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The Proliferation Trap

Proliferation describes a situation in which there are many firms competing in a market, but rather than attempting to underprice one another, they seek to carve the market into smaller and smaller niches, each of which is served by a very specific version of the product in question.

It is a danger to a firm that wishes to exploit the efficiency of developing a standard product that is sold to a broad range of consumers, rather than take on the additional expense of customizing the product for small groups of customers.

The problem a firm faces is very different: there is no single enemy to combat, as in the case of an aggressive cost-cutter, but a swarm of very small firms, like a swarm of ants, such that it is not possible to take on all challengers.

Case Study: Sears

The author considers the case of Sears, a long-standing retailer of consumer goods. In the later nineteenth century, Sears was a catalog retailer that specialized in shipping a wide variety of goods to small and remote locations, and began opening retail stores in the 1920s.

By the mid-nineties, its business had been thoroughly nibbled away by a wide array of other retailers: category killers, boutiques, general merchandisers, department stores, etc. Because it originally offered a wide range of goods, virtually every store or catalog threatened a small piece of its business, and the collective effect was considerable.

Moreover, each of its attackers was assaulting Sears in different ways, making it impossible to implement a single countermeasure to defend against all comers: some competitors were taking away the cost-conscious customers, others were taking away the quality-conscious ones. Category killers were taking away entire lines of business: Best Buy took appliances, Home Depot took hardware, Toys-R-US took toys, etc. The plethora of Internet retailers even killed its mail-order catalog channel.

Sears attempted a number of tactical maneuvers to counteract, but its efforts were poorly coordinated and inadequately funded. It abandoned the low-end consumers to discount chains but continued to position itself as cheaper than other department stores. It reduced its product offerings primarily to clothing ("Softer Side of Sears" campaign) and spun off some of its lines to stand-alone brands (separate hardware, automotive, and furniture chains) and sold off a few of them.

Even so, the company remained wedded to its general-store format for too long, and the smaller firms nibbled it to pieces. The firm was ultimately bought out by Kmart, which itself is on the brink of financial collapse.

Proliferating Hotels

The author then looks to the hotel; industry, where proliferation is rampant. In just over a year (the author doesn't state which year this was, but I think it was around 2005) at least 24 new hotel brands were launched, each catering to a specific set of needs and level of price sensitivity.

(EN: a quick check of Wikipedia lists 245 different hotel brands, and many of the larger players have multiple brands: Choice Hotels has 11 brands, Hilton has 12, Marriott has 20.)

Proliferation such as this arises when a firm identifies a specific set of needs that are not being met by an existing brand and establishes a brand to address those needs. whether it is a new firm seeking to enter the market or an established firm seeking to serve more customers. Differentiation becomes the means of competition, and it escalates to the point where the market is thoroughly Balkanized.

The author looks to Holiday Inn, which was at one time "the nation's innkeeper" with over 1400 three-star hotels that peppered the American interstates - each was strategically located to be within a day's drive of the next. Holiday Inn became the standard offering: comfortable but not posh, inexpensive but not cheap.

The first assault came from both ends. Two-star lodgings such as Motel 6 and Quality Inn offered a cheaper alternative for travellers who simply wanted a no-frills place to sleep at a discount price. Four-star chains emerged that offered more comfortable amenities at slightly higher prices for travellers who would spend more than one night. Fighting on two fronts crippled the firm, which was bought out in 1988, and ultimately fell into the two-star category (which itself is highly commoditized).

Most hotel companies respond to proliferation threats by piling onto a category: they establish a separate brand for a chain that responds to a competitor's threat to take a specific market segment by serving that very same segment. While this is feasible for a time, the industry has become so fragmented that a firm's own business becomes cannibalized: it operates so many properties in a given location that there are fewer guests at each property to cover the growing overhead expense.

Some firms are large enough to do this, whereas others attempt to limit their positions along specific market segments that are most profitable to serve. This is a choice between abandoning revenue to focus on a smaller number of customers, or accepting increased expenses to continue to serve a broad range.

Choice hotels is one of the most familiar examples of a fragmented firm: it began with Comfort Inns as a two-star property, but soon segmented itself to Sleep Inn (one star), Comfort Inn (two stars), Quality Inn (Three Stars) and Clarion Hotels (4 stars), and ahs in the present day grown to eleven brands, the distinctions between which seem a bit blurred.

(EN: Even the author's discussion seems to be fragmented and blurry: he seems to bounce from Choice to Starwood to Hilton to Marriott - and it seems like more of the same. The hotels each choose a specific market segment to address, to the abandonment of others.)

Sidebar: Hotel "Star" Ratings

The "star" ratings for hotels are largely arbitrary, and given that those who give ratings used different criteria, the author defines his terms:

Given the competition for the higher end, a few other categories are created:

Strategies For Responding To Proliferation

The author's suggestion to countering proliferation is "to manage the threats," and provides three examples:

  1. Escape proliferation by selecting threats, and focusing on a more specific market segment
  2. Attack and overwhelm the threats, choosing to fight on many fronts by creating brand extensions and a full-line portfolio.
  3. Turn the trap to their advantage by outflanking rivals by opening new positions above, below or at the extremes of the expected price line.

(EN: It strikes me that the author's suggestions for escaping proliferation are exactly the tactics that cause proliferation in the first place.)

Escape the Trap: Select Your Threats

Sometimes proliferation threats cannot be confronted directly: fragmenting your operations to serve smaller market segments requires additional cost, and the cost can price your product out of range.

Companies are inclined to seek market segments where there is the greatest potential for profit and the least amount of resistance from rivals, and can thrive if they have a sustainable competitive advantage for serving a specific market segment.

That is, if you abandon the segments in which you have no competitive advantage and cannot operate profitably, you're left with the segments in which you have an advantage and can make the most profit: it's abandoning unprofitable markets to competitors and seeking the best opportunities.

The alternative, to try to serve every segment, means that some of your brands will run at a loss and be subsidized by the more profitable brands, which merely siphons the resources from the most successful ones. The position that you will seek may be defined by a number of factors: the price sensitivity of customer segments, geographic locations, etc.

The author also suggests that "companies can also move in and out of less competitively intense areas as they appear and disappear." (EN: I'd agree on the basis of companies, but not brands. If a brand is constantly in fluctuation, it loses its value.) A firm that uses this approach must be nimble - to jump in before rivals recognize the opportunity, to exit before rivals recognize the problems.

Destroy the Trap: Overwhelm the Threats

Where there is no unoccupied segment to serve, firms must fight for market share against their rivals, to which end the author suggests two critical decisions: to concentrate your resources in one area or to fight on multiple fronts, and whether to confront the opponents simultaneously or sequentially.

Fighting on multiple fronts requires a great deal of resources, and smaller or more cash-strapped firms may not be able to afford to do so. Even for firms with considerable resources, the actions necessary to one conflict may be contradictory to the actions necessary to defend on another. You simply cannot, for example, be the lowest priced and highest quality provider in a given market.

The author looks to BJ's wholesale club, who was outsized by Costco and Sam's Club, and chose to compete for the higher-end market by focusing on fresh foods, lobster tanks, wider variety, high-quality brands, and exclusive-looking private labels. This sidestepped competition with Costco (which focuses mainly on supplying small businesses) and Sam's (which focuses on penny pinchers with an average income of $35K) by focusing on the more affluent residential market (household income averaging $80K), meanwhile remaining competitive with upscale supermarkets on price.

(EN: I looked into this company, and noted that it does not seem to be a competitor in the grocery business anymore - they stock "gourmet food and gift baskets" and seem to maintain a selection of organic meats and high-end seafood, but the main categories on their Web site are electronics, sporting goods, office supplies, home furnishings, and the like, which isn't really in the same merchandise category as Sam's and Costco.)

A second strategy is to "create a wolf pack" or brands that are able to compete with other companies on multiple fronts. The previous example of hotels demonstrates how a mid-grade hotel can create several different brands to compete on multiple fronts. He also mentions Sears, in spinning off specialty chains, but with the concession that they did not do this very well and starved many of its specialty retail brands to continue to support the mall anchor-store format un which it was increasingly uncompetitive.

Having or gaining critical mass (sufficient customers to operate profitably) is a challenge to defending against proliferation: when your firm changes its position, existing customers will not necessarily come along for the ride, and a launching a new brand requires significant expense to establish itself in the market.

The author mentions the watch industry as an example: for a time, Swatch dominated its category of affordable fashion watches, but other brands nibbled away at market segments. The firm acquired smaller companies and diversified its brands to a wolf pack of over 20 watch brands serving different market segments, but only one or two of these brands are recognized by consumers. Even so, the firm has the mass to focus on one brand to defeat one rival, then switch its focus to another that is threatened. As such, the firm has a diverse portfolio of brands and can "meet anyone, anywhere."

On timing, whether to take on competitors sequentially or simultaneously also depends on the availability of resources. The author presents Microsoft as a firm that has done both. In its early days as a small firm, it took on challengers one at a time, by incorporating their functions into applications: it presented a GUI to respond to Apple, developed Word to compete with WordPerfect, developed Excel to compete with Lotus, etc. AS the firm grew, it gained the resources to fight on multiple fronts.

The author considers partnerships and joint ventures as methods for keeping rivals at bay for a limited time, until the firm has the resources to challenge them, but does not provide a specific example of an instance in which this was done.

A merger or hostile takeover is an even more dramatic step, to eliminate the competitor by taking them over. Even the treat of a hostile takeover can be intimidating to rivals, as a competitor who feels themselves threatened will generally enter a period of retrenchment, slowing their innovation and expansion as they gear up to defend.

Another stall tactic is "ghost products" or "vaporware" - which involves creating a credible rumor that a powerful firm is about to move into a given product category and scaring off competitors who might otherwise have been the first-mover, even if the product is never actually created.

Finally, there's a mention of "fighting brands," which is a common marketing tactic that enables a company to produce a low-cost brand without detracting from the prestige of its main quality-focused brand. Companies generally experiment with a fighting brand in order to determine its effect on the market and can discontinue it with relatively little cost, whereas competitors who react to the fighting brand often make indelible mistakes.

Turn the Trap to Your Advantage: Outflank the Threats

Some firms may find that proliferation can be made to work to their advantage, because they have the speed and efficiency to quickly outflank competitors and nibble away at their market. For the firm in such a position, the author suggests a few tactics.

One approach is to look for "white space" in existing markets by squeezing in between market segments: the notion of a four-star hotel is a level of quality that is better than a standard three-star, but not quite as luxurious as a five-star. White space can be discovered in reviewing reports of customer satisfaction: wherever existing providers are failing to meet expectations, there is opportunity for a firm to build competitive advantage by addressing these specific gaps, often by neglecting areas that are (wrongly) assumed to be important.

The problem with white space is that it is short-lived. As soon as one firm recognizes an opportunity, others will move in as well. If the market is lucrative and the barriers to entry are low, they will arrive very quickly. (EN: I recall a lecture about "second mover advantage" - which challenges the conventional wisdom that being there first is important, as the first firm must make its own mistakes to learn from them, whereas the second mover can more easily preserve their reputation and brand integrity by learning from the mistakes of others. - though this requires them to be critical rather than imitative. Looking to historical evidence, the first mover is seldom the industry leader for long.)

Another approach to fostering proliferation is to nibble off smaller market segments. Consider fitness clubs for women, which gathered significant popularity because existing facilities were open to all but primarily geared toward male clientele and hence unsuitable for (and hostile to) women.

The author goes on rather a long tare about the Las Vegas tourism industry, which for years was beset by local gambling in various states (and overseas) as well as intense competition with one another. Some of the proliferation strategies are:

It's worth noting that many Vegas properties seem to be diffuse in their efforts, trying to be everything to everyone: there may be a roller coaster and an arcade for families and an adult-oriented cabaret, a cheap buffet and a four-star restaurant, penny slots and a high-limit salon, all at the same property. This creates all the more opportunity for a small competitor to seize the attention of a specific niche market.

The author also considers the tactic of shifting the marketing focus as a method of competition: pharmaceutical companies traditionally marketed their medicines to doctors, but some recognized the value of selling themselves to insurance companies, pharmacy chains, and even directly to the end consumer as the power and influence of doctors has waned over recent decades.

Each of these segments has a different set of interest: the doctors are fearful of malpractice over side-effects, insurance companies and pharmacies want to control costs, and the patients want an effective cure. In this instance, the product remains the same, but the value that is proposed to the buyer is differentiated.

Choose a Threat-Management Strategy

The choice of a specific threat-management strategy against proliferation depends on the nature of the market, the firm's resources, and the level of threat. The size or ambition of a firm can also play a role: the firm that seeks to serve the entire market will be required to face more challenges than a firm that will happily and profitably serve a smaller niche.

The resources of a firm are often the greater determinant of strategy, as firms are constrained by virtue of lacking the resources to effectively defend a market against multiple large opponents in an effective manner. To take on more than you can afford is a quick route to collapse.

The author presents a list of questions managers should ask when faced with the prospect of taking on a new segment or a new competitor:

For larger firms, the author provides three general rules:

  1. Be as ambitious as you can afford to be. A large firm has the power and resources to pursue many courses rather than putting all its eggs in one basket.
  2. Maximize efficiencies. A key competitive advantage for a larger firm is in controlling costs by efficiencies of scale as well as shared resources.
  3. Sway competition. A large firm can more easily scare away small competitors merely by threatening to step into their niche. It can also partner with or buy out smaller competing firms, which is sometimes more efficient that directly competing.

Different rules apply to a smaller business:

  1. Curb your ambition. A small firm doesn't have the resources to take on many competitors at once and can easily be broken by taking on too many different strategies.
  2. Maximize customization. The nimbleness of a small firm is its competitive advantage. It may lack the resources to have economies of scale, but it also lacks the enormous overhead that prevent larger firms from making significant changes in operations to serve the needs of a particular segment.
  3. Fight judiciously. Using resources effectively means determining where they have the greatest potential for profit. It's a terrible waste of limited resources to fight a battle with little chance of winning, or one whose victory will result in little reward.

The author also mentions the economy as the rising tide that can life all ships, or the waning tide that can beach them. As the economy turns sour, consumers shift to the lower end of the price line, sacrificing quality for cost, and luxury has less appeal not because of competition among firms, but because of atrophy in the market in which all firms compete. A depressed economy generally reduces the threat of proliferation, but feds the threat of deterioration.

And finally ,a warning to firms who seek to engage in a battle of proliferation: once it has begun, it is very difficult to stop it. Once you have catered to the specific needs of a market segment, it will become their expectation that you will continue to do so, and if you decide to move away from them, don't expect them to follow, but instead to flock to a competitor who continues to serve them well.

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