Outperformance in deliving economic rent appears independent of market structure
A recent empirical study of a sample of over 2,000 companies concluded that the economic rent captured by companies in the top quintile outstrip those in the middle quintiles by a factor of 30 on average and the top quintile captured over 90% of the total economic rent created by all companies. While much focus is dedicated naturally to the characteristics of those companies in the top quintile, less focus is given to why the vast majority of companies either just achieve or fail to achieve their cost of capital. Equally, counter to what may seem intuitive, there doesn’t seem to be any bias in relation to the prevailing industry structure (i.e. highly concentrated versus highly fragmented competitive environments) between those companies in the winning circle versus those that are not.
An overdependence on operations excellence
So, what is driving this prevalence of competitive convergence that seems immune to changes in industry structure? Having worked in, and advised for, a range of mature asset intensive companies operating in highly concentrated competitive markets for over 30 years, I suspect that one of the key reasons sits with core strategy and the strategy development process. One of the most common, yet under-delivered, strategic objectives holding centre place in many strategic plans is a singular focus on delivering increases in market share and profit margins by improving operating excellence.
Outperforming peers on operations excellence is more challenge than it may appear
While operating excellence is a comfortable bedfellow to any strategy – what many strategies fail to capture is the need for this excellence to be (statistically) superior or differentiated to the equivalent operating improvements undertaken by competitors over the same time period. In addition, ideally the improvements should be difficult to replicate or imitate. Otherwise, the tendency is for improvements to be imitated quickly by competitors with benefits passing through to customers in the form of lower pricing or improved features for the same price.
Consolidated markets are more prone to competitive convergence
What strategies frequently fail to identify is a company’s core comparative advantage and how that advantage can be leveraged to create differentiated economic outcomes. In some respects, companies operating in more consolidated competitive market, and particularly if they are physical asset intensive, are less likely to seek real differentiation than those operating in more fragmented and capital light market structures. That is, asset intensive industries operating in consolidated markets are more prone to competitive convergence.
There are a number of logical reasons why this may be the case:
• Where market concentration is driven/supported by greater asset intensity it is not surprising that operations excellence dominates strategic thinking and planning processes in companies where physical assets dominate both the balance sheet and organisation attention.
• The higher the market concentration, the higher the imperative/temptation for companies to provide offerings to all customer segments. Over time, repeated drives for improved functional and operational efficiency tends to drive convergence in organisational processes and product and service offerings; regardless of the underlying needs of customer sub-segments. This pressure is further enhanced in asset intensive companies where the up-stream drive for increased volumes (i.e. improving volume market share) tends to work against down-stream’s efforts to maximise value from offer customisation and value optimisation (i.e. improving value market share).
• In concentrated markets, there tends to be a higher degree of transparency in the actions of competitors making it more difficult to ‘surprise’ with new capabilities or approaches. This transparency enhances the temptation and probability of competitors being fast followers of any move that proves successful in the market.
The shift from tangible to intangible
Physical assets can be a source of competitive advantage in their own right – take for example a mining company with a superior orebody; a manufacturing company with proprietary technology; or a digital platform company with scale and reach. However, in many cases rapid technology dispersion reduces this advantage over time.
However, what is often under-appreciated and underleveraged in strategy reviews in asset intensive industries is the differentiating potential of intangible assets. Importantly, these are assets that may be more difficult for competitors to both understand and imitate. Traditionally, intangible assets such as branding are a powerful lever – particularly those brands successful in engendering high levels of customer trust through repeatable and predictable outcomes i.e. a known entity. However, the onset of the digital revolution is vastly expanding the power and potential of intangible assets. It is unlocking the knowledge and insights that come from harnessing trends, behaviours, and biases to enable positioning for best economic gain. It is the ability to target, to combine or bundle, to retreat or attack, and to identify needs and service them better.
Underrepresentation of key organisation functions in strategy development
So why aren’t asset intensive companies leveraging intangible assets more to escape the grasp of competitive convergence? The importance of each function in an organisation depends on the underlying logic of strategic differentiation. It doesn’t mean that any function (such as manufacturing) is not important (to deliver competitive cost, quality and supply position) it just means that some functions dealing more with intangibles (e.g. digital or R&D, or product design, or customer branding) may have a higher ability to deliver more powerful and sustainable strategic differentiation. In many cases, these functions/capabilities are underrepresented in the strategy development processes within asset intensive companies.
The prize of enhancing differentiated competitive advantage.
Like all things in business, separating from the herd feels uncomfortable, is not without execution risk, and generally the preserve of the courageous. The prize for those with the courage to differentiate is reinforcing competitive advantage.