Wounding the Giants

In the late 1990s Austrian businessman Dietrich Mateschitz launched a new, unproven product into the United States soft drink market—the same market dominated by industry giants Coca-Cola and Pepsi.

The move flew in the face of lessons any business student learns in Strategy 101. According to Michael Porter’s famous Five Forces Model, large barriers to entry—obstacles in the path of those seeking entry into new markets—should have discouraged Mateschitz from getting past the conception phase of his endeavor.

After all, why would a rational person ever choose to compete with the likes of Coke, a company that spends billions of dollars on marketing each year to build and maintain its brands?

But the confident Mateschitz ventured forward, launching an “energy drink” called Red Bull. In the process he created a wildly successful new product category and made a personal fortune.

IN SEARCH OF THE HOLY GRAIL

Whether a fledgling entrepreneur, seasoned CEO, or someone in between, most businesspeople are attracted by what could arguably be considered the “holy grail” of enterprise—the chance to sell products in markets where companies enjoy large profit margins and even larger mass-market appeal.

Soft drinks. Sneakers. Software. Once these grails are acquired, companies like Coca-Cola, Nike, and Microsoft protect their product with gusto, erecting as many barriers to entry as possible in an effort to prevent would-be pillagers from encroaching on fruitful turf.

Alas, to those on the outside looking in, the allure of above-average profits is often too much to disregard. Before long, emboldened entrants like Red Bull’s Mateschitz talk themselves into competing in attractive markets, challenging incumbents in a battle that’s unequal and usually short-lived.

Was Mateschitz’ Red Bull experience a fluke? Or do companies really profitably enter attractive markets without getting clobbered? Can tiny Davids methodically slay—or at least wound—seemingly insurmountable Goliaths?

The answer is yes, according to two Marriott School professors whose research on the topic was recently published in the Harvard Business Review. Co-authors David J. Bryce and Jeffrey H. Dyer contend that smart managers employ three key strategies, usually in combination, to crack even the best-guarded markets.

Although there are savvy managers who understand the importance of not attacking the competition head on, the duo’s efforts more formally “provide a framework for companies to conceptualize how to design a successful indirect attack,” says Bryce, an assistant professor of organizational leadership and strategy. The three strategies to launch a successful indirect attack include: (1) leveraging excess capacity in existing assets or resources, possibly including those of partners, (2) reconfiguring the value chain, and (3) creating products that initially appeal to niche customers but not mainstream customers.

“We don’t give them the answers; we don’t tell them exactly what to do,” he continues. “But when companies are contemplating an expansion move, they can get everybody in a room and say, ‘Ok, folks, we’ve got to brainstorm around these three components and come up with an approach to this market that relies on these kinds of ideas.’”

LAUNCHING INDIRECT ASSAULTS

To uncover the strategies, Bryce and Dyer examined companies that successfully entered the United States’ most profitable markets between 1990 and 2000. At the end of their four-year study, they identified three intriguing findings.

First, intimidating tools of the incumbent—including price wars, ad blitzes, and lawsuits—didn’t faze entrants all that much. In fact, there were almost five times as many entrants to the top ten most profitable markets as there were to average industries.

“The analogy we use is that bees are attracted to the honey and that’s also where the incumbents see the big upside,” says Dyer, the Horace Beesley Professor of Strategy. “What they don’t fully appreciate is the downside or the risks of entry and the barriers to enter those markets. I think people enter because of hubris, overconfidence—they think they can make it work when others haven’t, and they often find they’re wrong.”

The duo’s second finding was that new entrants in attractive markets had a particularly tough go of it, typically earning returns 30 percent lower than counterparts in all other less attractive industries. Finally, when entrants into attractive markets were profitable, their returns on assets were nearly seven times those of all entrants to the top markets and almost four times the returns of the profitable entrants in less attractive markets.

So how exactly did the underdogs do it?

When Bryce and Dyer identified the strategies that successful entrants used to surmount barriers to entry, one theme stood out: entrants never attacked incumbents directly, instead relying on methods of indirect assault. The more indirect the attack, the more likely it was to work.

In their article the professors put it this way:

Smart newcomers refuse to challenge incumbents on the latter’s terms and turf. They don’t duplicate existing business models; they don’t compete for crowded distribution channels; and they don’t go after mainstream customers—at least not at first. Almost without exception they take a page out of the military handbook: Never attack the enemy in its strongholds initially. Attack at its weakest points, gain competitive advantage, and later, if doing so meets your objectives, attack its strongholds. Red Bull is a classic example of just such an approach, the professors say. The company entered the U.S. soft drink market selling a skinny, $2-per-8.3-ounce can of highly caffeinated soda. The product was initially distributed via bars and nightclubs, touted as an instant kick-in-the-pants for tired twenty-somethings more interested in partying than in a good night’s sleep.

The product caught on, gaining enough of a following and generating enough profit that Red Bull was eventually able to maneuver its way into conventional stores. By increasing advertising that touted the drink’s energy enhancing properties, the company soon enjoyed a 60 percent share of the newly created $650 million energy drink market by 2005.

In contrast, Richard Branson, the CEO of Virgin Drinks, took a much more direct approach when he attempted to launch Virgin Cola in the United States. To drive home the point that he saw the entry of his beverage into the market as a head-to-head fight with Coke and Pepsi, Branson drove a tank through a wall of cans. Despite his braggadocio, Virgin wasn’t able to get past the incumbents’ strong grip on shelf space. Although people flying Virgin Airlines today can still enjoy a can on some flights, Virgin Cola flopped in the United States, never making much of an impression in the marketplace.

“When companies go after customers that incumbents are ignoring; if they can go for fringe customers; if they use a very different business model so that the incumbent doesn’t see it as direct competition, the new entrants have time to amass the resources to eventually withstand a retaliation from the big players,” Dyer says.

MAGIC THROUGH COMBINATION

According to Bryce and Dyer, companies can avoid repeating Virgin’s mistakes by considering three basic strategies to mount a successful indirect attack.

First, leverage the excess capacity in existing assets and resources or those of partners. Second, reconfigure value chains—the value adding activities a company performs—by changing the nature of the activities themselves or by changing their order. And third, create products that initially appeal to a niche of customers.

On their face, the three strategies don’t seem revolutionary, but there’s more to the approach than initially meets the eye, Dyer says.

“What’s new here is that we determined you’re going to be much more successful if you can use these entry strategies in combination or in pairs, or even use all three simultaneously,” he says.

It’s not just a matter of only leveraging resources or reconfiguring value chains or going to niche markets. Those elements, by themselves, “are not really all that interesting,” Bryce admits. “It’s when companies use a combination of those approaches to come up with some really innovative strategy that they’re able to effectively position themselves to grow and flourish.”

MIX AND MATCH

One company Bryce and Dyer identified that successfully combined the strategies of “reconfiguring the value chain” and “creating a niche” is Skype. Using Skype’s software, customers can make inexpensive phone calls via the Internet.

Getting into the telecom services industry is cost prohibitive because of the vast amounts of capital required to build the infrastructure for a nationwide network. To successfully compete Skype reconfigured the value chain by answering the somewhat subversive question, “How can we use the very network created by our competition to compete against them?” At the same time, Skype successfully targeted a niche market of people intrigued by the idea of saving money by circumventing the established system. Initially, the telecom giants didn’t pay much attention to the company. But the appeal of inexpensive phone calls quickly attracted a critical mass of customers and that attracted the attention of eBay, which acquired the company two years after its start for a cool $2.6 billion.

Of course, the strategies identified by Bryce and Dyer don’t just work for Internet startups. In fact, Bryce says using the framework itself more completely appeals to large companies. His reasoning? Small companies don’t usually have substantial assets or resources they can leverage, leaving value chain reconfiguration and niche strategies as their primary entry options.

Wal-Mart is a big-box retailer that has effectively leveraged its value chain and assets to snag a 5 percent share of the overall U.S. soft drink market, say Bryce and Dyer. Because the company owns the very shelf space manufacturers covet, Wal-Mart was able to nimbly jump that typically large hurdle to place Sam’s Choice brand beverages within the reach of millions of customers. In addition, Wal-Mart worked closely with premium private-label manufacturer Cott Corporation to design a production and distribution system that allowed the companies to get soda into stores more cheaply than incumbents.

Unlike Virgin Cola’s attempted entry into the market, Wal-Mart succeeded partially because Coke and Pepsi were unable to change their business models, Dyer says.

“It’s a much simpler way of doing distribution, and Coke and Pepsi can’t imitate as easily the reconfiguring of value chain in the activities as they can simply imitate a niche energy product or a fruit-based drink, for example,” Dyer says.

TRIPLE THREAT

Most companies combine two of the strategies to great success. However, Jakks Pacific, a California-based toy and action figure manufacturer, has entered the highly profitable video game industry by combining all three.

Instead of selling expensive video game consoles that require the purchase of games on cartridge or disc, Jakks Pacific only offers easy-to-use handheld video game controllers that plug directly into television sets. Jakks’ games come installed directly on the controller and cost somewhere in the $20 range. Featuring characters from movies, television, and comic books, Jakks Pacific appeals to preteen kids and price-conscious adults.

Of course, the quality of the games doesn’t compare with that of Xbox 360 or PlayStation 3, but that’s not the point. The games are portable, fun, and inexpensive. According to Bryce and Dyer’s estimates, the company’s game sales increased by approximately $25 million per year from 2003 to 2005, and overall company revenues doubled from $316 million to $661 million. In comparison, Microsoft has lost $4.5 billion since launching the original Xbox in 2002—its direct attack on industry incumbents—and has yet to turn a profit on the product.

Through the lens of the Bryce-Dyer model, Jakks Pacific scored a hat trick by, first, partnering with others to leverage brand capital from well-known TV programs and movies to create new games. Second, the company reconfigured the value chain by including game software directly in the game controller and licensing content directly from intellectual property owners. And third, Jakks Pacific cultivated a niche audience by targeting adults and children who want the fun of playing a video game without having to grow extra fingers to manage complex multibuttoned controllers.

FRAMEWORKS AND THE REAL WORLD

Jakks Pacific, Red Bull, and Skype have employed the strategies outlined by Bryce and Dyer to great success. But do most managers even think about market entry in this way?

“There’s one type of company that’s very deliberate about applying the strategies and says, ‘Look, we are small; we are underresourced. We simply don’t have the investment funds or the wherewithal to go up against a major company. Let’s look for some alternatives that will give us the opportunity or the ability to get into this market,” Bryce explains.

The other kind of company gets there in an evolutionary way. “What you have is this natural process in which, as companies are expanding, they look to what they know how to do and add to it incrementally to expand successfully,” Bryce says. “When they do that, they wind up just naturally moving into niches, leveraging existing resources, or—more radically—reconfiguring the value chain.”

In the end, it’s not just the companies that benefit. “Companies that apply the framework and are more creative in their entries strategies are, first of all, more competitive,” Bryce says. “But more broadly, this has the potential of enhancing the overall standard of living because the companies are able to create products and services in niche areas at lower cost. That ultimately serves the consumer.”

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Article written by Grant Madsen
Photography by Bradley Slade

ABOUT THE AUTHOR
Grant Madsen is the marketing director at American Crafts. He earned a BA in communications from BYU in 1998 and an MBA in 2007.