Conversely, incumbents often reject the notion of adopting the new format on the grounds that doing so would require abandoning their up-market feature and amenity offering, and thus cause an unthinkable revenue loss. They fail to see a major opportunity: that the company can combine high features and amenities with the new format’s low costs. There is a realistic opportunity, for instance, for a traditional airline to continue providing high levels of service while adopting Southwest’s more efficient production model. (In Exhibit 2, the traditional airline could move down the dotted line to the new format with mainstream features.)
This confusion also seems to underlie Harvard Business School Professor Clayton Christensen’s well-known views on format competition. Professor Christensen argues that innovative products and business formats (or “value networks,” as he calls them) begin life underperforming the requirements of a market’s core customers. Later, as the intruder’s performance improves, it gains the ability to enter the incumbents’ core markets. Whatever the merits of this view with respect to technological innovations such as improved disk drives, it does not apply to new business formats. The choice of business format and the choice of amenity level are largely independent of each other. Most format innovations indeed appear at the low end of the market, but this is only because that represents the simplest and most expedient route for the intruder to monetize its innovation.
When a new-format intruder offers more features and amenities than its traditional competitors do, they will not necessarily be the same mix. The new format makes some amenities easier and some harder to provide, so the intruders do what any seller would do: accentuate their advantages. Airline passengers, for example, may wait a bit longer for connecting flights on Southwest, but they get nonstop flights more frequently. Retail customers may drive a bit farther to shop at a “big box” store, but they can choose from a broader variety of goods. In any case, these differences tend to be modest; the new format’s lower costs and prices swamp any differences in its amenity mix.
Late in the cycle, as new-format intruders take ever more market share, the increasingly strapped incumbents often start to merge. From one perspective, these mergers appear inevitable and beneficial: Old-format companies face a contracting market, which simply cannot support as many of them as it did before (even if the overall market remains robust). However, the traditional companies often expect more from this kind of industry consolidation than it can provide. Too often, they view consolidation as a real fix, rather than seeing it correctly as another step in their decline. This is because they view their collective overcapacity as the problem, rather than recognizing it as a symptom of the format invasion.
The Incumbent’s Opportunity
Some incumbents have responded successfully to a format invasion. When they do, the results are extraordinarily profitable. We’ve looked at several companies that took on a format invasion successfully, and at several others that more or less tried but failed. Nothing we’ve seen indicates that the companies that made a successful transition to a new format had any greater depth of technical, financial, or operational resources than the peers they left behind. Nor did we find that they had “less to lose” by giving up the old format. But the winners adhered to a few basic principles, while avoiding some clear pitfalls.
The experience of Best Buy and Circuit City over the past decade comes close to being a controlled experiment on this point. At the outset, nothing about Best Buy’s market position or format distinguished it from Circuit City. If anything, Circuit City had more resources with which to innovate. But Best Buy identified and acted upon an opportunity where Circuit City did not.