Strategy Dynamics Briefing 52: When type-1 and type-2 rivalry operate together

It is rare for any type of rivalry to operate entirely alone…

Examining the three main types of rivarly:

• Type-1 rivalry to capture new potential customers could feasibly happen if the product or service is entirely new, and if any customer, once committed, would find it hard to switch. The market for enterprise-resource-planning systems (ERP) comes close to this ideal – once a substantial business has committed to using SAP it would be complex and costly to throw that out and use something else.
• Type-2 could only operate alone in very mature markets, when virtually no new customers ever emerge and every customer has to buy from only one supplier. The market for supplying businesses with electrical power comes close to that ideal, though even there a small number of new opportunities arise each year.
• Type-3 rivalry (to be explained more in the next briefing) to operate alone also requires that no new customers are created, and that all customers be entirely disloyal so they switch purchases constantly between suppliers. The sale of some fast-moving consumer commodity products to retail stores would be close to this ideal.

Figure 1 shows what happens with both type-1 and type-2 rivalry operating together between the two coffee stores discussed in Briefings 50 and 51. Customers are

1. won by each store from the potential population if their price is attractive, lost back again if not, and
2. switch between the stores at a rate that depends on the differential in price.

Here’s the pricing scenario:

		Our price	Rival’s price
	First half-year	$2.95	$2.80
	Second half-year	$2.80	$3.15

The rival store launches at the same time as us, offering a lower price in an effort to capture customers before we do. After the first half year, our concern with limited customer numbers causes us to drop our price, while the competitor raises price in the belief that higher margins can be captured with little loss of customers or sales volume.

During the first 26 weeks, our rival’s more attractive price enables them to capture customers more quickly than we do — 2618 versus our 1409. Importantly, we not only win customers more slowly, but also many of those that we do win switch to our competitor. This can be seen in the first half of the time chart for “customers switching to our store per week” (center), where a negative number indicates customer losses from our store. Despite the competitor’s lower price and therefore gross margin, this is more than sufficient to give it higher sales and profits. Indeed, we have still not broken into profit at all.

The second half-year sees this situation reversed. Although few undeveloped potential customers remain by week 26, our new lower price allows us to continue capturing those who remain. Our rival’s higher price actually causes some customers to stop using their store and return to the potential stock (the negative flow of “rival’s net new customers won per week“). Those customers then become available for us to capture. At the same time, our wide price advantage leads to rapid switching of customers directly from their store to ours (the high positive flow of “customers switching to our store per week”). Driven by these two mechanisms, our sales grow strongly, push profits into positive territory, whilst our competitor loses sales and profitability.

Once again, different behavioral responses by customers would generate different trajectories for customer numbers, sales and profits than are shown in Figure 1. In practice, then, it is important to understand the nature and scale of those responses. It would not be sufficient, for example, for the competitor in about week 28 to observe simply that weekly sales had fallen. They should identify to what extent that loss is due to each of the four consequences from the pricing changes—customers ceasing to use their store, switching to our store, visiting less often, or spending less on each occasion. In this illustration, the second of these mechanisms is powerful, whereas the third and fourth are modest. Consequently, the competitor would know that its immediate loss of sales was likely to get still worse. If, on the other hand, the early drop in sales were caused mostly by fewer, lower spend visits, rather than by customer switching, they could expect sales and profits not to fall much further.

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