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Illustrations by Elwood Smith |
But these standard explanations are misleading. In the 1990s, incumbents like GM, Ford, United, and US Air (now US Airways) were already losing market share and money whenever they faced the intruders directly. Only rising markets elsewhere kept them profitable. Today, even if their employment costs were equalized, their pension obligations were lifted, and crude oil prices returned to $28 per barrel, they would still have higher costs and lower quality than their new competitors.
The real explanation is format invasion. Every business has a format — its own distinctive way of organizing the many activities involved in delivering its product or service. Incumbents suffer (as GM, Ford, United, and US Airways have suffered) when intruders enter their markets wielding new types of business formats. These new ways of assembling commonplace assets deliver familiar goods and services at massively lower cost, often 20 to 40 percent lower, while maintaining or improving quality. The traditional market leaders fail to recognize the power and potential of their competitors’ new formats. They cling instead to their old familiar formats, and gradually but inevitably lose ground to the new ones.
Some business observers credit technological innovation as being the most critical factor in transforming an industry. But successful new formats do not rely on new or proprietary technology. Indeed, incumbents often have broader and deeper technological capabilities than intruders. Instead, new formats achieve their massive cost advantage by changing several of the business’s main functions at once, often reaching backward to include suppliers or forward to include distributors. These changes are tightly interlinked: The new format “works” only when it’s adopted as a whole, which makes the transition to a new format daunting for incumbents.
Other observers equate market development and growth with a “killer app” — a new feature or hit product, like the Chrysler minivan, the Apple iPod, or Pfizer’s Viagra. Hence the frenetic chase for the new feature or hit product that will open the wallets of an existing market segment or galvanize a new one. But a new business format has little to do with innovative features or technological novelty. Rather, massively lower cost is the killer app in many markets — as companies as diverse as Dell, Inditex (Zara) apparel, Countrywide Financial, Nucor, Wal-Mart, and Charles Schwab, as well as Toyota and Southwest Airlines, have shown. Toyota’s lean manufacturing methods, which ruthlessly eliminated the waste in its production systems, led to costs far below those of the Big Three Detroit automakers. Southwest’s point-to-point format for air travel vastly reduced the ground and flight costs inherent in the “hub-and-spoke” format of the airline industry’s established leaders. In recent decades, intruders wielding new business formats have trounced traditional incumbents across a wide range of industries: personal-computer manufacturing, car care, mortgage lending, stockbrokerage, steel, and many varieties of retailing, from groceries to books to gasoline.
An effective format invasion throws open for question the prevailing operating assumptions of an industry. Consider, for example, two recent format invasions in the European gasoline retail sector. The predominant format for the past several decades was the large, self-service gas station combined with a convenience store, which had supplanted the older format of small, full-service gas stations with repair bays. Jet, now a subsidiary of ConocoPhillips, has entered the Scandinavian market with a wholly new format: a completely unattended gas station. Effectively, it is a giant vending machine. By eliminating the station manager, cashiers, and other support costs, the new stations require only half as much margin per liter of gas to earn an attractive return. They can offer an almost unbeatable combination of low prices and convenient locations.
