There’s a pretty common pattern in business of people observing an old established company incumbent in some market ploughing on year after year and a fresh young upstart trying to break in and compete, and the new entrant always seems like the dynamic one, the innovative one, the one that’s the consumers’ champion, the one that’s doing very interesting things.
Classic examples are British Airways for example, who face competition from Virgin, they got very annoyed by Virgin, and more recently of course has faced competition from low cost airlines. But it’s a very common pattern, you had Hertz competing against Avis, Avis saying we’re proud to be number two and we’ll always provide you better service because we’re not the established incumbent. It appeals really to our sense of the story of the underdog, and we know in real life we always tend to favour the underdog, and businesses love to present themselves as the underdog competing against some complacent old dog sitting there just doing the same old thing year after year.
Now there’s some truth I think in that stereotype of incumbents and new entrants, but rather than just thinking the incumbents are stupid or the incumbents are lazy or complacent, it’s worth considering business strategy by the perspective of each of the players, and asking not, why are incumbents less good value and why do incumbents tend to be less dynamic, but asking why does it make sense for them to be that way? What is going on in their mind that makes them different from the dynamic upstart? And the truth is the incentives for the upstart and for the incumbent are very, very different in business.
If you're the upstart you have absolutely nothing to lose by taking risks. If you fail you don’t have an established business that you're throwing away. If you're the incumbent you do, and that’s why you'll tend to play it safe. It doesn’t make sense to take risks in the way that it does for the new entrant.
Another case and point is pricing. If you're the upstart you can charge a low price, you're not losing profits on any existing customers by doing that, but if you're the incumbent, well if you start charging a low price, you're throwing away profits that you were making on lots and lots of existing customers who would never leave you even if you continued to charge a high price.
So it’s back to this point that it looks as though one is good and the other is bad, it looks as though one is dynamic and the other slothful, but it’s not really that way. One does what is best for it to do, which is to be dynamic, to take risks and to cut its prices, and the other does what is right for it to do, which is to stay in that position, hope for the best and not to be too dynamic straight away.
Of course, when the upstart starts taking away huge amounts of market share all bets are off, the strategy of charging higher prices and sitting on the existing customers won't work for the incumbent, but until the incumbent knows that’s what the upstart’s going to achieve, it often makes sense for them to behave as they do. It’s not just because they don’t know how to be dynamic.
That’s my opinion, you can join the debate with the Open University.