Quarterly Journal on Management
From the publishers of THE HINDU BUSINESS LINE
Vol. 2 :: No. 2 :: August 1998
John C. Camillus
Competitive strategy in the case of small businesses offers special challenges and also special opportunities. For instance, in the case of an undifferentiated product, the generic "cost leadership" strategy may not be available to small businesses. The cost advantages stemming from high volumes and the experience curve effects that are available to large businesses are not accessible by small businesses. On the other hand, "focus" strategies play to the unique strengths and flexibility of the small business. When thinking about strategy, particularly when competitors possess many different characteristics, it is useful to remember that if one is an alligator, it is better to fight a bear in the swamp rather than on hard ground. In this article we will offer some guidelines regarding the competitive options that need to be considered by small businesses, in effect, describing the swamp into which we wish to draw the competition. These guidelines will include how best to tailor generic strategies to the context of small businesses, the relevance of game theory to small businesses, and the implications of being a follower or first mover.
Tailoring Generic Strategies to Small Businesses
The three generic strategies identified by Michael Porter, namely cost leadership, differentiation and focus are all options available to small businesses. However, the contexts in which these individual strategies may gainfully be considered by small businesses need to be well understood. In the area of cost leadership, the advantages of high volume and rapid movement down the experience curve are advantages that large businesses, by definition, possess. The areas in which small businesses may find cost advantages are very limited. Advances in manufacturing technology are not likely to provide small companies with a sustainable advantage. Such advances can often be readily replicated by large companies. Smaller companies may find that their ability to control overhead costs and maintain a lean organization, while significant, can be matched by well-managed, larger companies that understand and exploit economies of scale and scope.
A valuable tool that can help in the search for cost leadership is the value chain. The value chain is perhaps the most widely used tool of strategic analysis. In fact, it can be a very effective and powerful way of determining what generic strategies may be most relevant and how best to implement the selected strategies. The value chain as described by Michael Porter is diagrammed in Figure 1. By examining each element of the value chain it may be possible to identify areas in which a smaller organization may find opportunities for lowering costs below those of the competition. Procurement and inbound logistics may perhaps be addressed by locating close to sources. This kind of locational flexibility may not be possible for larger companies without sacrificing some of the advantages of scale and scope on which they build cost leadership. Similarly other elements of the value chain may be managed differently than the approach adopted by competitors.
Another approach to operating with lower total costs than larger competitors is available to smaller organizations. By engaging in partnerships with selected customers, it may be possible to reduce costs such as advertising and distribution. In order to develop partnerships with customers it is necessary to offer advantages that cannot be matched readily by other organizations. This suggests that it is necessary to pay substantial attention to being very different than other companies.
This search for differentiation is likely to be more productive for small businesses than the search for cost leadership. Here again the value chain is perhaps the most important analytical tool. By examining each element of the value chain it should be possible to identify the areas with the highest potential for differentiation. In order to ensure that larger competitors with greater resources cannot swiftly duplicate the characteristics that distinguish the product or service, it may be necessary to go beyond the more obvious, physical elements of the value chain. For instance, it may be possible to consider providing access to the company's internal management information system to selected customers in order to speed up their ordering process, or to provide them with the latest information regarding delivery status. For a large company to provide similar access may be considerably more difficult given that their systems are likely to be more complex and that more executives would be involved in such a policy decision.
The greater flexibility of smaller organizations is a characteristic that needs to be exploited in the context of building a differentiation strategy. The small chemical companies in New Jersey are able to survive and in fact prosper despite the enormous resources of the major chemical companies, both domestic and international, that operate in the U.S. The small companies differentiate themselves in terms of the rapidity with which they are able to provide specialized chemicals with unique characteristics that are required by their customers. Furthermore, their small scale is often an advantage in the context of very specialized chemicals because the quantities ordered are likely to be limited and therefore more consistent with their production capabilities.
This matching of products, markets and technologies is the hallmark of a strategy of focus. Indeed, almost by definition, small businesses are most suited to the nature of a focus strategy. The literature on competitive strategies is replete with examples of small and medium-size companies that do extraordinarily well in selected niches. Not only do they dominate the niches in which they operate, but they also tend to be highly profitable.
The effective implementation of focus strategies requires a recognition of the importance of identifying and building on the organization's distinctive or core competence. Engaging in modification of elements of the value chain in ways that are not consistent with the organization's distinctive competence is likely to be detrimental to the elements of differentiation and cost leadership on which a good focus strategy has to be built.
An interesting aspect of implementing a strategy of focus is that increasing sales by widening the customer base may not prove beneficial to the organization. Selecting the right customers is a not so obvious but an utterly necessary element of a focus strategy. Selling to the " wrong" customer may increase costs and complexity beyond the marginal income that such additional sales may provide. If customers become too diverse in terms of their needs, the many advantages of a focus strategy tend to vanish.
The notion of selecting the "right" customers is a logical sequence to the next set of concepts that have particular significance for smaller businesses, namely that of partnering with key stakeholders.
Game Theoretic Perspectives
The traditional perspective of game theory is that it is a zero-sum game, where, for one player to win another player must lose. This highly adversarial approach is risky for a small player competing with a larger opponent with deep pockets. An alternative perspective that merits consideration is that of redefining the rules of the game in order to create a niche for one's own organization that is not attractive or directly threatening to competitors with greater resources. One approach to creating such a niche is to engage with selected stakeholders to fashion a new way of doing business or a new business segment with high barriers to entry.
Partnering with important stakeholders is a very real possibility for small businesses because of their intrinsic flexibility and their focus on a limited set of customers and other related organizations such as suppliers and distributors. Assuming a focus strategy it is likely that these stakeholders are few in number, or even if there are several, it is likely that they possess homogeneous characteristics. It is reasonable to expect that it would be relatively easy to get to know them well in preparation for building mutually beneficial partnerships.
Normally, when thinking of the customer one is inclined to view the relationship in a limited fashion, essentially as a transaction that involves the exchange of goods or services for an appropriate compensation. Partnering, however, suggests that multiple and strong interactions or connections exist. Not surprisingly, the value chain can again be employed in order to identify stakeholders with the greatest potential for a productive partnership and also to identify the bases on which such partnerships can be developed. For instance, suppliers' design and engineering departments may appreciate information about desired performance characteristics rather than material and dimensional information. Such information could enable them to effect simplifications that make production easier or more efficient. Similarly, sharing long term sales estimates and demand patterns with the supplier could be of great value to them in developing their own procurement and production schedules. Becoming a preferred and accommodating customer in the eyes of one's suppliers could lead to significant quality and cost enhancements, not to mention a greater willingness on the part of the supplier to adjust to occasional unanticipated requirements that one may encounter.
Analyzing the customers' value chain may uncover or suggest many such areas for building partnerships. The potential for building a strong relationship with the customer's procurement operations is obvious and has been touched upon earlier. Warehousing, inventory and distribution practices can be tailored to the customers' particular requirements Multiple other points of interaction will be apparent when looking at each element of one's own value chain in juxtaposition with each element of the customer's value chain .For example, interacting with a customer's R&D and design units could not only provide advance information about planned changes, but also offer the opportunity to influence or assist in identifying possibilities for improvement that relate better to one's own capabilities and preferred developmental directions. Getting to know the customer's marketing department and, indeed, the customer's customer may provide valuable insights as to how one can serve the customer better and tie the two organizations together even more strongly. Such relationships can result in building market segments or niches that the two organizations together are uniquely equipped to serve.
Such alliances with major customers promote the likelihood of growing with and sharing in the customer's success. If the customers one partners with expand internationally, then the small supplier may be provided with a minimal risk opportunity to also grow internationally. Interestingly, being small does not necessarily mean being a one-country, domestic company. As Germany's mittelstand firms have shown, a relatively small business can dominate a carefully developed niche worldwide.
These examples illustrate the secrets of successful growth for the small business. By growing the niches in which it operates, and by partnering with growing companies the small business can grow without inviting retaliatory moves on the part of larger and more resource-rich competitors. Growth through diversification may in effect shine a light on the territory that may attract the competition. On the other hand, growth through innovation creates the "swamp" that larger competitors may find forbidding territory.
Innovation to Create First-Mover Advantages
Small businesses that are willing to eke out a subsistence existence may choose to follow the lead of major competitors in terms of new products and markets. This would entail minimal R&D, market research, creativity and risk-taking. Judgment would, of course, have to be applied so as not to violate the larger competitors' sense of the territory that they wish to claim as their own. The preceding discussion on focus and partnering and the attractive routes to growth suggests, however, that small businesses with high aspirations in terms of profitability and growth need to innovate, need to stimulate growth in the niches that they occupy and need to support the growth of their partners.
Adopting a first-mover stance is inherently more risky than being a follower. Of course, the potential rewards are greater. First, the virgin nature of the territory being developed means that the first mover faces no immediate competition and may be in a position to erect entry barriers such as patent protection, long-term contracts with customers, no-compete agreements with key employees, agreements with the best-suited distributors, image and brand equity development, and commitments from suppliers. Second, profitability can be controlled so as not to encourage aggressive new entries by deep-pocket competitors. Third, tacit knowledge can be developed that would provide a sustainable edge over later entries.
There are situations in which being a first-mover could be highly undesirable. A context to be approached with caution is where complementary resources or infrastructure development are required to support the new products or services. Large companies with substantial resources at their command are better equipped to innovate in such situations where distribution channels need to be built, or supporting equipment, devices or technology need to be developed. If, however, innovation is undertaken in the context of a focused strategy, and partnerships with key customers, suppliers and distributors, the risks attendant on being a first-mover can be minimized.
There is considerable anecdotal evidence to support the key recommendations, namely implementing a strategy of focus, building partnerships with major stakeholders and adopting a first-mover approach. In addition to the American chemical boutiques and the German mittelstand firms referred to earlier, several instances of the synergistic power of these three approaches in combination can be cited. A particularly striking example is the development and growth of Safelite, a company that installs replacement windshields in cars. It competed successfully with major and dominant companies in the business by a strategy of focusing on selected regions, by partnering with insurance companies that usually paid for the replacement windshields by simplifying the insurance companies' verification and reimbursement processes thereby significantly reducing their clerical and claim processing costs, and by doing its own installations contrary to the more expensive industry practice of authorizing independent installers. Other companies such as Air Products & Chemicals and Marks & Spencer have followed these recommended guidelines to grow from being industry upstarts to being the dominant players in their industries.
A small business that chooses to be focused, that is eager to build partnerships and that dares to innovate is likely to be well positioned for enduring success.
The author is Donald R. Beall Professor of Strategic Management at the Katz Graduate School of Business, University of Pittsburgh.