The new dynamics of competition

The new dynamics of competition

In its early days strategy was a loose affair. Content originated either from commonsense approaches such as strengths, weaknesses, opportunities and threats (SWOT) analysis or from frameworks like the Boston Consulting Group’s growth-share matrix.

In 1979, however, Michael Porter’s five forces model changed the field forever. It masterfully synthesised the practical implications of economic research on industrial organisations from the 1960s and 1970s. Knowledge-based innovation put strategy on the map as a field of study, virtually overnight. Competitive Strategy, Porter’s practitioner-oriented book, became an enormous success.

From that backdrop, a general model of competitive strategy, which I call the value capture model (VCM), has emerged. It uniquely applies the mathematical concept of cooperative game theory to research on business strategy. (‘Cooperative’ is a misnomer, as the math focuses on competitive dynamics.) As such, the VCM has an explanatory, predictive potential that no other theory of competitive strategy can claim.

The model is a work in progress, but scholars are starting to use it to explain the dynamics of competition and to identify practical implications for strategic decision making. At the VCM’s core is this axiom: “The value that any party can capture from engaging in transactions with a given set of parties is bounded by the value each of them can add to parties outside the set.”

In this article I will explain the axiom and its implications for how we need to think about strategy.

Redefining competition: from five forces to one

In most industries, a firm, its suppliers and its customers all have choices about how and with whom they create value. To produce more value, they may change how they engage in transactions with existing suppliers and customers or may switch to other suppliers and customers. Those agents, in turn, have similar alternatives in how they transact with the original firm and with their own suppliers and customers.

That reality suggests a formal definition of competitiveness that applies equally to all the firms, suppliers and customers in an industry: a tension between the value generated from transactions that a firm undertakes with a given set of agents and the forgone value it could have generated from transactions with other agents. That definition enables you to assign formal identities to the agents involved; to place them in a mathematical game theory model; and, with given measures of competitive tension, to examine the payoffs from their investments in resources and capabilities. No other current theory of strategy offers the ability to model the effect of strategic decisions so precisely or to use data to test hypotheses about what kinds of management processes or investments improve a given firm’s ability to capture value in its industry.

From value chain to value network

The VCM offers a new way for practitioners to map a firm’s competitive landscape. Traditionally, and certainly in Porter’s framework, value is seen as the product of a chain of activities: a firm takes material from suppliers, adds some value and sells a product to customers. It haggles with suppliers and customers over price, and its profitability depends on the appeal of its value-price proposition to customers relative to that of other companies.

The VCM framework replaces the firm’s value chain with what I call a value network map – essentially, a productive social network with linkages defined by actual and potential transactions. The map has two major components. The first is the firm’s value network, which comprises the agents (typically, suppliers and customers) who conduct actual, value-creating transactions with the firm. If no opportunities to create value exist beyond the network itself, there is no competition. Competition renders undeniable certain claims on the value produced. Without competition, the parties are left haggling among themselves, each attempting to persuade the others of the value they merit.

Competition arises from the second component of the value network map: agents outside the network who wish to transact with agents inside the network but that, for some reason, are not currently allowed to engage in such activity. For example, suppose that manufacturer A wants to sell through retail outlet B, but scarce shelf space prevents the transaction from occurring. In the VCM, the collection of all such agents is the value network’s competitive periphery. When agents in the periphery wish to transact with a firm, that firm’s capture of the value created by the network is likely to increase. That’s because if the firm is offered too little in return for its activities within the network, it can choose to cut its transactional ties and form a new network with agents in the periphery.

Factoring in the strategic decision

So far, my description of the VCM has focused on variables beyond the control of individual firms – specifically, the agents in their existing value networks and the degree of competition for those agents as determined by the presence of alternative network partners. But those variables rarely dictate the exact value a firm ends up capturing. The value actually captured is, of course, a consequence of the firm’s strategic decisions.

A firm’s strategic investments in capabilities and resources can be measured on two dimensions: the effect of the capabilities and resources on the actual and potential value that partners in a network create; and the extent to which they enhance the ability of a firm to pry value from its transaction partners. Resources and capabilities that influence value, whether actual or potential, are deployed with competitive intent. By contrast, resources and capabilities developed to persuade a firm’s transaction partners to give up value, beyond what competition dictates, are deployed with persuasive intent.

Typically, a firm uses competitive capabilities and resources to increase the range of value (the minimum, the maximum, or both) that is available for capture, consistent with the competitive intensities of its situation. So a deployment of resources that drives a minimum value up to the level of a maximum value benefits the firm, especially if its persuasive resources are weak. Competitive resources are usually easy to identify. A firm’s products and services, productive assets, innovation skills and customer service quality all affect the value that the firm creates within its network and that it could create with agents in its competitive periphery.

It might be a decade before the VCM can provide practitioners with a turnkey managerial tool. Nevertheless, work on the VCM is already revealing important insights for leaders who aim to chart a strategic direction for their firms. If scholars in the field of strategy do succeed in creating a streamlined version of the model with a reasonably full complement of input variables, it will become an important theoretical paradigm.

Michael D. Ryall is an associate professor of strategy at the University of Toronto’s Rotman School of Management.

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