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Cycle of competition

The challenge
An incumbent firm already operating successfully in an industry improves existing
barriers to entry and erects new ones. Any challenger firm wishing to enter the
industry must attempt to overcome these barriers. This does not necessarily mean
attacking the market leader head-on. This is a risky strategy in any case, because of the
incumbent firm's resources in cash, promotion and innovation. Instead, the challenger
may attack smaller regional firms or companies of similar size to itself that are vulnerable
through lack of resources or poor management.
Military analogies have been used to describe the challenger's attacking options.
.
1. The encirclement attack consists of as large a number of simultaneous flank attacks
as possible in order to overwhelm the target.
2. The bypass attack is indirect and unaggressive. It focuses on unrelated products,
new geographic areas and technical leap-frogging to advance in the market.
3. Guerrilla attack consists of a series of aggressive, short-term moves to demoralise,
unbalance and destabilise the opponent. Tactics include drastic price cuts, poaching staff,
political lobbying and short bursts of promotional activity

The response
If the incumbent makes no response to the initial campaign, the challenger will widen its
attack to other, related or vulnerable market segments, using similar methods to those
outlined above. On the other hand, the incumbent may respond; this will often be by
means that amount to reinforcing the barriers to entry, such as increasing promotional
spending.
Military analogies have also been used to describe defensive strategies for market
leaders.
(a) Position defence relies upon not changing anything. This does not work very well.
(b) Mobile defence uses market broadening and diversification.
(c) Flanking defence is needed to respond to attacks on secondary markets with
growth potential.
(d) Contraction defence involves withdrawal from vulnerable markets and those with
low potential. It
may amount to surrender.
(e) Pre-emptive defence gathers information on potential attacks and then uses
competitive
advantage to strike first. Product innovation and aggressive promotion are important
features.
A challenger faced with such moves may decide to start a price war. The disadvantage
of this is that it will erode its own margins as well as those of the incumbent, but it does
have the potential to reshape the market and redistribute longer-term market share.

Fighting back
An incumbent faced with a vigorous and resourceful challenger may decide in turn to
attack the entrant's own base, perhaps by cutting price in its strongest market. This
may have the result of causing the challenger to move on towards entry into another
attractive market as it seeks to expand.

Resource implications
Both attacking and defending require the deployment of cash and strategic skill. In
particular, extending competition to new geographical and national markets can raise the
risks and costs involved to an extent that inhibits rivalry.

Hypercompetition
It is possible for competition in an industry to cycle fairly slowly, with extended periods of
stability. This
allows the careful building of competitive advantages that are difficult to imitate.
Hypercompetition, by contrast, is a condition of constant competitive change. It is
created by frequent, boldly aggressive
competitive moves. This state makes it impossible for a firm to create lasting competitive
advantage; firms that accept this will deliberately disrupt any stability that develops in
order to deny long-term advantage to their competitors. Under these conditions,
continuing success depends on effective exploitation of a series of short-term moves.

Innovation and competitive advantage


For many organisations, product innovation and being the first mover may be a major
source of
competitive advantage.
(a) A reputation for innovation will attract early adopters, though it depends in part on
promotional
effort.
(b) Customers may find they are locked in to innovative suppliers by unacceptable costs
of switching to competitors.
(c) The learning (or experience) curve effect may bring cost advantages.
(d) The first mover may be able to define the industry standard.
(e) A price skimming strategy can bring early profits that will be denied to later
entrants.
(f) Legal protection, such as patents, for intellectual property may bring important
revenue
advantages. This is particularly important in the pharmaceutical industry.
However, the first mover also has particular problems:
Gaining regulatory approval where required
Uncertain demand
High levels of R&D costs
Lower cost imitators
Costs of introduction such as training sales staff and educating customers

Features of poor corporate governance


The scandals over the last 25 years have highlighted the need for guidance to tackle the
various risks and problems that can arise in organisations' systems of governance.

1 Domination by a single individual


A feature of many corporate governance scandals has been boards dominated by a
single senior executive with other board members merely acting as a rubber stamp.
Sometimes the single individual may bypass the board to action their own interests. The
report on the UK Guinness case suggested that the Chief Executive, Ernest Saunders paid
himself a 3 million reward without consulting the other directors. .

2 Lack of involvement of board


Boards that meet irregularly or fail to consider systematically the organisation's activities
and risks are
clearly weak. Sometimes the failure to carry out proper oversight is due to a lack of
information being provided.

.3 Lack of adequate control function

An obvious weakness is a lack of internal audit.

Another important control is lack of adequate technical knowledge in key roles, for
example in the audit committee or in senior compliance positions. A rapid turnover of
staff involved in accounting or control may suggest inadequate resourcing, and will make
control more difficult because of lack of continuity.

.4 Lack of supervision
Employees who are not properly supervised can create large losses for the organisation
through their own incompetence, negligence or fraudulent activity. The behaviour of Nick
Leeson, the employee who caused the collapse of Barings bank was not challenged
because he appeared to be successful, whereas he was using unauthorised accounts to
cover up his large trading losses. Leeson was able to do this because he was in charge of
both dealing and settlement, a systems weakness or lack of segregation of key roles
that featured in other financial frauds.

.5 Lack of independent scrutiny


External auditors may not carry out the necessary questioning of senior management
because of fears of losing the audit, and internal audit do not ask awkward questions
because the chief financial officer determines their employment prospects. Often
corporate collapses are followed by criticisms of external auditors, such as the Barlow
Clowes affair, where poorly planned and focused audit work failed to identify illegal use
of client monies.

.6 Lack of contact with shareholders


Often board members may have grown up with the company but lose touch with the
interests and views of shareholders. One possible symptom of this is the payment of
remuneration packages that do not appear to be warranted by results.

7 Emphasis on short-term profitability


Emphasis on short-term results can lead to the concealment of problems or errors,
or manipulation of accounts to achieve desired result

The governance framework


JS&W say that the most fundamental expectations of organisations concern who they
should serve and how their direction and purposes should be determined. This is the
province of corporate governance, which is also concerned with the supervision and
accountability of executives.
The governance framework describes whom the organisation is there to serve and
how the purposes and priorities of the organisation should be decided.
JS&W

The governance chain


Where the management of a business is separated from its ownership by the
employment of professional managers, the managers may be considered to be the
agents of the owners. Agency theory is concerned with adverse selection and moral
hazard, the problems that arise as a result of the separation of ownership and control. In
many organisations, corporate governance takes the form of a chain of responsibility and
accountability.
Few large businesses are directly managed by their owners. In the case of larger
companies, the
shareholders may be numerous and unlikely to wish to take part in the management of
the company,
viewing it simply as a vehicle for investment. Even where ownership is concentrated,
large companies tend to be managed mostly by professional managers who have little
ownership interest, if any.
In most large commercial organisations, the situation is even more complex in that
governance is
exercised through many links in a chain. Managers are accountable to more senior
managers and so on up to the board of directors. The directors enjoy an element of
autonomy, but in many cases they will effectively be accountable to the representatives
of a few large institutional shareholders or perhaps those of a single venture capital

company. The chain of accountability may then continue, with those representatives
themselves are accountable ultimately to the individual savers and investors that provide
their funds.
This separation of ownership from control has been a feature of business for over a
century and brings with it a recurring problem: the business should be managed so as to
promote the economic interest of the shareholders as a body, but the power to manage
lies in the hands of people who may use it to promote their own interests. How may such
conflicts of interest be resolved and managers be made to favour the interest of the
owners rather than their own?
This problem is not confined to the management of companies: it is the general problem
of the agency relationship and occurs whenever one person (the principal) gives
another (the agent) power to deal with his or her affairs. The relationship between
principal and agent has been subjected to some quite abstruse economic and
mathematical analysis; this area of study is called agency theory. It proceeds on the
basis that principals and agents are rational utility maximisers.
Two important concepts are used to explain the things that can go wrong in the agency
relationship:
adverse selection and moral hazard.
Adverse selection is the making of poor choices. It occurs perhaps most often because
the chooser lacks
the information necessary to make a good choice.
Adverse selection can be exacerbated in the agency relationship when the agent has an
incentive to
With hold information from the principal, thus creating information asymmetry. We see
this in two
important instances:
(a) Appointment of the agent: the principal attempts to appoint a competent and
trustworthy agent,
but potential agents thus have an incentive to conceal any evidence there may be that
they are
incompetent or untrustworthy.
(b) Assessing the agent's performance: the principal desires to reward the agent
according to the
standard of their performance, but the agent controls or is able to influence the
information the principal uses to assess that performance.
Disclosure is thus a major theme in corporate governance.
Moral hazard arises whenever people are protected from the adverse consequences of
their actions; they have no incentive to exercise correct judgement and are free to act in
an irresponsible manner.
To protect a person from the adverse consequences of their behaviour is to encourage
irresponsibility, hence the moral dimension of the concept.
Moral hazard is not confined to principal-agent relationships. It occurs in banking, for
example, when government guarantee schemes allow bankers to make injudicious loans.
In the agency relationship, we are concerned with the use the agent makes of the
authority with which they have been entrusted. Moral hazard will exist unless at least
part of the agent's remuneration is contingent upon them making responsible use of their
authority.
Agency theory is clearly relevant to the modern business organisation. The directors are
the agents of the shareholders, employed to manage the business in the shareholders'
interest. To do this they are given considerable power over the resources of the business.
How can the shareholders be sure that they will not abuse this trust?
To a lesser extent, agency theory also applies within the organisation. The directors
cannot do everything: as we have said, they must employ subordinate managers to put
their plans into action. How can the directors be sure that those subordinates are not
abusing their trust?