CONFIDENTIAL

Chapter 6
Crafting Business Strategy for
Dynamic Contexts

Document
Date

This report is solely for the use of client personnel. No part of it may be
circulated, quoted, or reproduced for distribution outside the client organization
without prior written approval from McKinsey & Company. This material was
used by McKinsey & Company during an oral presentation; it is not a complete
record of the discussion.
OBJECTIVES
Unit of measure

1 Identify the challenges to sustainable competitive

advantage in dynamic contexts
2 Understand the fundamental dynamics of
competition
3 Evaluate the advantages and disadvantages of
choosing a first-mover strategy
4 Analyze and develop strategies for managing
industry evolution
5 Analyze and develop strategies for technological
discontinuities
6 Analyze and develop strategies for high-speed
environmental change
7 Explain the implications of a dynamic strategy for
the strategy diamond and strategy implementation

* Footnote
2
Source: Source
THE TALE OF NAPSTER
Unit of measure
Business model options

Bank-
Napster Music
rupt Roxio and iTunes
A la carte
sell single songs

Sold
to
Software Unlimited downloads
Roxio Software Music Subscription
and music for $9.99/month
Business
Software

Real-network's Rhap-
sody lets music lovers
sold

Streaming
listen as much as they
want for one monthly
fee
Sonic
Software
solutions

* Footnote
3
Source: Source
THREE CAUSES OF DYNAMIC CONTEXTS
Unit of measure Examples

When incumbents and, Mini-mills entered with a new

Competitive especially, new entrants use a business model and incumbent
Interaction new business model they drive steel companies did not respond
dynamism in market

As industries evolve and Arm and Hammer almost lost its

Industry competition shifts from lead position when baking soda
evolution differentiation to price/low-cost, became commoditized
advantages shift between rivals

When technological change is The shift to digital photography

Technological discontinuous, it does not favors the strengths of Sony not
change sustain existing leaders photography incumbent like
advantages Kodak
* Footnote
4
Source: Source
PHASES OF COMPETITIVE INTERACTION
Unit of measure

Phase 1 Phase 2 Phase 3 Phase 4

Discovery Customer Competitor Evaluation of
and reaction reaction action and
competitive reaction
new action effectiveness

Source: Adapted from K.G. Smith, W.J. Ferrier, and C.M. Grimm, “King of the Hill: Dethroning the Industry Leader,”
* Footnote
Academy of Management Executive 15:2 (2001), 59-70 5
Source: Source
THE SPECTRUM OF COMPETITIVE RESPONSES STRATEGIES
Unit of measure

Difficult
ent
u lm
nn
n /A
Ease with threat can

tio
rp
so
be controlled

A b
g/
pi n
S ha
n/
a tio
liz
utra
e
n t/N
m e
nt ain
o
Great

Limited Extensive

Scope of response
* Footnote
6
Source: Source
CONTAINMENT
Unit of measure

Containment

Neutralization Limit the extent to which the new entrant’s

innovation impacts your business
For example: American Airlines can partially
contain Southwest by using its bargaining
Shaping power to secure more exclusive airport gates

Absorption

Annulment

* Footnote
7
Source: Source
NEUTRALIZATION
Unit of measure

Containment

Neutralization Try to short-circuit the moves of

innovators or new entrants before they
make them
For example: The Recording Industry
Shaping Association of America launched such a
fierce legal attack on Napster that it
forced even smaller Napster-like firms to
stay out of the fray
Absorption

Annulment

* Footnote
8
Source: Source
SHAPING
Unit of measure

Containment

Neutralization Shape the innovation so it becomes

something the incumbent can live with or
even benefit from
For example: For years the American
Shaping Medical Association used regulators to
attack chiropractors; now they shape
chiropractic medicine to become a
complement to traditional medicine
Absorption

Annulment

* Footnote
9
Source: Source
ABSORPTION
Unit of measure

Containment

Neutralization Minimize the risks entailed by being

either a first mover or an imitator
For example: In the late 1980s Microsoft
purchased Intuit, the maker of Quicken
Shaping and QuickBooks; because it identified
money-management software as a high-
growth opportunity.

Absorption

Annulment

* Footnote
10
Source: Source
ANNULMENT
Unit of measure

Containment

Neutralization Improve incumbent products and

services to annul an innovation or new
entrant’s offering
For example: Kodak has improved the
Shaping quality of its film-based prints so that they
are superior to many digital-based
alternatives

Absorption

Annulment

* Footnote
11
Source: Source
PROS AND CONS OF FIRST MOVERS
Unit of measure

A first-mover is often better off than a A first-follower is often better off than
fast follower when: a first mover when:
• It achieves absolute cost advantage • Rapid technology advances allow a
fast-follower to leapfrog the first mover

• Its reputation and image advantages • The first mover’s offering strikes a
are hard to copy chord but is flawed

• Its customers are locked in (i.e., • The first mover lacks a key
switching costs exist) complement (e.g., channel access) that
the follower possesses

• Scale of the first move makes imitation • First-mover costs outweigh the
unlikely advantages of being the first-move

* Footnote
12
Source: Source
A GALLERY OF FIRST-MOVERS AND FAST FOLLOWERS
Unit of measure Imitators/fast
Product Pioneer(s) followers Comments
Automated DeLaRue (1967) Diebold (1971) The first movers were small entrepreneurial
teller machines Docutel (1969) IBM (1973) upstarts that faced two types of competitors: (1)
(ATMs) NCR (1974) larger firms with experience selling to banks and
(2) the computer giants. The first movers did not
survive
Ballpoint pens Reynolds (1945) Parker (1954) The pioneers disappeared when the fad first ended
Eversharp (1946) Bic (1960) in the late 1940s. Parker entered 8 years later.
Bic entered last and sold pens as cheap
disposables
Commercial DeHaviland (1952) Boeing (1958) The pioneers rushed to market with a jet that crashed
jets Douglas (1958) frequently. Boeing and Douglas (later known as
McDonnell-Douglas) followed with safer, larger, and
more powerful jets unsullied by tragic crashes
Credit cards Diners club (1950) Visa/Master- The first mover was undercapitalized in a business
Card (1966) in which money is the key resource. American
American Express entered last with funds and name
Express (1968) recognition from its traveler’s check business
Diet soda Kirsch’s No-Cal Pepsi’s Patio Cola The first mover could not match the distribution
(1952) (1963) advantages of Coke and Pepsi. Nor did it have the
Royal Crown’s Diet Coke’s Tab (1964) money or marketing expertise needed for massive
Rite Cola (1962) Diet Pepsi (1964) promotional campaigns

* Footnote
Diet Coke (1982)
13
Source: Source
A GALLERY OF FIRST-MOVERS AND FAST FOLLOWERS (CONT.)
Unit of measure Imitators/fast
Product Pioneer(s) followers Comments
Light beer Rheingold’s and Miller Lite (1975) The first movers entered 9 years before Miller and
Gablinger’s (1968) Natural light 16 years before Budweiser, but financial problems
Meister Brau Lite (1977) drove both out of business. Marketing and
(1967) Coors light distribution determined the outcome. Costly legal
(1978) battles, again requiring access to capital, were
commonplace
Bud light (1982)

PC operating CP/M (1974) Microsoft DOS The first mover set the early industry standard but
systems (1981) did not upgrade for the IBM PC. Microsoft bought
Microsoft an imitative upgrade and became the new
Windows (1985) standard. Windows entered later and borrowed
heavily from predecessors (and competitor Apple),
then emerged as the leading interface

Video games Magnavox’s Nintendo (1985) The market went from boom to bust to boom. The
Odyssey (1972) Sega (1989) bust occurred when home computers seemed likely
Atan’s Pong (1972) Microsoft (1998) to make video games obsolete. Kids lost interest
when games lacked challenge. Price competition
ruled. Nintendo rekindled interest with better games
and restored market order with managed
competition. Microsoft entered with its Xbox when
perceived gaming to be a possible component of its
* Footnote wired world
Source: Adapted from S. Schnaars, Managing Imitation Strategies (New York Free Press, 1994), 37-43 14
Source: Source
EVALUATING A FIRM’S FIRST-MOVER DEPENDENCIES
ON INDUSTRY COMPLEMENTS
Unit of measure
Status of complementary assets
Freely available Tightly held and
or unimportant important

It is difficult for anyone to Value-creation

Weak protection
Bases of first mover advantages

make money: Industry opportunities favor the

from imitation

incumbent may simply holder of complementary

give new product or
service away as part of its
larger bundle of offerings
Strong protection
from imitation
assets, who will probably
pursue a fast-follower
strategy

First mover can do well Value will go either to first

depending on the mover or to party with the
execution of its strategy most bargaining power

* Footnote
15
Source: Source
STRATEGIES FOR MANAGING COMMODITIZATION
Unit of measure Examples

Value-in-use Timken bundles commodity

approach product with key components

Anticipating
Process
Dell sells directly to
innovation
consumers
approach
Managing
commoditization
K-mart and KB Toys both
Market
reduced number of customers
focus
when they restructured
Responding

Service Hotels may charge extra for

innovation cable TV and computer hookups

* Footnote
16
Source: Source
EFFECT OF TECHNOLOGICAL DISRUPTION
Unit of measure
Performance
Maturity

Maturity Growth

Disruption

Growth

Embryonic

Embryonic
Time

* Footnote
17
Source: Source
FOUR ACTIONS FRAMEWORK: KEY TO THE VALUE CURVE
Unit of measure
Reduce
The key to discovering a What factors should
new value curve lies in be reduced well
answering four basic below the industry
questions standard?

Eliminate Create/Add
Creating
What factors that the What factors that the
new markets:
industry has taken for industry has never
A new value
granted should be offered should be
curve
eliminated? created or added?

Raise
What factors should
be raised well above
the industry standard?

* Footnote
Source: Adapted from W.C. Kim and R. Mauborgne, “Blue Ocean Strategy,” California Management Review 47:3 (2005), 105-121 18
Source: Source
HIGH AND LOW-END DISRUPTION
Unit of measure
Strategy that may result in huge
new markets in which new
High-end
players redefine industry rules to
unseat the largest incumbents

Strategy that appears at the low

end of industry offerings,
Low-end
targeting the least desirable of
incumbents’ customers

* Footnote
19
Source: Source
 VALUE CURVE for U.S. WINE INDUSTRY – YELLOW TAIL
Unit of measure Expensive wines
Yellow tail
Cheap wines

High

Low

Price Above-the-line Vineyard Wine Ease of

marketing prestige range selection
Use of technical Aging Wine Easy Fun and
wine terminology quality complexity drinkability adventure
* Footnote
20
Source: Source
CONVENTIONAL VS. NEW MARKET-CREATION STRATEGIC MINDSETS
Unit of measure
Dimensions
of competition Head-to-Head competition New-market creation
Emphasizes rivalry Emphasizes substitutes across
Industry industries

Emphasizes competitive position Looks across groups and

Strategic group and within group and segments segments
industry segments
Emphasizes better buyer service Emphasizes redefinition of the
Buyers buyer and buyer’s preferences

Emphasizes product or service Emphasizes complementary

Product and value and offerings within industry products and services within and
service offerings definition across industries and segments
Emphasizes efficient operation Emphasizes rethinking of the
Business model of the model industry business model

Emphasizes adaptation and capa- Emphasizes strategic intent-

Time bilities that support competitive seeking to shape the external
* Footnote
retaliation environment over time
21
Source: Source
SOME WELL-KNOWN DISRUPTIONS
Unit of measure

Microsoft took 15 years to grow from boutique

software firm to Goliath

Atari grew from $50 million to $1.6billion over 5

years, doubling every year

Compaq grew from zero revenues to $ 1billion

in 5 years

* Footnote
22
Source: Source
CREATING OPTIONS FOR FUTURE COMPETITIVE ADVANTAGE AND
PROFITABILITY
Unit of measure
Profit

Horizon 3
Tactical Seed options for future
growth business
probing
Horizon 2
Drives growth in
emerging new business

Horizon 1
Defend and extend
current business
Time
* Footnote
23
Source: Source
IMPROVISATION AND SIMPLE RULES
Unit of measure

Just as Jazz musicians can improvise ... corporations can become more
when they play together because they flexible by allowing improvisation
follow a set of simple rules ... under a set of simple rules

Simple rules
• Customer is always right
• Always run highest profitability
products
• Never

* Footnote
24
Source: Source
TACTICAL PROBING OPERATIONAL TACTICS CAN BECOME STRATEGICALLY
IMPORTANT
Unit of measure

discount initiative
Merrill lynch Tactical initiatives

• Futures – trading

• Simplified mutual-fund offerings

Though some initia-
tives failed, several
Charles enabled Charles
Schwab
• Internet products services
Schwab to further
differentiate itself
from its bare-bones
• Credit cards
competition
E* Trade

• Outline mortgage

* Footnote
25
Source: Source
STAGING AND PACING IN THE REAL WORLD
Unit of measure
“Five years is the maximum that you can go without refreshing the brand ... We did it
British Airways (relaunched Club Europe Service) because we wanted to stay ahead so that we
could continue to win customers”

“In each of the last three years we’ve introduced more than 100 major new products,
Emerson Electric which is about 70% above our pace of the early 1990s. We plan to maintain this rate
and, overall, have targeted increasing new products to (equal) 35% of total sales”

The inventor of Moore’s Law stated that the power of the computer chip would
Intel double every 18 months. IBM builds a new manufacturing facility every nine
months. “We build factories two years in advance of needing them, before we have
the products to run in them, and before we know the industry is going to grow”

40% of Gillette’s sales every five years must come from entirely new products (prior
Gillette to its acquisition by P&G). Gillette raises prices at a pace set to match price
increases in a basket of market goods (which includes items such as a newspaper,
a candy bar, and a can of soda). Gillette prices are never raised faster than the
price of the market basket.

30% of sales must come from products that are fewer than 4 years old
3M

* Footnote
Source: S. Brown and K. Eisenhardt, Competing on the Edge: Strategy as Structure Chaos (Boston: Harvard Business School Press, 26
1998)
Source: Source
REAL OPTIONS – FIVE CATEGORIES
Unit of measure

1. Waiting-to-invest options. The value of waiting to build a factory

until better market information comes along may exceed the value
of immediate expansion

2. Growth options. An entry investment may create opportunities to

pursue valuable follow-up projects

3. Flexibility options. Serving markets on two continents by building

two plants instead of one gives a firm the option of switching
production from one plant to the other as conditions dictate

4. Exit (or abandonment) options. The option to walk away from a

project in response to new information increases its value

5. Learning options. An initial investment may generate further

information about a market opportunity and may help to determine
whether the firm should add more capacity

* Footnote
27
Source: Source
THE VALUE OF REAL OPTIONS
Unit of measure

DCF value Value of Total busi-

real options ness value

Current Real- Total

business + options = business
value value value

Source: L.E.K. Consulting LLC, Shareholder Value Added: Making Real Decisions with Real Options (Accessed September 12, 2005),
* Footnote
www.lek.com/ideas/publications/sva 16.pdf. 28
Source: Source
SUMMARY
Unit of measure

1 Identify the challenges to sustainable competitive

advantage in dynamic contexts
2 Understand the fundamental dynamics of
competition
3 Evaluate the advantages and disadvantages of
choosing a first-mover strategy
4 Analyze and develop strategies for managing
industry evolution
5 Analyze and develop strategies for technological
discontinuities
6 Analyze and develop strategies for high-speed
environmental change
7 Explain the implications of a dynamic strategy for
the strategy diamond and strategy implementation

* Footnote
29
Source: Source