strategic Control for Growth

In this story, the perfect storm happened during a time of prosperity. It was late 2012, and Apple could do no wrong. It had been able to control the value chain from front to back with complete autonomy – and extract superior margins as a result. Apple, like many companies before it, felt that it could do anything and everything better than its competitors.

Apple was convinced, correctly, that the future was not in wired devices. The “cloud” was connecting devices to the internet, and devices were becoming interconnected in houses wirelessly – this was the future. However, Apple was saddled with ten-year-old plugs on all of their devices that interconnected audio and video, and they still needed to encourage customers to move over to a wireless world.

If you think about it, Apple had every incentive in the world to facilitate this changeover back in 2012 because of their interconnectivity (e.g., of iTunes libraries with iPhones, iPads, and computers). This is what had made Apple “sticky”: once you bought into the Apple “ecosystem,” another type of product wouldn’t be able to interconnect with other devices (by design), and hence the barrier to switching to another system of devices was formidable.

So, what were Apple’s options at the time as they switched to a new system that consisted of a charger and sync device (i.e., the “lightning” plug), which were combined with wireless playback of video and audio via your Wi-Fi network at home and a cloud-based system outside your home? Apple had two main strategic options:

1 Leverage its strong brand name and the “lock” it already had on its customer base by leveraging every penny out of the new cords and accessories (via huge margins and high prices). After all, much of this book has been about leveraging strength in one market for gain in another. Apple had the potential to extract huge margins on cables and related accessories and – as this line of thinking goes – they should have extracted every penny that they could.

2 Recognize that the key is creating – and keeping – a “lock in” ecosystem for users; thus, Apple needed to avoid creating product-related purchasing barriers – and thus facilitating a switch to rival products. Think of this as the razor/razor blades problem in reverse: (i) give away (or nearly so) the cables, cords, and devices that let customers interconnect all of their wireless devices and (ii) make your margins on the actual products (e.g., iPhones and iPads). If you want to encourage customers to move to the system of the future (wherein devices are interconnected wirelessly), you should do everything you can to make it easier for them to do so.

What did Apple do? They overplayed their hand and overestimated the willingness of their customers to pay anything at all for Apple products. They introduced new cables and accessories at exorbitant prices (e.g., $29 for a simple charging cord). Further, all of the old accessories became obsolete even though there was a simple solution to keep them functional: Bluetooth adapters (which came into the market in force about a year later). Moreover, a rival (Samsung) was about to introduce a successful rival product (i.e., the Galaxy S4) that gave away a wireless HDMI audio/video adapter.

Add to this the perfect storm – the Apple Maps fiasco. Apple forced users to use their new proprietary map app – one that quite often got the directions wrong! At the time, Google Maps worked quite well; however, it wasn’t approved for the new phones and operating system. Not coincidentally, Apple began to appear fallible, and its stock price reflected this – falling from a record high of more than $700 a share to, at one point, less than $400 a share.1

We call this “blowback to the core” – when you overplay your hand and it negatively affects your core business. Apple made a fundamental mistake: while they may have been able to extract huge margins on accessories, it made little sense for them to do so. Customers had to spend money to replace old cables and accessories precisely at a time when rivals were catching up.

Key Takeaway: Know and protect your core. Any attempt to leverage strengths in other parts of the market or value chain should always be done when it makes it more likely that customers will choose your core.

Apple’s lightning cable fiasco pushed customers away from their core. By contrast, as discussed earlier, when Jeppesen Marine needed to leverage its core in digital navigation charts, it was able to get onto the bridge of ships and give customers an integrated suite of tools to navigate and save fuel. Pushing hard to gain such access enabled them to charge better rates for their core navigation products. Never jeopardize your core. Never.

Canonical Limited, a U.K.-based software company privately held by South African entrepreneur Mark Shuttleworth, has more than 500 employees and $30 million in revenues in more than thirty countries. Canonical focuses on open-source software across a variety of applications.2 Ubuntu is a leading Linux-based operating system produced by Canonical and is named after the southern African philosophy of Ubuntu (which is often translated as “humanity towards others”).

One of Canonical’s recent areas of focus has been on mobile operating systems (OS); it first announced plans for an Ubuntu mobile OS at the beginning of 2013 – and has been attempting since to become the third leading mobile platform in the industry (behind Apple iOS and Google’s Android). Even more ambitious, Chinese phone makers BQ and Meizu, anxious to differentiate themselves in the market, announced their plans to manufacture smartphones based in the Ubuntu Linux-based operating system – potentially a huge coup for Canonical because of the size of the Chinese market and the power of BQ and Meizu.

The “human-ness” of Ubuntu as “open-source” and free has taken on a somewhat ironic twist in the market as it faces the “stick” strategy of strategic control exerted by one of its most powerful competitors; this illustrates the potential power and pitfalls of strategic control to keep new entrants and rivals at bay.

In an absolutely classic application of the concept of a strategic control point, Apple bought up enough sapphire glass to supply other companies for years – effectively buying up the world’s supply of sapphire glass for three years. This is key, because sapphire glass was thought at the time to be a critical component in today’s smartphone manufacturing because of its super-tough, scratch-resistant properties. How many of us have dropped our iPhones and marveled at how – somehow – they didn’t break or scratch?

Imagine Canonical’s frustration. They’ve seemingly done everything right. They developed a well-supported, open-source, free operating system that is highly rated and sourced key manufacturers in a critical region of the world to manufacture new smartphones based on its mobile operating system; however, they found that a commodity needed for the production of its phones was now owned, for three years, by a key rival – Apple. In a seemingly brilliant move, akin to Minnetonka’s buying up of the world’s supply of pumps when it introduced Softsoap®, Apple could now focus on what matters most to their success in mobile phones: competing with Google’s Android platform – with all other competitors kept safely at bay. Brilliant. Or so it seemed.

Apple’s control of sapphire glass was a classic example of a strategy that went awry – not for strategic but for operational reasons. Apple delayed introducing sapphire glass during the launch of its steel and gold Apple Watches; there were quality issues associated with the new furnaces at its supplier’s Mesa Arizona plant. Apple’s chief supplier of sapphire crystal – GT Advanced Technologies (GTAT) – committed to building larger furnaces to meet Apple’s scale requirements only to find out that the quality of the sapphire produced by the furnaces didn’t meet Apple’s quality requirements. GTAT also found the terms of its contract with Apple “oppressive and burdensome,” according to court papers, and eventually filed for bankruptcy. The end result was that Apple wrote off more than $1 billion on the furnaces at GTAT’s Mesa facilities.3

Even with strategic control points, “the best laid plans of mice and men often go awry” – and this is no less true for Apple and sapphire glass.

In business, convoluted logic abounds. One recent example involves AT&T U-Verse, which gave up a no-cost annuity by refusing to correct an employee error. The following is a true story. We had just moved into our beautiful new home within walking distance of shops, tree-lined streets, and other quaint houses. Since I often work at home, internet provision was important. So, we focused on ensuring that we had internet ready to go from the start.

We decided to equip our new home with AT&T’s U-Verse service – which included internet, television, and phone service for about $200 a month. AT&T came on-site and installed all services, and we were up and running. However, just three days after closing on our new home, we received an “overdue” bill from AT&T stating that we owed them $260 – now overdue for more than a month. Obviously, this was an error of some sort since we had just moved in within the past week. We called AT&T and were told that this was due for the previous six weeks of service. When we told the customer service representative (and her supervisor) that this must be an error since we had only been in the house three days, we were told that we were being billed from the time the previous owners had called to stop service – a full six weeks before we had even owned the house or moved in! I then told the supervisor that we obviously weren’t going to pay for the previous owners’ service. AT&T then had two choices: (i) take the previous owners’ charges off our bill and correct this error or (ii) connect me to whomever could immediately disconnect and cancel our service.

1 They could correct this error and remove any charges from before we moved in – essentially refunding the incorrectly billed $260 (and presumably contacting the previous owners to collect what they owed). Even if we legitimately owed this $260 (which we did not), refunding $260 would have enabled AT&T to keep us as a customer. This would have given them an annuity of $200 per month for the next 10 years (the time we expect to be in this home) with essentially no marginal cost of service provision – all for a one-time “cost” of $260. Under this choice:

2 Refuse to budge on their error and lose us as customers. At best, they might collect $260, but they would lose 10 years × 12 months × $200 per month in revenue. Under this choice:

What did they do? They connected us to the disconnection department. Within about three minutes, they had lost us as a customer forever – losing approximately $24,000 in revenue over 10 years!4 We are now happy Comcast customers.

Interestingly, research on “service recovery” has indicated that customers are considerably more likely to buy from companies associated with service errors that were handled in ways that exceeded expectations than from companies with no errors.

The old saying that “the writing is on the wall” is relevant when spotting trends in business. Holden Beach is a small town in Brunswick County on the North Carolina shore; it was home to two small hardware stores (including a local True Value store) that competed with the larger Home Depot and Lowe’s that are twenty minutes away in the “booming” big town of Shallotte. About two years ago, the True Value store reorganized the floor space – shrinking the hardware floor space by 50 percent and opening a consignment store in the other half. This was a surefire sign that the store’s bankruptcy was not far behind. Sure enough, shortly thereafter they liquidated inventory with a “Going out of Business” sign on the storefront, and the store has since closed. Similarly, the True Value in Durham, North Carolina, rented space to a pharmacy and closed its doors about six months later. These “signs” are the first indication that the end is in sight.

Conversely, the sooner you know that you have won the war the better; it tells you when you can afford to take your foot off the pedal. In Compete Smarter, Not Harder, I told the story of Blockbuster’s early dominance of the video rental business, based on a strategy of “stocking deep” (i.e., having enough of the current titles on hand so that you can always get the most recent title at Blockbuster). Local “Mom and Pop” video retailers generally couldn’t afford to match such a strategy since they didn’t have the “deep pockets” of a Blockbuster. Wayne Huizenga, the CEO of Blockbuster at the time, said that Blockbuster knew it had won the war (beating out the local video rental stores) the minute the Mom and Pop stores would put up the “2-for-1” signs on their doors.

These signs are incredibly easy to spot when you know where to look. For example, retailer Barnes & Noble generated $3.66 billion in 2018, down from over $5 billion back in 2013.5 Worse yet, they experienced a series of declines in online sales over much of this time period as well (e.g., 15 percent and 14.4 percent year-on-year declines in 2015 and 2016, respectively).6 To add to these woes, the Wall Street Journal noted Barnes & Noble’s “Mystery of Vanishing Sales”7 – the fact that a smaller and smaller proportion of Barnes & Noble’s sales at its brick-and-mortar stores are associated with books. Toys, games, e-readers, and novelties make up a larger and larger portion of their sales. Sales continued to fall through at least the second quarter of 2019 (when they reported a net loss of $18.7 million, or 26 cents a share).8 These are all telltale sign of things to come. Just like the Mom and Pop retailers being forced into 2-for-1 sales and the True Value store allocating space to a consignment shop and a pharmacy, Barnes & Noble (with shrinking online sales and having to fill brick-and-mortar space with things like toys and games) showed signs that it wouldn’t exist in its current state for long.9

The lesson here isn’t the need to move away from the core as industries and sectors evolve; rather, it is that good companies use core strength to invest in new businesses. A telltale sign of a company in trouble is a shrinking core concurrent with a failure to invest in new market opportunities; indeed, this has predicted the failure of countless firms (e.g., Borders, Kodak, Dell, BlackBerry), whereas the number of successes is considerably less (e.g., IBM, Xerox). If you’re caught in a business with a shrinking core (and fail to transform the business away from the core), you’re fighting an uphill battle; a “fire sale,” at the core, is one surefire sign that the battle is being lost!

Overplaying Your Hand – Green Mountain Coffee Roasters, Keurig, and Digital Rights Management10

Playing from strength is often crucial when utilizing points of strategic control; however, sometimes companies overestimate their market strengths and overplay their hands for a variety of reasons (e.g., arrogance, a lack of strategic discipline, overzealous senior management). One recent example is that of Green Mountain Coffee Roasters (GMCR) and its Keurig brand of coffeemakers.

GMCR is a company with a rich, colorful history. In 1981, GMCR began as a small café in Waitsfield, Vermont, roasting and selling brewed coffee. If you visit its visitors’ center in a restored Waterbury, Vermont, train station, you will read about and hear quaint stories of small-town values; an organic, fair trade product; and wholesome roots.

Keurig, founded in 1990 by entrepreneurs Peter Dragone and John Sylvan, pioneered single-serve coffeemakers via a patented K-Cup brewing system. The K-Cup system consists of single-serving “K-Cup” plastic packets (i.e., the grounds and paper filter are inside a plastic cup, with a foil seal on top). GMCR purchased a 35 percent interest in Keurig in 1996 and acquired it outright ten years later (in 2006) for $160 million.

In order to fully understand GMCR’s overzealous approach – and how they overplayed their hand – some background on the market for coffee and single-serve makers and packets is key. By the end of World War II, a handful of large companies dominated the U.S. coffee industry – Chase & Sanborn, A&P, and Maxwell House controlled a combined 40 percent of the U.S. coffee market (Folgers, Nestlé, and Hills Brothers controlled much of the rest). Starting in the early 1960s, however, coffee consumption in the United States declined from 3.1 cups per person per day (in 1963) to less than two cups per day in the early 1980s. Due in large part to a market that was shrinking, the major players were forced to compete vigorously for market share, and the U.S. coffee market became increasingly dominated by mass-produced coffee throughout the 1970s and 1980s. Inferior-quality beans were distributed through grocery retailers, and brewed coffee was sold through delis and 7-Elevens; this resulted in an opening for “specialty,” higher-quality coffee.11

At the age of twenty-six, Howard Schultz began working for Hammerplast, a U.S. subsidiary of Perstorp, the Swedish housewares company. While working for Hammerplast in Chicago, he became curious as to why a small company in Seattle – Starbucks Coffee, Tea and Spice – was ordering so many plastic coffee filters. In fact, despite having just a few outlets, it was ordering more filters than large retailers such as Macy’s. After traveling to see this small company in Seattle, he was so impressed that shortly thereafter, in 1982, he joined the company as the director of operations and marketing. At around the same time, he visited Milan on a buying trip and became convinced that there was a market for high-quality coffee inside a coffee culture (i.e., a “third place” to drink coffee besides the home and office) – all of this aided by, as he described it, the “swill” that came from mass-produced, cheaper coffee that was the norm in the United States at the time.

In 1986, Schultz opened his first retail store in Seattle and named it il Giornale after the Italian word for newspaper. He eventually bought Starbucks in August 1987, and the rest, as they say, is history. As the specialty coffee market grew in the United States over the ensuing twenty years, new opportunities appeared in the home-brewed market – somewhere between the “upmarket” (and expensive) Starbucks and the lower-end, “automatic drip” coffeemakers of the past.

While Starbucks and others pushed high-quality (and more expensive) beans into distribution for home use, others – most notably Keurig – pioneered the “single-serving” pods for home use. The main advantage of “single-serve” pods was ease of use – you could just drop a pre-manufactured “pod” into the coffeemaker, press a button, and a single serving of coffee would be produced in seconds; the quality of the coffee was determined by the coffee inside the pods. Starbucks even developed, licensed, and continues to sell pods with Starbucks coffee inside the original “K-Cup” version (patented by Keurig).

When February 2014 rolled around, GMCR (which now owned Keurig) controlled about 89 percent of the market for single-serve machines and approximately 73 percent of U.S. sales of single-serving packets, with margins of approximately 50 percent. Much of this dominant market share – and margin – was controlled via the original patents on the K-Cup system that GMCR had acquired (along with Keurig) in 2006.

GMCR’s revenue share and earnings growth started to decline after the key patents expired,12 since competitive, “unlicensed” pods (sold and distributed by third-party providers) began to penetrate the market with prices, not surprisingly, up to 25 percent lower than that of the “official” licensed pods. Without ongoing patent protection, GMCR seemingly had few available options to stem the tide of competitive, “unlicensed” K-Cup pods that were flooding the market and forcing the company to lower its 50 percent margins. Or did it? Since its acquisition of Keurig in 2006, GMCR actually possessed two points of strategic control and was playing them well.

Strategic control point 1 (2006–12) – patents. When GMCR acquired all of Keurig in 2006, it also acquired its K-Cup patents and enforced them vigorously – quite rightly: the U.S. patent system (one of the most vigorous and viable in the world) is set up to reward innovation and provide a return on investment for companies that innovate. In 2012, however, GMCR and Keurig faced the expiration of key patents.

Strategic control point 2 (2006–present) – distribution. GMCR’s “textbook” purchase of Keurig in 2006 was indeed a “strategic nirvana”: the dominant player in a fast-growing segment of the U.S. coffee market (single-serving brewers) combined with a company – GMCR – that was able to acquire a ready distribution vehicle for its coffee and had a nearly captive audience as a result of its patents. If you wanted a single-brew, easy-to-use coffee system, Keurig machines were sold at every major retailer, as well as online, and Keurig was the dominant system. The accompanying patented K-Cups were distributed in every major grocery chain, large retailers (e.g., Walmart, Target, and Costco), and were available online and via virtually every distribution channel imaginable.

Through 2012, GMCR masterfully played distribution penetration – and Keurig’s dominance in the brewers. Distribution combined with the K-Cup patents almost guaranteed dominant market share (which it had developed by 2012, with almost 100 percent of K-Cup pods and 89 percent of the single-serve brewer market). If another competitor were to enter, it would not only have to develop a new brewing system that didn’t infringe on GMCR’s patents but would also have to find a way to match GMCR distribution (on both the brewer and K-Cup side) – an enormous undertaking and a significant barrier to entry for any potential entrant/competitor.

GMCR’s dominance may have led to arrogance, however. In 2014, GMCR overplayed its hand by attempting to introduce a third point of strategic control, a move that invited competition into this space via the creation of a huge gap in the market – resulting in what we call “blowback to the core.”

Patents as a source of strategic control were no longer an option for GMCR, since they had expired; thus, GMCR turned to leveraging two other potential points of strategic control – distribution and technology – which were both implemented via coercion.

Potential strategic control point 1 – distribution. Once the patents expired, distribution became a key point of strategic advantage, as it was hard to replicate. The inevitability that competitors would enter with lower-priced, competitive K-Cups was clear; with 50 percent margins, there was just too much to be gained by third-party manufacturers and retailers alike. Wise, proactive steps would have been to recognize and move into adjacent markets ahead of the competition (e.g., as Starbucks has done so well over the years by expanding from stores to grocery retailers to new geographies and new product lines) and to lower margins on GMCR K-Cups (to decrease the incentive for competitors to enter).

What GMCR chose to do, however, invited antitrust intervention; it cut off the suppliers and partners (by agreement) that also chose to distribute “non-licensed” K-Cups. With its dominant market share in these markets, this was almost guaranteed to produce competitive lawsuits under the Sherman and Clayton acts and/or via Department of Justice/Federal Trade Commission action. (See the section in this chapter describing these key U.S. antitrust acts.) Such aggressive actions by a near monopoly – in order to cut off suppliers in an attempt to prevent competitive entry – would almost certainly raise the attention of regulators. Here, GMCR overplayed its hand, essentially inviting litigation and/or government intervention.

Potential strategic control point 2 – technology. Once the patents expired and revenue and profit growth slowed (see figure 5.1), GMCR decided to force its dominance on customers in another “creative” way. GMCR announced in early 2014 that it was instituting a “Digital Rights Management” (DRM) system on all of its new coffeemakers – in essence, a chip that would be placed on all licensed K-Cups; if the K-Cup wasn’t a Green Mountain K-Cup (i.e., if it was manufactured and sold by a competitor), the Keurig system wouldn’t work; thus it forced customers to buy GMCR K-Cups. In the absence of competitive entry (i.e., when there are other barriers to entry), such a strategy could indeed work; however, in this instance – since GMCR could no longer enforce key K-Cup patents – its 50 percent margins on K-Cups opened the door for competitors on both the machine and the K-Cup side.

Thus, in this instance, the implementation of DRM on all new Keurig machines strongly encouraged other manufacturers to enter; it created a huge gaping hole in the market for lower-priced, machine alternatives that didn’t have DRM chips built in. Thus, GMCR overplayed its hand and encouraged competition in the context of both machines and K-Cup alternatives. The implementation of a DRM chip was not a viable option for strategic control but a potential source of alienating its core customers. No customer needs or wants a DRM chip after all!

So, what would you have done under these circumstances? What should GMCR have done?

One solution would have been to use its strengths and revenue in the single-serve market to develop other, related markets ahead of its competitors. GMCR still had a huge advantage in distribution and revenue in existing markets that could facilitate entry into adjacent markets (e.g., alternative beverages, commercial markets, and even markets in new geographies). Indeed, to the extent that the DRM system was used as a “sand fence” strategy (see the earlier discussion), such a “stall” strategy could have made sense; the problem with it, however, was that it had the potential to hasten the demise of the company’s core revenue-generating product line – a scary proposition in any case!

In December 2015, it was announced that Keurig Green Mountain, Inc., would be acquired by a JAB Holding investor group for $13.9 billion in cash – a deal completed on 3 March 2016. Since GMCR stock had been battered on Wall Street for a year after the Keurig 2 DRM strategy was initiated – its share price was down over 62 percent – JAB Holdings was able to buy the stock at $92 a share (which was 89 percent higher than the company’s twenty-day moving average prior to the announcement). This was the largest premium for any acquisition in the beverage industry ever compiled by Bloomberg.14

How, then, given the discussion above, does this make sense? Sometimes there is a fit, and sometimes it just works out. In this instance, JAB is a closely held, Luxembourg-based investment firm that (i) manages the $19 billion fortune of Austria’s Reimann family,15 (ii) is run by a trio of seasoned consumer-industry executives (who were planning to mount a challenge to global leader Nestlé SA in the coffee industry), and (iii) owns a controlling stake of Jacobs Douwe Egberts, Peet’s Coffee & Tea, Caribou Coffee, Einstein Noah Restaurant Group, Espresso House, Pret-a-Manger, and Baresso Coffee. Thus, the JAB GMCR acquisition is part of a much larger strategy, making GMCR uniquely valuable to JAB (versus to the market at large on their own) – which has ready-made, tailored distribution outlets (all of these retail businesses) at the ready for its K-cups!16

JAB plans to consolidate coffee – on a par with how Anheuser-Busch InBev consolidated the malt beverage industry. As such, Keurig and GMCR – and likely Dunkin’ Donuts – fitted within a much larger strategy. Peet’s, Caribou, Einstein’s Bagels, Pret-a-Manger, and other locations provided a natural outlet for Keurig K-Cups (and a distinct positioning advantage for its Espresso House and Baresso coffees). Thus, for JAB Holdings, GMCR was uniquely positioned to provide value to JAB in ways that others were not (more recently, in July of 2018, Keurig Green Mountain, in turn, acquired the Dr. Pepper Snapple Group for $18.7 billion).17

In short, GMCR and Keurig got lucky; it is exceedingly unlikely that they built the company and positioned it for this one acquisition. Don’t build your strategy around expectation of a fortunately positioned acquisition, for it is rare when such a suitor saves the day!

Some important items to think about when planning for impending patent expiry include the following:

• Plan for patent expiry ahead of time. Leverage strengths in your core market well before your advantage dissipates. For GMCR, this would have been between 2010 and 2012 – long before they responded to declining revenue and profits by instituting the Digital Rights Management (DRM) chip. Always play from strength.

• Don’t overplay your hand; recognize the inevitable. GMCR’s DRM system had the potential to alienate existing customers and hasten competitive entry.

• Proliferate as a way to deter entry but be careful. Proliferating your product line as GMCR did by introducing a wide variety of coffeemakers and beverage pods significantly reduces the incentive for rival entry. Combine this with reduced margins (i.e., below the current 50 percent) and entry is considerably less likely than if you introduce a DRM system to preclude entry. Always seek legal advice here, as potential antitrust violations abound.

• Expand to adjacent markets before patent expiry; know that competition and margin erosion are inevitable. Starbucks has been a master at this over the years (e.g., by moving into other product lines, retail channels, and geographies).

• Find features and attributes that your customers value (rather than making them angry by forcing them to buy your metaphorical razor blades if they buy your razors).

• And, finally, don’t expect your industry’s equivalent of JAB Holdings to come to your rescue – such a fitting and happy outcome is rare indeed!

We would be seriously remiss if we didn’t discuss antitrust issues; indeed, leveraging strategic control points should always be done with the involvement of legal counsel. U.S. antitrust law is a bit of an oxymoron in that it is actually a combination of federal and state laws, federal agencies (U.S. Department of Justice [DOJ] and the Federal Trade Commission [FTC]), U.S. “antitrust” laws and policy, and legal decisions required to interpret and enforce existing laws.

There have been countless papers, books, and courses devoted to the subject; however, the origins of current “antitrust” law go back to the Industrial Revolution. The fact that we call it “antitrust” speaks to its origins. The backbone of federal antitrust law in the United States is the Sherman Act, which was passed in 1890 – at the height of the “trust” era wherein such titans as Rockefeller, Carnegie, and Morgan ruthlessly dominated the competitive landscape and drove countless smaller players out of business.18 The Sherman Act makes it illegal to attempt to form a monopoly or to restrain trade. In 1914, Congress passed the Clayton Act, which prohibited certain practices (e.g., certain forms of price discrimination and tying), and the Federal Trade Commission Act (which formed the FTC). Later, the Robinson-Patman Act of 1936 restricted a firm’s ability to give advantageous deals to large sellers in cases where the impact would substantially lessen competition.

All of these acts – and a series of related ones – are enforced at the federal level by a combination of the DOJ and the FTC. How industries and cases are allocated/divided across the two agencies is largely based on history, agreement, and a de facto division that has evolved over the years. In addition to this federal oversight, various state laws are enforced by state attorneys general and, in some cases, state agencies. Furthermore, individual companies also have the right to bring an action, under both federal and state law.

At the federal level, the use of “monopoly power” to substantially lessen competition is often a trigger for initiating antitrust enforcement action when it results in consumer harm. Think of this as containing three parts: (i) the existence of monopoly power; (ii) the lessening of competition; and (iii) consumer harm. There are various definitions and measures of monopoly power and its impact on competition; however, the “Lerner Index” and the “Hirschman-Herfindahl Index” (HHI) are perhaps the two most important indices that have historically been used. The HHI is defined as the sum of the market shares of the firms in a given industry squared. Since a monopolist has a market share of 100 percent by definition, the maximum value of HHI is 10,000 (100 × 100). Conversely, in an industry with many small players, the index can approach zero. (Imagine an industry with a very large number of firms, each with infinitesimal market shares; the sum of those market shares would be close to zero.) Highly concentrated industries with HHI greater than 2,500 will likely generate interest and potential action by the FTC or the DOJ.19

The Lerner Index measures how much a firm can raise price over marginal cost – expressed as a percentage of marginal cost. The rationale here is that monopolists have the ability to raise price over marginal cost, but firms operating in a perfectly competitive (e.g., a commodity) business would have little or no ability to raise price; thus, the higher the Lerner Index, the greater the monopoly power in the industry – and the more consumers are harmed as a result.

This topic could fill many books; however, for our purposes, it is important to note that much of this book discusses the use of strategic control points and leveraging strength to gain competitive advantage – even using examples from Carnegie and Rockefeller that today would be subject to immediate and swift antitrust intervention. In the technology space, various antitrust actions have been taken by (and against) IBM, Microsoft, Apple, Samsung, Google – and many other firms that are held up as examples of good strategy. For example, Apple and Google were both afraid of Microsoft when the original iPhone and Android operating systems were being developed:

Google executives were convinced that if Windows on mobile devices caught on, Microsoft would interfere with users’ access to Google search on those devices in favor of its own search engine. The government’s successful antitrust trial against Microsoft in the 1990s made it difficult for the company to use its monopoly on desktops and laptops to bully competitors. It could not, for example, make Microsoft’s the default search engine in Windows without giving users a choice between its search engine and those from Google, Yahoo, and others. However, on smartphones, few rules governed how fiercely Microsoft could compete. It didn’t have a monopoly there. Google worried that if Microsoft made it hard enough to use Google mobile devices and easy enough to use Microsoft search, many users would just switch search engines. This was the way Microsoft killed Netscape with Internet Explorer in the 1990s. If users stopped using Google’s search engine and began using a competitor’s such as Microsoft’s, Google’s business would quickly run aground ... “It’s hard to relate to that [fear of Microsoft] now, but at the time we were very concerned that Microsoft’s mobile strategy would be successful,” Schmidt said in 2012 during testimony in the Oracle v. Google copyright trial.20

Thus, we would be remiss if antirust considerations were not raised in this book. If you were to exert monopoly power (i.e., via utilizing sufficient market share in a way that has a detrimental impact on consumers and is based on the strategies discussed here), you might very well face unwelcome regulatory antitrust interventions. While more detailed coverage of the nuances of antitrust policies and regulatory interventions is well outside the scope of this book, always remain aware of the issues and get legal counsel at every stage – forewarned is forearmed.

Uber and Airbnb are facing similar issues – many drivers and property owners are becoming unhappy with their increasingly “consumer-friendly” terms. Thus, many drivers and property owners are opting to drive for Lyft or rent with Vacation Rental by Owner (VRBO). As companies like Uber or Airbnb become bigger and more powerful, they need to heed local regulatory hurdles; as a result, they may impose more stringent regulations on their suppliers (i.e., the drivers and owners). Further, discussions about “breaking up big tech” (referred to earlier in this book) have been in the forefront of the popular press for some time now, focused on the FANG companies – Facebook, Amazon, Netflix (to a lesser degree), and Google.

• Be aware of the hazards of “blowback to the core”; be sure not to overplay your hand, particularly if loosening of a key strategic control point is possible as a result.

• Know and protect your core always. Any attempt to leverage strengths in other parts of the market or value chain should always be done when it increases the likelihood that customers will choose your core.

• When you can’t build on the core (as was the case when Keurig’s patents were expiring), use your core strengths to move into adjacent markets. Grow outward from the core (e.g., Starbucks has been a master at this).

• One bad business decision and poorly trained employees (e.g., who are not taught to “do the right thing”) can cost you dearly. Empower your customer service staff to minimize the likelihood of blowback to the core.

• The sign is often in the signs – be aware of the telltale signs of demise (e.g., a need to shrink core businesses versus utilizing strong core sales to invest in your company’s future). The writing is often on the wall. So always be on the lookout for it.

• Always be aware of antitrust considerations, and utilize legal counsel throughout.

1 Source: Wharton Wharton’s WRDS data base (University of North Carolina at Chapel Hill license).

4 For simplicity purposes, we ignore present value and other considerations here.

9 Indeed, in June of 2019, it was announced that Barnes & Noble agreed to be bought out in a private equity deal by Elliott Management Corp. for $475 million in cash, a figure that was criticized by many. Allison Prang, “Barnes & Noble Narrows Loss, but Sales Decline,” Wall Street Journal, 19 June 2019: https://www.wsj.com/articles/barnes-noble-narrows-loss-but-sales-decline-11560949387.

10 This section relies heavily upon the following court filing: Treehouse Foods, Inc., Bay Valley Foods, LLC, and Strum Foods, Inc. v. Green Mountain Coffee Roasters, Inc. and Keurig, Incorporated, United States District Court for the Southern District of New York, Civil Action No. 14CV0905, court filing 2/11/14, as well as the following sites:

11 The source for much of this section about the U.S. coffee industry at this time and about Howard Schultz specifically is Nancy F. Koehn, “Howard Schultz and Starbucks Coffee Company,” Harvard Business School case 9-801-361, February 2001. (Revised September 2005.)

17 The combined company was renamed Keurig Dr. Pepper and began trading publicly again on the New York Stock Exchange under the ticker KDP. Shareholders of Dr. Pepper Snapple Group own 13 percent of the combined company, with Keurig shareholder Mondelez International owning 13 percent to 14 percent of that fraction. JAB Holdings owns the remaining majority stake: https://en.wikipedia.org/wiki/Keurig_Dr_Pepper#cite_note-13.

18 For an entertaining view of the time, see the History Channel’s The Men Who Built America.

20 Fred Vogelstein, Dogfight: How Apple and Google Went to War and Started a Revolution (New York: Farrar, Straus and Giroux, Kindle Edition, 2013), 51.