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Strategy in the telecommunications market
Strategy in the telecommunications market The effects of liberalization and competition
M. G. Carney While the debate continues over the appropriate mix of planning and competition in telecommunications, ~ a number of governments have introduced varying degrees of liberalization and pro-market regulation. As a result of this experience, some conclusions can already be drawn about the way competition actually works in the complex and dynamic telecommunications industry. When the idea of deregulating telecommunications began to gather momentum in the 1970s, little was known about how firms would respond to competition. 2 It seemed likely that the market would operate in a different way from the eighteenth-century concept of the 'invisible hand'. Yet the collapse of Brannif Airlines in the USA following deregulation warned government planners and businesses that illconsidered strategies in competitive markets can have lethal consequences. In telecommunications, governments recognized the potential disruption of services and danger to domestic employment, and tended M. G. Carney is an Assistant Professor in to introduce liberalization incrementally. Behind this policy lay the the Department of Management, Faculty of implicit assumption that previously-regulated businesses required time Commerce and Administration, Concordia University, 1455 De Maisonneure Blvd, to adapt their organizations, products and strategies to competitive conditions. West Montreal, Quebec, Canada. In the UK, the significant deregulatory legislation is contained in the 1Hans Bergendorf, Torsten Larsson and 1981 Telecommunications Act which empowers the Secretary of State Ruben Naslund, 'The monopoly vs. com- for Trade and Industry to license market entry. Subsequently, several petition debate', Telecommunications Policy, Vol 7, No 4, December 1983, pp institutional agencies and procedural arrangements have been estab297-308; John Langdale, 'Competition in lished to monitor and implement the new regulatory framework. telecommunications', TelecommunicaDrawing upon the UK experience, we can identify and describe some tions Policy, Vol 6, No 4, December 1982, of the ways firms have attempted to cope with strategic issues created p 283; and Gerald Brock, The Telecommunications Industry: The Dynamics of and exacerbated by deregulation. This article is based upon the premise Market Structure, Harvard University that certain types of market conditions provide particular strategic Press, Cambridge, MA, 1981. problems or imperatives to which participants must respond if they are 2,.i.F. Mahon and Edwin A. Murray, to remain viable and prosperous. A two-dimensional matrix describing continued on p 246
This article identifies some of the ways in which firms in the telecommunications industry have attempted to cope with deregulation, drawing upon the experience already evident since Iiberalization began a few years ago. The author argues that certain types of market conditions provide particular problems for firms, to which they must respond if they are to remain prosperous. A matrix describing four market types is offered as a facsimile of the competitive conditions now found in the telecommunications industry, and examples are given from the UK. Economic, technological and political factora affect the strategic behaviour which firms must follow, but in different ways and at different times.
0308-5961/86/030245-1353.00 © 1986 Butterworth & Co (Publishers) Ltd
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four limiting or extreme market types is offered as a facsimile of the competitive conditions now found in the telecommunications industry.
The nature of competitive environments
continued from p 245
'Deregulation and strategic transformation', Journal of Contemporary Business, Vol 9, No 2, 1980, pp 123-141; and J. F. Mahon and Edwin A. Murray, 'Strategic planning for regulated companies', Strategic Management Journal, Vol 2, 1981, pp 251-262. aWarren G. Bender, 'Telecommunications decisions: a reassessment of assumptions', in Kathleen Lancaster, ed, International Telecommunications, Lexington Books, Lexington, MA, 1982.
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We are used to thinking of the core of the telecommunications industry as a natural monopoly. While the real extent of natural monopoly remains an open question, the structure of the industry has now become more fragmented than was previously thought possible. However, this fragmentation is uneven as various product-market areas have been affected differently by liberalization and technical change. Closer inspection reveals the industry to be composed of a network of product-market areas, each populated by a variety of producers linked in an interdependent pattern of competitive and cooperative relations. British Telecom (BT) is the central organization in this network and plays a dominant role in mediating access to the market. The changing relationship between BT and telecommunication service users has received the majority of popular attention as a result of deregulation, However, we suggest that the principle effect of deregulation has been to disturb a historically stable pattern of interdependence between the P T T and equipment-producers. Many of the changes now occurring in the industry are related to the manoeuvring of firms and creation of new alliances, rather than technical change p e r se. For this reason, the strategic behaviour of firms is critical to understanding the direction of change in the industry. Deregulation emphasizes the role of the market mechanism in controlling and regulating industries. In theory, the market works through competition between autonomous firms; deregulation aims to increase the numbers of autonomous firms participating in the industry by reducing state-created barriers to entry. Economists measure the potential for competition in terms of market concentration. Generally, the lower the level of concentration, the greater the intensity of competition. The logic of strategy from a particular firm's perspective is to increase concentration in its own product:market area since the absence of competition enables the firm to meet the demands and expectations of its stakeholders (employees, shareholders, customers, etc) and guarantees longer-term survival and viability. A cursory examination of several telecommunications productmarket areas reveals that markets differ in their capacity for concentration. The market for local-area domestic voice services remains concentrated in the hands of BT and, despite technological developments, little change is anticipated in the foreseeable future. Trunk and businessdedicated local-area networks have become less concentrated by the entry of the Mercury consortium. Regulatory impediments apart, one does not expect these product-market areas to become 'perfectly competitive' in the classical economics sense. With continued technological development we are likely to see the emergence of a two- to five-firm oligopolistic structure with some product and/or service differentiation. At the equipment supply side of the industry, we may see a trend towards increasing concentration. In the public switch market, 17 firms currently supply approximately 85% of the world market, 3 but exploding R & D costs, combined with decreasing product life cycles, are
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4Charles Perrow, 'A framework for the comparative analysis of organizations', American Sociological Review, Vol 32, 1967, pp 194-208; Jerald Hage, Theories of Organizations: Form, Process and Transformation, John Wiley, New York, 1980; and Joan Woodward, Management and Technology, HMSO, London, 1958. SPerrow, op cit, Ref 4.
likely to consolidate the industry as weaker firms either fail or are acquired by larger firms. However, competition at the national level is mediated through the PTT, and the willingness to use more than one source for large switches may increase competition in the short term - as instanced in BT's decision to use L.M. Ericsson's AXE system in addition to its domestic suppliers to enhance its modernization programme. In the peripherals market, there are very low levels of concentration. The number of firms manufacturing and retailing electronic telephones is probably inestimable - a truly competitive market has emerged in this and similar product areas. Generally, concentration is a function of several factors, but most critical are capital start-up costs, economies of scale in production and government or P'FT procurement policy. Naturally, the degree of concentration in an industry has important implications for a firm's strategy and some of these will be explored below. In addition, one other factor - task knowledge - has a significant impact upon a firm's strategic posture. While economists tend to classify markets in terms of their concentration, sociologists and organization theorists focus upon technology as a basis of differentiating environmental contexts. 4 For instance, Hage argues that markets can be usefully classified in terms of the sophistication of the technology involved and the rate of product change; in general, the more sophisticated the technology and the higher the rate of product change, the greater are the task knowledge requirements necessary to participate in the market. Task knowledge is a broader concept than technology; it refers to the clarity of the means-to-ends relationship with respect to a particular task. 5 We shall describe a product-market area as being unambiguous when tasks are relatively routine and well understood by those performing them. For example, the operation of a telex service, though technically complex, is well understood. Similarly, the marketing and distribution of telephones is fairly clear cut and unambiguous, as it is based upon the technology of retailing. In contrast, the operation of a cellular radio system is, in our terms, ambiguous. The existence of several types of cellular radio system, and rapid developments in related technologies such as radio and microwave communications, represent a field of uncertainty for firms seeking to enter this area. Moreover, the likelihood of unanticipated problems occurring with any particular technology often demands task knowledge and expertise beyond an operator's experience. Task ambiguity is not limited to 'hard technologies" such as cellular radio. The case of System X demonstrates how ambiguity affects the marketing task. Each participant in the System X consortium held different beliefs about the way the switch should be promoted internationally. Consequently, several different approaches, including a procedure of lead tender, joint marketing effort, and individual marketing, have been tried with inconclusive results. Task ambiguity is clearly related to technical change within an industry, but it can also emanate from outside the industry or from a change in expectations of firms by government or consumers. For instance, when government asks a nationalized firm to meet commercial financial targets, it may face ambiguity if its task knowledge is grounded in the idea of providing universal service.
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In unambiguous product-market areas, potential competitors may easily acquire the necessary task knowledge to enter that area. A manufacturer of office dictation equipment was able to produce and market a telephone answering machine within months of the liberalization of the UK peripheral attachments market. In comparison, the task knowledge required to participate in the PABX market is sufficiently ambiguous that even organizations such as IBM have had difficulty in gaining a foothold. The presence of task ambiguity provides scope for differential learning and permits early entrants to develop competences and superior expertise - in effect creating a monopoly based upon knowledge. However, as a technology matures, its application becomes routine and easily understood; hence, it is easily acquired or transferred. For the sake of exposition, we may make an ordinal distinction between 'high" and 'low' on the dimensions of concentration and ambiguity. The combination of these dimensions gives a four-cell matrix which represents limiting case types of market environment. These environments and conditions can be seen in Table 1. We are now in a position to consider what strategies are available to organizations participating in product-market areas characterized by the conditions outlined in Table 1.
Type 1 markets
6The classical economic theory of the firm posits a production function which is a book of 'technological blueprints' freely available to firms.
The conditions in this type of environment are the nearest to the concept of perfect competition in modern industries; markets are fragmented and task knowledge easily attainable. 6 As market entry is relatively easy, an influx of entrepreneurial type firms is assured. Technology is mature and products are not easily differentiable; there is little option for firms except to compete on the basis of price. The strategic imperative for firms in price-competitive markets is internal operating efficiency. To remain viable, firms must ensure efficient working practices, seek out sources of low cost inputs, and generally exploit opportunities for cost reductions. This view of management is consistent with the classical economics theory of the firm. The emergence in the UK telecommunications industry of the 'telephone boutique' illustrates the nature of this type of market. The existence of the "telephone boutique' firm is due to its ability to undercut BT prices significantly for similar products, Operators of these Table 1. A typology of market environment conditions.
Ambiguous
1
Type 3 Low capital requirements Low economies of scale Heterogeneous products Novel technology
Type 4
High capital requirements
Introduction and growth
phase
High economies of scale Heterogeneous products Novel technology Introduction and growth phase
of product life-cycle
of product life-cycle
Type 1 Low capital requirements Low economies of scale Homogeneous products
Type 2 High capital requirements High economies of scale Homogeneous products Routine technology Mature and decline phase product life-cycle
Task knowledge
Unambiguous
Routine technology Mature
and
decline
product life-cycle Low <
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phase
of
Concentration
of
> High
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7R. J. Butler and M. G. Carney, 'Strategy and strategic choice: the case of telecommunications', Strategic Management Journal, Vol 7, pp 161-177, 1986. aAny firm entering the mass retail market requires some knowledge of locations, consumer tastes and buyer behaviour, as well as property, etc. 9'Sorry... wrong number for Ansaphone', The Sunday Times, 11 July 1982; 'Japan enters answering machine war', Marketing, 10 June 1983. I°BT strongly supported a move establishing a regulation classifying products into approved and unapproved categories. Manufacturers and retailers are required to indicate the status of products by means of a clearly displayed label. Unapproved products'cannot be attached to the network. A number of new entrants to the market have had difficulty in gaining approval and some claim BT actively obstructed the approval process. 'BT flouting DOl's rules', Electronics Weekly, 7 July 1982; 'BSI defends its standards position', Electronics Weekly, 27 November 1981. 11Jeffrey Pfeffer and Gerald R. Salancik, The External Control of Organizations: A Resource Dependence Perspective, Harper & Row, New York, 1978. ~2James Thompson, Organizations in Action, McGraw-Hill, New York, 1967.
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boutiques typically have experience in electronics products retailing and low administrative overheads, and are able to buy from low-cost sources (usually Far Eastern suppliers). 7 In contrast, BT cannot, at present, meet such price competition. Having no retailing experience, it must incur significant start-up costs. 8 Each retail unit must bear a portion of administrative overhead and is committed to certain suppliers (usually, higher-cost domestic sources). Organizations traditionally associated with BT have experienced a similar problem in responding to the price competition imperative of Type 1 markets. Prior to the liberalization of attachments, the firm Ansaphone supplied and serviced a large portion of the answering machine market in cooperation with BT. Following liberalization, Ansaphone were reported 9 to have experienced a huge loss of clients to new entrants who undercut their prices. Ansaphone had difficulty in responding to the competition as their task knowledge had been developed around the concept of 'service'. The answering machine is now a mature product, its production and operation well understood. Thus little knowledge is required to operate the machine, which renders obsolete the need for service. A strategy built upon 'service' knowledge is no longer feasible in a market where price competition and internal efficiency provide the central strategic imperatives. Other product-market areas characterized by Type 1 conditions include telecommunications components, maintenance services, and several product areas whose technologies are reaching maturity. How might these markets develop in the near future? Clearly, much depends upon the strategies of dominant telecommunications firms and upon future government regulatory policy. The interaction of these two factors often creates gaps and niches which are quickly filled by efficient and short-term profit-conscious entrepreneurs. Such entrepreneurs may be seen as 'environment takers', in the sense that they lack the political and economic influence necessary to maintan a market in a particular form. For instance, the population of telephone boutiques may decline rapidly as large retail chains become organized or as BT attempts to alter the rules of the game.~° Similarly, the existence of a market in PABX maintenance is dependent upon Department of Industry decisions and the policies of PABX manufacturers. Once created and free of government involvement, these markets are likely to settle down to an equilibrium consistent with the laws of supply and demand.
Type 2 markets Organization theorists describe this type of market structure as a negotiated environment. 1~ Because of high concentration, the market mechanism cannot guarantee equitable outcomes for users. Therefore, the policies and behaviour of producers must be negotiated with the state and other relevant interests. The purpose of negotiation is to establish a domain consensus, ~2 which is a situation where the role and objectives of organizations are considered acceptable to those capable of providing support for the domain. The strategic imperative for organizations occupying central positions in Type 2 markets is one of domain maintenance. This involves actions designed to retain the status quo. The principle objective is to keep other organizations from entering the domain and sharing the available resources. During periods of market change, the imperative becomes
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13Butler and Carney, op cit, Ref 7. 14Richard J. Butler and M. G. Carney,
'Public choice, ambiguity and regulation', paper presented at EGOS Colloquium, Stockholm, Sweden, June 1985. A similar argument was made by the National Bus Company in seeking to resist the deregulation of the Inter-City Bus Transport Network. lSBruce Owen and R. Braeutigan, The Regu/ation Game, Ballinger, Cambridge, MA, 1978. ~6Franklin M. Fisher, John J. McGowan
and Joan M. Greenwood, Folded, Spindled and Muti/ated: Economic Ana/ysis and U.S. vs. IBM, The M.I.T. Press, Cambridge, MA, 1983.
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one of domain extension to incorporate significant growth areas within the boundaries of the domain. The appropriate strategy is one of consolidation.~3 In a negotiated environment, the strategy hinges upon legitimating the organization's right to service a domain exclusively. The organization must convince relevant domain supporters that it is uniquely able to meet the requirements of the domain or that it is capable of achieving some specific objective within it. Traditionally, most of the telecommunications industry has been a Type 2 market. Consensus on the idea of natural monopoly and related concepts of cross-subsidization and universal service has permitted PT-Fs to legitimate a monopoly within the industry. As task knowledge was, in our terms, unambiguous and well understood by the PTI', government had accepted the prevailing view that a centralized organization should service the domain. However, technical innovations have, to some extent, undermined the idea of natural monopoly. Innovation has created a context where PT'I's can no longer claim exclusive and definitive knowledge of the industry, since non-traditional telecommunications firms have demonstrated an ability to deliver sometimes superior communications services. The domain consensus has broken down; the boundaries of the domain and the rights of participants in the industry are now open to renegotiation. BT's response to deregulation illustrates the consolidation strategy in practice. In the early stages of liberalization, BT naturally sought to protect its total domain and resorted to arguments of universal service and necessary cross-subsidization between business and domestic and rural users of the telephone service. ~4This strategy was partly successful as only one new entrant to the trunk network portion of the industry was licensed and BT gained guarantees that no other licence would be granted for seven years. Here, the implicit agreement is that the P'I~ should, to some extent, operate as a social service - that is, provide a product below economic cost to certain parts of the population. Consequently, negotiations focused upon the extent of liberalization in the peripheral attachments market. Here, too, BT attempted to maintain its position. BT could argue that liberalization would lead to the importation of 'shoddy' and 'inferior" goods; hence, the need to devise strict approval standards for all new peripherals. The creation of approved standards and agencies to implement them proved frustrating and time-consuming to many potential entrants and acted as a deterrent. BT and its domestically based suppliers also warned of the danger of large-scale redundancies in the U K equipment market as a result of too much liberalization. The implicit agreement is that firms should pursue the objectives of employment creation in addition to purely commercial objectives. In essence, the consolidation strategy is designed to buy time necessary to adjust to changing conditions. In tixe USA, A T & T practised much the same strategy, though in the context of courts and antitrust legislation, to meet the threat posed by IBM and other innovative firms. 15 Consolidative strategies are not limited to nationalized industries; they are also seen in the private sector. Here, the negotiation features are not quite as apparent but they do play a role. Competition in free markets does sometimes produce winners, ~6 that is, the most able and competent firms may legally create a monopoly through superior
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17Richard A. Bettis and William K. Hall, 'Strategic portfolio management in the multibusiness firm', California Management Review, Vol 24, No 1, 1981, pp 23-38. 18Raymond E. Miles and Charles C. Snow, Organizational Strategy, Structure and Process, McGraw-Hill, New York, 1978. 19j. Redwood, Public Enterprise in Crisis, Basil Blackwell, Oxford, 1980. 2°D. Dunkerley, T. Spyby and M. Thrasher, 'lnterorganizational networks: a case study of industrial location', Organization Studies, Vol 2, No 3, 1981, pp 229-248.
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performance. This monopoly may, for instance, be due to the effective management of an innovation which has proved attractive to consumers. Once an organization has established an innovation, the key managerial task becomes one of routinization and efficiency..In business policy terms, the common prescription is to 'milk the cash cow '~7 (a cash cow is a high market share mature product or, in our terms, a Type 2 market product), to provide resources for innovative and developing products. However, product maturity and routinization result in decreased task ambiguity, which permits other firms to emulate the innovation and compete on the basis of price and efficiency. Technically, then, the monopoly created through superior performance is temporary as other firms are attracted to the market by potentially high profits. The original innovator will seek to maintain the monopoly for a longer period in order to appropriate a greater share of the monopoly profits. The defence of the position will take several forms - for instance, predatory pricing or the creation of advertising barriers to entry. These, however, are costly (they reduce monopoly profit) and more economical means may be sought, such as the establishment of a patent or a copyright. In other cases, a firm may claim to be providing other benefits in the public interest. For example, in globally competitive markets, domestic firms may seek import tariffs and quotas in the interest of protecting domestic employment. At this point, the distinction between public and private firm behaviour becomes blurred as both resort to government or other regulatory means to defend against increased competition. In the absence of government involvement or an ability to negotiate regulatory protection, firms may pursue what Miles and Snow TM call a defender strategy. This is similar to the consolidative strategy, in seeking to prevent competitors from entering a domain. It differs in that the focus of attention is internal. The defender strategy demands that the organization define a very narrow domain and adapt itself to excel at meeting the specific requirements of that domain. The strategy is sound as long as the domain remains stable and other organizations are unable to emulate the adaptions necessary to maintain prominence. However, the strategy is vulnerable to major shifts in the domain which could leave the defender adapted to a non-existent market. The criticism of PT-Fs and their traditional suppliers' anticompetitive behaviour 19 is probably unjustified since firms, public or private, will seek to avoid competition by whatever means available. The ease of access by nationalized business to the corridors of government power does, of course, facilitate the consolidative strategy; but private firms, too, are not without influence. 2° It remains questionable whether consolidation merely delays the inevitable changes brought about by competition and technological development, or whether it fundamentally alters the course of the market. On the one hand, some monopolies and artificially-created barriers to entry appear permanently entrenched. On the other, one might argue that the stronger the monopoly, the more intonse are attempts to circumnavigate it. This latter view is the perspective taken in the Austrian school of economics, whose approach is found to be useful in the context of Type 3 markets.
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Type 3 markets These are fragmented markets where task knowledge is ambiguous. The dynamics of such markets have been explored by the Austrian school of economics,- which relaxes the classical economics assumption of perfect knowledge. Through this, these writers are able to picture competition as a continuous process rather than a position of equilibrium. The agents of competition are entrepreneurs whose task is to discover new knowledge. Through their profit-seeking behaviour, entrepreneurs reveal and diffuse this new knowledge in society. The market mechanism ensures that only useful knowledge (which may include a new technology or a new use for an existing technology) will be diffused, as it is only such knowledge which will be adopted and applied by others in pursuit of profit. This form of competition differs from that of Type 1 markets where competition is based on price, that is, doing something which is already known, more efficiently. The strategy pursued by firms in this type of market is one of development, where the aggregate effect of individual strategies is to produce a process of incremental innovation in the market as a whole. Individual firms seek to gain a lead over others by making minor developments and improvements in a product. As markets are fragmented, no one firm is usually large or powerful enough to make a really large innovation. Ambiguity requires firms to develop expertise and superior task knowledge if they are to remain in the competition which, in practice, entails research and development effort. The development strategy is risky since R&D effort may not result in commercially viable outcomes; consequently, the strategic imperative for firms is the acquisition of sufficient resources to sustain developmeat. Multiproduct firms - that is, those carrying a portfolio of growth and maturing products - are at an advantage over new entrant, singleproduct firms since maturing products, if managed properly, provide the necessary support for resource-thirsty growth products. However, low barriers to entry ensure that a steady stream of start-up and entrepreneurial firms will be present in the market. Such firms, lacking the resources from mature products, must devise other means of acquiring support. A number of resource acquisition strategies are possible: government may be a viable source, but is not necessarily attractive since government involvement may be perceived as a constraint on future action and is often incongruent with a pioneering entrepreneurial culture. A particularly successful development may generate internally sufficient resources to sustain the strategy. Finally, firms may engage in joint ventures or other initiatives to share the burden; this, in fact, is a cooperative strategy which is discussed in more detail below. The nature of strategy in Type 3 markets can be illustrated through the case of the PABX market. Following a series of deregulatory decisions in the USA, the number of participants in that market increased markedly (see Table 2). 22 Many of these new entrants were existing manufacturers previously excluded from the market due to regulation. However, several were completely new firms which suggests that economies of scale were not large enough to prohibit start-up entrants. Rapid developments in digital technology have since increased the costs and risks of remaining in this product-market area. Some firms have failed or been acquired by stronger firms, while others have been •
21F. A. Hayek, 'The use of knowledge in society', American Economic Review, Vol 35, No 4, 1945, pp 519-530; Ludwig von Mises, Human Action: A Treatise on Economics, Yale University Press, New Haven, 1949; and J. A. Schumpeter, Capitalism, Socialism and Democracy, Harper & Row, New York, 1942. A modern proponent of the Austrian school is Israel M. Kirzner, Perception, Opportunity and Profit, University of Chicago Press, Chicago, 1979. 22Diane L. Cornwell, 'Competition in the US subscriber equipment marketplace: 1990', in Kathleen Lancaster, ed, International Telecommunications, Lexington Books, Lexington, MA, 1982.
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Strategy in the telecommunications market Table 2. US PABX industry participants, 1969 and 1980. 1969 "
1980
1980
GTE Automatic Electric IT] Stromberg-Carlson Western Electric
Anaconda Ericsson Chestel/IPC Digital Telephone Systems/ Farinon (Harris) Fujitsu GTE Automatic Electric Hitachi ITr Mitel NEC
Northern Telecom/Danray Oki Philips
Plessey Reliable ROLM Corporation Siemens Stromberg-Carlson Tele/Resources Wescom (Rockwell) Western Electric Womack
Source: Arthur D. Little, Inc.
forced into a cooperative mode, through joint ventures and technologysharing agreements. In the UK, liberalization has fragmented the PABX market, but not to the same extent as in the USA, as government and BT have to some degree limited market entrance. However, the fundamentals of Type 3 market competition are to be found. A contrast between the fortunes of two companies, Plessey and Mitel, reveals some of the problems of the development strategy. Plessey was initially unprepared to face competition in the PABX market and was dependent upon the technology of a US-based firm. Mitel, who had pioneered the development of small PABXs, entered the UK market with a technological lead and was able to obtain large BT contracts against strong domestic competition. By early 1983, Plessey had closed the gap with its own (IDX) PABX and recaptured lost market share. Meanwhile, Mitel fell behind due to production problems with its own new product (the SX2000). Such problems are a feature of ambiguous task knowledge markets. The situation remains dynamic but there is evidence that Mitel (essentially a single-product firm) is experiencing difficulties with development strategy. Incurring losses in the 1984 financial year, Mitel sought Canadian government support. Some have suggested that these difficulties are due to Mitel's handling of its maturing product 23 (the SX200) which, although gaining initial high market share in North America, is now suffering intense price competition from later market entrants. Subsequently, BT acquired a 51% controlling interest in Mitel. In addition to the PABX market, the VANS and office automation sectors share similar competitive environments where a comparable process is likely. The approach outlined in this article suggests that, if firms do not undertake a development strategy, they will be left with the option of competing on the basis of price and efficiency in the maturing segments of the market. However, the developmental strategy requires close attention to managing the resources necessary to continue such a strategy. Some of the problems associated with this have been hinted at, but increasingly, a cooperative strategy is being selected as a means of coping with acute resource dependence. We may now consider this type of strategy and the conditions where it is appropriate in more detail.
Type 4 markets 2aWayne Lilley, 'Leading-edge disasters', Canadian Business, Vol 57, No 12, December 1984, pp 36-45,
As the costs associated with development and innovation rise, barriers to entry increase and markets tend towards concentration. These are what we have described as Type 4 markets. The trend towards these
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conditions is exacerbated in telecommunications due to technical convergence, which means firms require task knowledge in areas beyond their traditional scope and competence. Electrical switch manufacturers, for example, require increased knowledge of computers and data processing; PTTs require knowledge of satellite technology, cable TV and broadcasting, and so on. Developing such task knowledge internally requires a large learning effort and long gestation period. This process can be short-circuited through a cooperative strategy. Cooperation can be achieved through various means including joint ventures, consortia, tacit agreements, technology sharing, and membership in trade associations. However, the strategy is not without pitfalls. Small members can become dominated by a more powerful ally. Large firms can be exploited by small firms who 'free-ride'. 24 For instance, a joint venture designed to achieve some specific end can be exploited by an organization leaking information back to the parent, which gives the parent an advantage in some other sphere where the venturers are in competition. Some of the specific problems of managing cooperative strategies have been explored elsewhereY but the important points can be highlighted here. The effective operation of the cooperative strategy requires goodwill and trust between parties as, under conditions of ambiguity, it is difficult to specify precisely the commitments and responsibilities of each party at the outset of the venture since the future outcome is vague. Without ambiguity, it would be possible to write a specific contract with appropriate contingency arrangements which formally defines the contribution of each participant. 26 Generally, we would expect a cooperative strategy to be hedged by a contract or some other formal arrangement. Yet there can be little doubt that highly formalized relations do not allow for the give and take necessary to deal with a context of continually emerging and unforeseen problems. Trust and goodwill facilitate mutual adaptation but are sensitive to the observed conduct of participants and tend to be tenuous. Cooperative strategies are most viable under certain conditions. When the objective of a particular joint strategy is overriding and of equal interest to all participants, then one can expect full cooperation. If an objective is of secondary importance to a subsection of the participants, then we might anticipate reduced commitment whenever a line of action conflicts with a superior objective. Cooperation is usually most viable when participants are not normally in competition for the same markets or other sources of support; that is, between unlike organizations. Moreover, an alliance of unlike organizations is likely to bring together different types of task knowledge which is frequently necessary to create an innovation. The history of the development of the System X consortium illustrates 24Marcur Olson, The Logic of Collective Action, Harvard University Press, Cam- some of the potential problems with the cooperative strategy. The bridge, MA, 1971. participants in this project (GEC, Plessey, STC and BT) have 2SM. G. Carney, 'The viability of joint action in the information technology industry', traditionally enjoyed good and close relations. The initial development paper presented to Administrative Science of System X took place against the backdrop of the ending of the bulk Association of Canada conference, Mon- supply agreement and an unanticipated reduction of equipment orders treal, May 1985. from BT, in effect throwing STC, GEC, and Plessey into intensified ~Oliver E. Williamson, 'Transaction-cost economics: the governance of contractual competition. It has been suggested that work on the switch was delayed relations', Journal of Law and Economics, until BT formally posted contracts. 27 Later IT/', the parent company of Vol 7, No 1, 1979, pp 73-104. 27'Three companies into one project won't STC, developed a competitive product (System 12) and STC's commitment to the project was questioned. STC later left the consortium go', The Guardian, 21 April 1982.
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following divestiture by the parent. BT has been said to interfere too closely with development of the switch and then held responsible for inhibiting overseas sales. (The greater the overseas sales effort, the more System X would have to be modified for specific markets, which would result in BT having less control over future developments.) Generally, the consortium has been plagued by a lack of trust and this may have contributed to its failure to fulfil the expectations made of it. Perhaps a more successful recipe for a cooperative strategy is to be found in the case of Project Mercury. The project is a competitive trunk network of special interest to business users. The original participants in this consortium were distinctly unalike and included a merchant bank (Barclays), a petroleum company (BP), and a telecommunications network systems operator (Cable & Wireless). One might argue that this combination represented the required knowledge and resources necessary for a project of this nature; that is, technical skills, finance, knowledge of user requirements and, importantly, considerable political influence. Later, both BP and Barclays withdrew from the consortium leaving Mercury as a wholly-owned subsidiary of Cable & Wireless. In a sense, both organizations had served their purpose in the project; the political ambiguity surrounding Mercury was ameliorated once government began actively promoting it and the operationalization of the network reduced some of the financial risk, permitting capital to be raised in more conventional ways. Emerging areas of ambiguity and uncertainty revolve around Mercury's attempt to enter the international market. Mercury remains in the cooperative mode seeking US based allies for new joint ventures. The cooperative strategy appears to be of growing importance in the information technology industry in general, and in the UK since liberalization. The strategy is likely to be most viable when the relationship between participants is symbiotic, as opposed to potentially competitive or commensurate. Table 3 summarizes the main points about strategy in particular types of markets. It would be misleading if this perspective were to present a picture of a disintegrating and fragmented industry as a whole. The industry remains interdependent, but the nature of dependence is changing and participants are attempting to establish viable positions. This inevitably leads to new alliances and relationships between existing firms and new entrants. The turbulence in the industry may be seen as having its roots in the wider advances of information technology - its principle effect is to create increased levels of task ambiguity for participants. Secondly, the trend towards decreased state involvement in industry, with programmes of deregulation and privatization, permits a freer flow of Table 3. Summery of strategies end imperatives by market type.
Type 1
Strategy:
Imperative: Type 2
Strategy:
Price competition
Internal operating efficiency
Imperative:
Consolidation Domain maintenance
Type 3
Strategy: Imperative:
Developmental Resource acquisition
Type 4
Strategy: Imperative:
Cooperation
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Strategy in the telecommunications market
organizations and resources into previously prohibited market arenas. Figure 1 illustrates the dynamics of the industry. The major source of dynamism occurs in Type 3 markets. The developmental strategy in the eyes of the Austrian economists is the pursuit of a monopoly and monopoly profits. Whenever economies of scale and barriers to entry are sufficiently small, new entrants will seek to emulate or improve upon a successful development and share in the monopoly profits. Accumulating competition forces the original developer to maintain its effort and this demands a continued flow of resources. To this end, the original developer will seek to routinize and increase the efficiency of production of its initial development. At this point the product falls under Type 2 market conditions: that is, the market is concentrated (it contains the developer and early emulators and improvers), but the technology is now no longer ambiguous and other followers lacking high task knowledge expertise are able to enter on the basis of price competition and efficiency. The original developer will, of course, seek to defend its product through whatever means available (the consolidation strategy). In regulated markets, this may succeed for a considerable time. However, even the protection of regulation does not guarantee isolation from price competition. BT experienced much competition in the peripheral attachments markets long before formal liberalization, as price-competitive firms simply ignored the restrictive rules and sold their wares through a loophole in the legislation. In fact, a corollary of the intensive price competition and efficiency pressures of Type 1 markets is that firms will seek to circumvent and even break regulations which restrict access to attractive market opportunities. We might anticipate, then, a growth of "underground' economies wherever regulations are severely restrictive. Since such firms are likely to be small, the risk of detection by regulatory authorities is not high. Moreover, such semi-legal strategies are often the only ones available to firms which do not have the political support necessary to influence the regulatory process and liberalization policy. Continued regulation avoidance by entrepreneurial firms, however,
Type 4 marke~s
Type 3 markets
Development strategy
="
Resource dependence
=.
1
Routinization and reduced ambiguity
Price competition
Cooperative strategy
Assembling resources enter
~
Consolidation
strategy
Type 1 markets
Type 2 markets
Figure 1. The dynamics of strategic behaviour. 256
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Strategy in the telecommunications market
tends to undermine the legitimacy of restrictive practices and may encourage a pro-market government to extend liberalization plans. Where no adequate means exist to defend a monopoly, and where innovative development opportunities become exhausted, Type 3 markets rapidly evolve towards Type 1 conditions. Alternately, where developmental strategies become more costly, a product-market area may evolve towards Type 4 conditions. Thi-ough cooperation, a group of organizations may assemble the required resources to mount an effective challenge to Type 2 monopolies. The competitive threat posed by Type 4 markets is based upon innovation leading to a period of intermodal competition. However, a consortium, having established a position in the market, will then have cause to consolidate and defend its niche against potential competition. For instance, once Project Mercury had secured its licence, it too was reported to have sought government assurances that similar licences would not be issued in the near future. 28
Conclusions
aS'Mercury granted a breathing space', Electronics Weekly, 23 November 1983.
This article has sought to explain some of the dynamics of the telecommunications industry. It has been observed that, under certain conditions, firms must devise strategies to cope with the imperatives of the product-market area. Due to the interconnections of the industry, the pursuit of a particular strategy will lead to new imperatives as competition and technologies evolve. The logic of strategic behaviour means that firms must pay attention to economic, technological and political factors in various sequences and at different times. Multiproduct firms may find themselves practising multiple strategies as they have interests in several types of market. However, there may be limits to the number and types of market areas in which any single organization may effectively participate. Management theorists have suggested that businesses build their strategies around a unique 'distinctive competence' or 'particular task knowledge'. The main effect of liberalization and technical change is that firms must modify strategies and learn new competences. Established telecommunications businesses must learn the competences of operating in more competitive markets, while new entrants must acquire the knowledge needed to cope with the political and regulatory environment of the industry. The pace at which businesses can adapt to new conditions will vary, but they should be careful in selecting areas of development. Generally, we would suggest that firms concentrate their effort and resources in areas which offer synergy; that is, where a particular competence might be most enhanced.
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M. G. Carney While the debate continues over the appropriate mix of planning and competition in telecommunications, ~ a number of governments have introduced varying degrees of liberalization and pro-market regulation. As a result of this experience, some conclusions can already be drawn about the way competition actually works in the complex and dynamic telecommunications industry. When the idea of deregulating telecommunications began to gather momentum in the 1970s, little was known about how firms would respond to competition. 2 It seemed likely that the market would operate in a different way from the eighteenth-century concept of the 'invisible hand'. Yet the collapse of Brannif Airlines in the USA following deregulation warned government planners and businesses that illconsidered strategies in competitive markets can have lethal consequences. In telecommunications, governments recognized the potential disruption of services and danger to domestic employment, and tended M. G. Carney is an Assistant Professor in to introduce liberalization incrementally. Behind this policy lay the the Department of Management, Faculty of implicit assumption that previously-regulated businesses required time Commerce and Administration, Concordia University, 1455 De Maisonneure Blvd, to adapt their organizations, products and strategies to competitive conditions. West Montreal, Quebec, Canada. In the UK, the significant deregulatory legislation is contained in the 1Hans Bergendorf, Torsten Larsson and 1981 Telecommunications Act which empowers the Secretary of State Ruben Naslund, 'The monopoly vs. com- for Trade and Industry to license market entry. Subsequently, several petition debate', Telecommunications Policy, Vol 7, No 4, December 1983, pp institutional agencies and procedural arrangements have been estab297-308; John Langdale, 'Competition in lished to monitor and implement the new regulatory framework. telecommunications', TelecommunicaDrawing upon the UK experience, we can identify and describe some tions Policy, Vol 6, No 4, December 1982, of the ways firms have attempted to cope with strategic issues created p 283; and Gerald Brock, The Telecommunications Industry: The Dynamics of and exacerbated by deregulation. This article is based upon the premise Market Structure, Harvard University that certain types of market conditions provide particular strategic Press, Cambridge, MA, 1981. problems or imperatives to which participants must respond if they are 2,.i.F. Mahon and Edwin A. Murray, to remain viable and prosperous. A two-dimensional matrix describing continued on p 246
This article identifies some of the ways in which firms in the telecommunications industry have attempted to cope with deregulation, drawing upon the experience already evident since Iiberalization began a few years ago. The author argues that certain types of market conditions provide particular problems for firms, to which they must respond if they are to remain prosperous. A matrix describing four market types is offered as a facsimile of the competitive conditions now found in the telecommunications industry, and examples are given from the UK. Economic, technological and political factora affect the strategic behaviour which firms must follow, but in different ways and at different times.
0308-5961/86/030245-1353.00 © 1986 Butterworth & Co (Publishers) Ltd
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four limiting or extreme market types is offered as a facsimile of the competitive conditions now found in the telecommunications industry.
The nature of competitive environments
continued from p 245
'Deregulation and strategic transformation', Journal of Contemporary Business, Vol 9, No 2, 1980, pp 123-141; and J. F. Mahon and Edwin A. Murray, 'Strategic planning for regulated companies', Strategic Management Journal, Vol 2, 1981, pp 251-262. aWarren G. Bender, 'Telecommunications decisions: a reassessment of assumptions', in Kathleen Lancaster, ed, International Telecommunications, Lexington Books, Lexington, MA, 1982.
246
We are used to thinking of the core of the telecommunications industry as a natural monopoly. While the real extent of natural monopoly remains an open question, the structure of the industry has now become more fragmented than was previously thought possible. However, this fragmentation is uneven as various product-market areas have been affected differently by liberalization and technical change. Closer inspection reveals the industry to be composed of a network of product-market areas, each populated by a variety of producers linked in an interdependent pattern of competitive and cooperative relations. British Telecom (BT) is the central organization in this network and plays a dominant role in mediating access to the market. The changing relationship between BT and telecommunication service users has received the majority of popular attention as a result of deregulation, However, we suggest that the principle effect of deregulation has been to disturb a historically stable pattern of interdependence between the P T T and equipment-producers. Many of the changes now occurring in the industry are related to the manoeuvring of firms and creation of new alliances, rather than technical change p e r se. For this reason, the strategic behaviour of firms is critical to understanding the direction of change in the industry. Deregulation emphasizes the role of the market mechanism in controlling and regulating industries. In theory, the market works through competition between autonomous firms; deregulation aims to increase the numbers of autonomous firms participating in the industry by reducing state-created barriers to entry. Economists measure the potential for competition in terms of market concentration. Generally, the lower the level of concentration, the greater the intensity of competition. The logic of strategy from a particular firm's perspective is to increase concentration in its own product:market area since the absence of competition enables the firm to meet the demands and expectations of its stakeholders (employees, shareholders, customers, etc) and guarantees longer-term survival and viability. A cursory examination of several telecommunications productmarket areas reveals that markets differ in their capacity for concentration. The market for local-area domestic voice services remains concentrated in the hands of BT and, despite technological developments, little change is anticipated in the foreseeable future. Trunk and businessdedicated local-area networks have become less concentrated by the entry of the Mercury consortium. Regulatory impediments apart, one does not expect these product-market areas to become 'perfectly competitive' in the classical economics sense. With continued technological development we are likely to see the emergence of a two- to five-firm oligopolistic structure with some product and/or service differentiation. At the equipment supply side of the industry, we may see a trend towards increasing concentration. In the public switch market, 17 firms currently supply approximately 85% of the world market, 3 but exploding R & D costs, combined with decreasing product life cycles, are
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4Charles Perrow, 'A framework for the comparative analysis of organizations', American Sociological Review, Vol 32, 1967, pp 194-208; Jerald Hage, Theories of Organizations: Form, Process and Transformation, John Wiley, New York, 1980; and Joan Woodward, Management and Technology, HMSO, London, 1958. SPerrow, op cit, Ref 4.
likely to consolidate the industry as weaker firms either fail or are acquired by larger firms. However, competition at the national level is mediated through the PTT, and the willingness to use more than one source for large switches may increase competition in the short term - as instanced in BT's decision to use L.M. Ericsson's AXE system in addition to its domestic suppliers to enhance its modernization programme. In the peripherals market, there are very low levels of concentration. The number of firms manufacturing and retailing electronic telephones is probably inestimable - a truly competitive market has emerged in this and similar product areas. Generally, concentration is a function of several factors, but most critical are capital start-up costs, economies of scale in production and government or P'FT procurement policy. Naturally, the degree of concentration in an industry has important implications for a firm's strategy and some of these will be explored below. In addition, one other factor - task knowledge - has a significant impact upon a firm's strategic posture. While economists tend to classify markets in terms of their concentration, sociologists and organization theorists focus upon technology as a basis of differentiating environmental contexts. 4 For instance, Hage argues that markets can be usefully classified in terms of the sophistication of the technology involved and the rate of product change; in general, the more sophisticated the technology and the higher the rate of product change, the greater are the task knowledge requirements necessary to participate in the market. Task knowledge is a broader concept than technology; it refers to the clarity of the means-to-ends relationship with respect to a particular task. 5 We shall describe a product-market area as being unambiguous when tasks are relatively routine and well understood by those performing them. For example, the operation of a telex service, though technically complex, is well understood. Similarly, the marketing and distribution of telephones is fairly clear cut and unambiguous, as it is based upon the technology of retailing. In contrast, the operation of a cellular radio system is, in our terms, ambiguous. The existence of several types of cellular radio system, and rapid developments in related technologies such as radio and microwave communications, represent a field of uncertainty for firms seeking to enter this area. Moreover, the likelihood of unanticipated problems occurring with any particular technology often demands task knowledge and expertise beyond an operator's experience. Task ambiguity is not limited to 'hard technologies" such as cellular radio. The case of System X demonstrates how ambiguity affects the marketing task. Each participant in the System X consortium held different beliefs about the way the switch should be promoted internationally. Consequently, several different approaches, including a procedure of lead tender, joint marketing effort, and individual marketing, have been tried with inconclusive results. Task ambiguity is clearly related to technical change within an industry, but it can also emanate from outside the industry or from a change in expectations of firms by government or consumers. For instance, when government asks a nationalized firm to meet commercial financial targets, it may face ambiguity if its task knowledge is grounded in the idea of providing universal service.
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Strategy in the telecommunications market
In unambiguous product-market areas, potential competitors may easily acquire the necessary task knowledge to enter that area. A manufacturer of office dictation equipment was able to produce and market a telephone answering machine within months of the liberalization of the UK peripheral attachments market. In comparison, the task knowledge required to participate in the PABX market is sufficiently ambiguous that even organizations such as IBM have had difficulty in gaining a foothold. The presence of task ambiguity provides scope for differential learning and permits early entrants to develop competences and superior expertise - in effect creating a monopoly based upon knowledge. However, as a technology matures, its application becomes routine and easily understood; hence, it is easily acquired or transferred. For the sake of exposition, we may make an ordinal distinction between 'high" and 'low' on the dimensions of concentration and ambiguity. The combination of these dimensions gives a four-cell matrix which represents limiting case types of market environment. These environments and conditions can be seen in Table 1. We are now in a position to consider what strategies are available to organizations participating in product-market areas characterized by the conditions outlined in Table 1.
Type 1 markets
6The classical economic theory of the firm posits a production function which is a book of 'technological blueprints' freely available to firms.
The conditions in this type of environment are the nearest to the concept of perfect competition in modern industries; markets are fragmented and task knowledge easily attainable. 6 As market entry is relatively easy, an influx of entrepreneurial type firms is assured. Technology is mature and products are not easily differentiable; there is little option for firms except to compete on the basis of price. The strategic imperative for firms in price-competitive markets is internal operating efficiency. To remain viable, firms must ensure efficient working practices, seek out sources of low cost inputs, and generally exploit opportunities for cost reductions. This view of management is consistent with the classical economics theory of the firm. The emergence in the UK telecommunications industry of the 'telephone boutique' illustrates the nature of this type of market. The existence of the "telephone boutique' firm is due to its ability to undercut BT prices significantly for similar products, Operators of these Table 1. A typology of market environment conditions.
Ambiguous
1
Type 3 Low capital requirements Low economies of scale Heterogeneous products Novel technology
Type 4
High capital requirements
Introduction and growth
phase
High economies of scale Heterogeneous products Novel technology Introduction and growth phase
of product life-cycle
of product life-cycle
Type 1 Low capital requirements Low economies of scale Homogeneous products
Type 2 High capital requirements High economies of scale Homogeneous products Routine technology Mature and decline phase product life-cycle
Task knowledge
Unambiguous
Routine technology Mature
and
decline
product life-cycle Low <
248
phase
of
Concentration
of
> High
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Strategy in the telecommunications market
7R. J. Butler and M. G. Carney, 'Strategy and strategic choice: the case of telecommunications', Strategic Management Journal, Vol 7, pp 161-177, 1986. aAny firm entering the mass retail market requires some knowledge of locations, consumer tastes and buyer behaviour, as well as property, etc. 9'Sorry... wrong number for Ansaphone', The Sunday Times, 11 July 1982; 'Japan enters answering machine war', Marketing, 10 June 1983. I°BT strongly supported a move establishing a regulation classifying products into approved and unapproved categories. Manufacturers and retailers are required to indicate the status of products by means of a clearly displayed label. Unapproved products'cannot be attached to the network. A number of new entrants to the market have had difficulty in gaining approval and some claim BT actively obstructed the approval process. 'BT flouting DOl's rules', Electronics Weekly, 7 July 1982; 'BSI defends its standards position', Electronics Weekly, 27 November 1981. 11Jeffrey Pfeffer and Gerald R. Salancik, The External Control of Organizations: A Resource Dependence Perspective, Harper & Row, New York, 1978. ~2James Thompson, Organizations in Action, McGraw-Hill, New York, 1967.
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boutiques typically have experience in electronics products retailing and low administrative overheads, and are able to buy from low-cost sources (usually Far Eastern suppliers). 7 In contrast, BT cannot, at present, meet such price competition. Having no retailing experience, it must incur significant start-up costs. 8 Each retail unit must bear a portion of administrative overhead and is committed to certain suppliers (usually, higher-cost domestic sources). Organizations traditionally associated with BT have experienced a similar problem in responding to the price competition imperative of Type 1 markets. Prior to the liberalization of attachments, the firm Ansaphone supplied and serviced a large portion of the answering machine market in cooperation with BT. Following liberalization, Ansaphone were reported 9 to have experienced a huge loss of clients to new entrants who undercut their prices. Ansaphone had difficulty in responding to the competition as their task knowledge had been developed around the concept of 'service'. The answering machine is now a mature product, its production and operation well understood. Thus little knowledge is required to operate the machine, which renders obsolete the need for service. A strategy built upon 'service' knowledge is no longer feasible in a market where price competition and internal efficiency provide the central strategic imperatives. Other product-market areas characterized by Type 1 conditions include telecommunications components, maintenance services, and several product areas whose technologies are reaching maturity. How might these markets develop in the near future? Clearly, much depends upon the strategies of dominant telecommunications firms and upon future government regulatory policy. The interaction of these two factors often creates gaps and niches which are quickly filled by efficient and short-term profit-conscious entrepreneurs. Such entrepreneurs may be seen as 'environment takers', in the sense that they lack the political and economic influence necessary to maintan a market in a particular form. For instance, the population of telephone boutiques may decline rapidly as large retail chains become organized or as BT attempts to alter the rules of the game.~° Similarly, the existence of a market in PABX maintenance is dependent upon Department of Industry decisions and the policies of PABX manufacturers. Once created and free of government involvement, these markets are likely to settle down to an equilibrium consistent with the laws of supply and demand.
Type 2 markets Organization theorists describe this type of market structure as a negotiated environment. 1~ Because of high concentration, the market mechanism cannot guarantee equitable outcomes for users. Therefore, the policies and behaviour of producers must be negotiated with the state and other relevant interests. The purpose of negotiation is to establish a domain consensus, ~2 which is a situation where the role and objectives of organizations are considered acceptable to those capable of providing support for the domain. The strategic imperative for organizations occupying central positions in Type 2 markets is one of domain maintenance. This involves actions designed to retain the status quo. The principle objective is to keep other organizations from entering the domain and sharing the available resources. During periods of market change, the imperative becomes
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Strategy in the telecommunications market
13Butler and Carney, op cit, Ref 7. 14Richard J. Butler and M. G. Carney,
'Public choice, ambiguity and regulation', paper presented at EGOS Colloquium, Stockholm, Sweden, June 1985. A similar argument was made by the National Bus Company in seeking to resist the deregulation of the Inter-City Bus Transport Network. lSBruce Owen and R. Braeutigan, The Regu/ation Game, Ballinger, Cambridge, MA, 1978. ~6Franklin M. Fisher, John J. McGowan
and Joan M. Greenwood, Folded, Spindled and Muti/ated: Economic Ana/ysis and U.S. vs. IBM, The M.I.T. Press, Cambridge, MA, 1983.
250
one of domain extension to incorporate significant growth areas within the boundaries of the domain. The appropriate strategy is one of consolidation.~3 In a negotiated environment, the strategy hinges upon legitimating the organization's right to service a domain exclusively. The organization must convince relevant domain supporters that it is uniquely able to meet the requirements of the domain or that it is capable of achieving some specific objective within it. Traditionally, most of the telecommunications industry has been a Type 2 market. Consensus on the idea of natural monopoly and related concepts of cross-subsidization and universal service has permitted PT-Fs to legitimate a monopoly within the industry. As task knowledge was, in our terms, unambiguous and well understood by the PTI', government had accepted the prevailing view that a centralized organization should service the domain. However, technical innovations have, to some extent, undermined the idea of natural monopoly. Innovation has created a context where PT'I's can no longer claim exclusive and definitive knowledge of the industry, since non-traditional telecommunications firms have demonstrated an ability to deliver sometimes superior communications services. The domain consensus has broken down; the boundaries of the domain and the rights of participants in the industry are now open to renegotiation. BT's response to deregulation illustrates the consolidation strategy in practice. In the early stages of liberalization, BT naturally sought to protect its total domain and resorted to arguments of universal service and necessary cross-subsidization between business and domestic and rural users of the telephone service. ~4This strategy was partly successful as only one new entrant to the trunk network portion of the industry was licensed and BT gained guarantees that no other licence would be granted for seven years. Here, the implicit agreement is that the P'I~ should, to some extent, operate as a social service - that is, provide a product below economic cost to certain parts of the population. Consequently, negotiations focused upon the extent of liberalization in the peripheral attachments market. Here, too, BT attempted to maintain its position. BT could argue that liberalization would lead to the importation of 'shoddy' and 'inferior" goods; hence, the need to devise strict approval standards for all new peripherals. The creation of approved standards and agencies to implement them proved frustrating and time-consuming to many potential entrants and acted as a deterrent. BT and its domestically based suppliers also warned of the danger of large-scale redundancies in the U K equipment market as a result of too much liberalization. The implicit agreement is that firms should pursue the objectives of employment creation in addition to purely commercial objectives. In essence, the consolidation strategy is designed to buy time necessary to adjust to changing conditions. In tixe USA, A T & T practised much the same strategy, though in the context of courts and antitrust legislation, to meet the threat posed by IBM and other innovative firms. 15 Consolidative strategies are not limited to nationalized industries; they are also seen in the private sector. Here, the negotiation features are not quite as apparent but they do play a role. Competition in free markets does sometimes produce winners, ~6 that is, the most able and competent firms may legally create a monopoly through superior
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17Richard A. Bettis and William K. Hall, 'Strategic portfolio management in the multibusiness firm', California Management Review, Vol 24, No 1, 1981, pp 23-38. 18Raymond E. Miles and Charles C. Snow, Organizational Strategy, Structure and Process, McGraw-Hill, New York, 1978. 19j. Redwood, Public Enterprise in Crisis, Basil Blackwell, Oxford, 1980. 2°D. Dunkerley, T. Spyby and M. Thrasher, 'lnterorganizational networks: a case study of industrial location', Organization Studies, Vol 2, No 3, 1981, pp 229-248.
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performance. This monopoly may, for instance, be due to the effective management of an innovation which has proved attractive to consumers. Once an organization has established an innovation, the key managerial task becomes one of routinization and efficiency..In business policy terms, the common prescription is to 'milk the cash cow '~7 (a cash cow is a high market share mature product or, in our terms, a Type 2 market product), to provide resources for innovative and developing products. However, product maturity and routinization result in decreased task ambiguity, which permits other firms to emulate the innovation and compete on the basis of price and efficiency. Technically, then, the monopoly created through superior performance is temporary as other firms are attracted to the market by potentially high profits. The original innovator will seek to maintain the monopoly for a longer period in order to appropriate a greater share of the monopoly profits. The defence of the position will take several forms - for instance, predatory pricing or the creation of advertising barriers to entry. These, however, are costly (they reduce monopoly profit) and more economical means may be sought, such as the establishment of a patent or a copyright. In other cases, a firm may claim to be providing other benefits in the public interest. For example, in globally competitive markets, domestic firms may seek import tariffs and quotas in the interest of protecting domestic employment. At this point, the distinction between public and private firm behaviour becomes blurred as both resort to government or other regulatory means to defend against increased competition. In the absence of government involvement or an ability to negotiate regulatory protection, firms may pursue what Miles and Snow TM call a defender strategy. This is similar to the consolidative strategy, in seeking to prevent competitors from entering a domain. It differs in that the focus of attention is internal. The defender strategy demands that the organization define a very narrow domain and adapt itself to excel at meeting the specific requirements of that domain. The strategy is sound as long as the domain remains stable and other organizations are unable to emulate the adaptions necessary to maintain prominence. However, the strategy is vulnerable to major shifts in the domain which could leave the defender adapted to a non-existent market. The criticism of PT-Fs and their traditional suppliers' anticompetitive behaviour 19 is probably unjustified since firms, public or private, will seek to avoid competition by whatever means available. The ease of access by nationalized business to the corridors of government power does, of course, facilitate the consolidative strategy; but private firms, too, are not without influence. 2° It remains questionable whether consolidation merely delays the inevitable changes brought about by competition and technological development, or whether it fundamentally alters the course of the market. On the one hand, some monopolies and artificially-created barriers to entry appear permanently entrenched. On the other, one might argue that the stronger the monopoly, the more intonse are attempts to circumnavigate it. This latter view is the perspective taken in the Austrian school of economics, whose approach is found to be useful in the context of Type 3 markets.
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Type 3 markets These are fragmented markets where task knowledge is ambiguous. The dynamics of such markets have been explored by the Austrian school of economics,- which relaxes the classical economics assumption of perfect knowledge. Through this, these writers are able to picture competition as a continuous process rather than a position of equilibrium. The agents of competition are entrepreneurs whose task is to discover new knowledge. Through their profit-seeking behaviour, entrepreneurs reveal and diffuse this new knowledge in society. The market mechanism ensures that only useful knowledge (which may include a new technology or a new use for an existing technology) will be diffused, as it is only such knowledge which will be adopted and applied by others in pursuit of profit. This form of competition differs from that of Type 1 markets where competition is based on price, that is, doing something which is already known, more efficiently. The strategy pursued by firms in this type of market is one of development, where the aggregate effect of individual strategies is to produce a process of incremental innovation in the market as a whole. Individual firms seek to gain a lead over others by making minor developments and improvements in a product. As markets are fragmented, no one firm is usually large or powerful enough to make a really large innovation. Ambiguity requires firms to develop expertise and superior task knowledge if they are to remain in the competition which, in practice, entails research and development effort. The development strategy is risky since R&D effort may not result in commercially viable outcomes; consequently, the strategic imperative for firms is the acquisition of sufficient resources to sustain developmeat. Multiproduct firms - that is, those carrying a portfolio of growth and maturing products - are at an advantage over new entrant, singleproduct firms since maturing products, if managed properly, provide the necessary support for resource-thirsty growth products. However, low barriers to entry ensure that a steady stream of start-up and entrepreneurial firms will be present in the market. Such firms, lacking the resources from mature products, must devise other means of acquiring support. A number of resource acquisition strategies are possible: government may be a viable source, but is not necessarily attractive since government involvement may be perceived as a constraint on future action and is often incongruent with a pioneering entrepreneurial culture. A particularly successful development may generate internally sufficient resources to sustain the strategy. Finally, firms may engage in joint ventures or other initiatives to share the burden; this, in fact, is a cooperative strategy which is discussed in more detail below. The nature of strategy in Type 3 markets can be illustrated through the case of the PABX market. Following a series of deregulatory decisions in the USA, the number of participants in that market increased markedly (see Table 2). 22 Many of these new entrants were existing manufacturers previously excluded from the market due to regulation. However, several were completely new firms which suggests that economies of scale were not large enough to prohibit start-up entrants. Rapid developments in digital technology have since increased the costs and risks of remaining in this product-market area. Some firms have failed or been acquired by stronger firms, while others have been •
21F. A. Hayek, 'The use of knowledge in society', American Economic Review, Vol 35, No 4, 1945, pp 519-530; Ludwig von Mises, Human Action: A Treatise on Economics, Yale University Press, New Haven, 1949; and J. A. Schumpeter, Capitalism, Socialism and Democracy, Harper & Row, New York, 1942. A modern proponent of the Austrian school is Israel M. Kirzner, Perception, Opportunity and Profit, University of Chicago Press, Chicago, 1979. 22Diane L. Cornwell, 'Competition in the US subscriber equipment marketplace: 1990', in Kathleen Lancaster, ed, International Telecommunications, Lexington Books, Lexington, MA, 1982.
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31
TELECOMMUNICATIONS POLICY September 1986
Strategy in the telecommunications market Table 2. US PABX industry participants, 1969 and 1980. 1969 "
1980
1980
GTE Automatic Electric IT] Stromberg-Carlson Western Electric
Anaconda Ericsson Chestel/IPC Digital Telephone Systems/ Farinon (Harris) Fujitsu GTE Automatic Electric Hitachi ITr Mitel NEC
Northern Telecom/Danray Oki Philips
Plessey Reliable ROLM Corporation Siemens Stromberg-Carlson Tele/Resources Wescom (Rockwell) Western Electric Womack
Source: Arthur D. Little, Inc.
forced into a cooperative mode, through joint ventures and technologysharing agreements. In the UK, liberalization has fragmented the PABX market, but not to the same extent as in the USA, as government and BT have to some degree limited market entrance. However, the fundamentals of Type 3 market competition are to be found. A contrast between the fortunes of two companies, Plessey and Mitel, reveals some of the problems of the development strategy. Plessey was initially unprepared to face competition in the PABX market and was dependent upon the technology of a US-based firm. Mitel, who had pioneered the development of small PABXs, entered the UK market with a technological lead and was able to obtain large BT contracts against strong domestic competition. By early 1983, Plessey had closed the gap with its own (IDX) PABX and recaptured lost market share. Meanwhile, Mitel fell behind due to production problems with its own new product (the SX2000). Such problems are a feature of ambiguous task knowledge markets. The situation remains dynamic but there is evidence that Mitel (essentially a single-product firm) is experiencing difficulties with development strategy. Incurring losses in the 1984 financial year, Mitel sought Canadian government support. Some have suggested that these difficulties are due to Mitel's handling of its maturing product 23 (the SX200) which, although gaining initial high market share in North America, is now suffering intense price competition from later market entrants. Subsequently, BT acquired a 51% controlling interest in Mitel. In addition to the PABX market, the VANS and office automation sectors share similar competitive environments where a comparable process is likely. The approach outlined in this article suggests that, if firms do not undertake a development strategy, they will be left with the option of competing on the basis of price and efficiency in the maturing segments of the market. However, the developmental strategy requires close attention to managing the resources necessary to continue such a strategy. Some of the problems associated with this have been hinted at, but increasingly, a cooperative strategy is being selected as a means of coping with acute resource dependence. We may now consider this type of strategy and the conditions where it is appropriate in more detail.
Type 4 markets 2aWayne Lilley, 'Leading-edge disasters', Canadian Business, Vol 57, No 12, December 1984, pp 36-45,
As the costs associated with development and innovation rise, barriers to entry increase and markets tend towards concentration. These are what we have described as Type 4 markets. The trend towards these
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conditions is exacerbated in telecommunications due to technical convergence, which means firms require task knowledge in areas beyond their traditional scope and competence. Electrical switch manufacturers, for example, require increased knowledge of computers and data processing; PTTs require knowledge of satellite technology, cable TV and broadcasting, and so on. Developing such task knowledge internally requires a large learning effort and long gestation period. This process can be short-circuited through a cooperative strategy. Cooperation can be achieved through various means including joint ventures, consortia, tacit agreements, technology sharing, and membership in trade associations. However, the strategy is not without pitfalls. Small members can become dominated by a more powerful ally. Large firms can be exploited by small firms who 'free-ride'. 24 For instance, a joint venture designed to achieve some specific end can be exploited by an organization leaking information back to the parent, which gives the parent an advantage in some other sphere where the venturers are in competition. Some of the specific problems of managing cooperative strategies have been explored elsewhereY but the important points can be highlighted here. The effective operation of the cooperative strategy requires goodwill and trust between parties as, under conditions of ambiguity, it is difficult to specify precisely the commitments and responsibilities of each party at the outset of the venture since the future outcome is vague. Without ambiguity, it would be possible to write a specific contract with appropriate contingency arrangements which formally defines the contribution of each participant. 26 Generally, we would expect a cooperative strategy to be hedged by a contract or some other formal arrangement. Yet there can be little doubt that highly formalized relations do not allow for the give and take necessary to deal with a context of continually emerging and unforeseen problems. Trust and goodwill facilitate mutual adaptation but are sensitive to the observed conduct of participants and tend to be tenuous. Cooperative strategies are most viable under certain conditions. When the objective of a particular joint strategy is overriding and of equal interest to all participants, then one can expect full cooperation. If an objective is of secondary importance to a subsection of the participants, then we might anticipate reduced commitment whenever a line of action conflicts with a superior objective. Cooperation is usually most viable when participants are not normally in competition for the same markets or other sources of support; that is, between unlike organizations. Moreover, an alliance of unlike organizations is likely to bring together different types of task knowledge which is frequently necessary to create an innovation. The history of the development of the System X consortium illustrates 24Marcur Olson, The Logic of Collective Action, Harvard University Press, Cam- some of the potential problems with the cooperative strategy. The bridge, MA, 1971. participants in this project (GEC, Plessey, STC and BT) have 2SM. G. Carney, 'The viability of joint action in the information technology industry', traditionally enjoyed good and close relations. The initial development paper presented to Administrative Science of System X took place against the backdrop of the ending of the bulk Association of Canada conference, Mon- supply agreement and an unanticipated reduction of equipment orders treal, May 1985. from BT, in effect throwing STC, GEC, and Plessey into intensified ~Oliver E. Williamson, 'Transaction-cost economics: the governance of contractual competition. It has been suggested that work on the switch was delayed relations', Journal of Law and Economics, until BT formally posted contracts. 27 Later IT/', the parent company of Vol 7, No 1, 1979, pp 73-104. 27'Three companies into one project won't STC, developed a competitive product (System 12) and STC's commitment to the project was questioned. STC later left the consortium go', The Guardian, 21 April 1982.
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following divestiture by the parent. BT has been said to interfere too closely with development of the switch and then held responsible for inhibiting overseas sales. (The greater the overseas sales effort, the more System X would have to be modified for specific markets, which would result in BT having less control over future developments.) Generally, the consortium has been plagued by a lack of trust and this may have contributed to its failure to fulfil the expectations made of it. Perhaps a more successful recipe for a cooperative strategy is to be found in the case of Project Mercury. The project is a competitive trunk network of special interest to business users. The original participants in this consortium were distinctly unalike and included a merchant bank (Barclays), a petroleum company (BP), and a telecommunications network systems operator (Cable & Wireless). One might argue that this combination represented the required knowledge and resources necessary for a project of this nature; that is, technical skills, finance, knowledge of user requirements and, importantly, considerable political influence. Later, both BP and Barclays withdrew from the consortium leaving Mercury as a wholly-owned subsidiary of Cable & Wireless. In a sense, both organizations had served their purpose in the project; the political ambiguity surrounding Mercury was ameliorated once government began actively promoting it and the operationalization of the network reduced some of the financial risk, permitting capital to be raised in more conventional ways. Emerging areas of ambiguity and uncertainty revolve around Mercury's attempt to enter the international market. Mercury remains in the cooperative mode seeking US based allies for new joint ventures. The cooperative strategy appears to be of growing importance in the information technology industry in general, and in the UK since liberalization. The strategy is likely to be most viable when the relationship between participants is symbiotic, as opposed to potentially competitive or commensurate. Table 3 summarizes the main points about strategy in particular types of markets. It would be misleading if this perspective were to present a picture of a disintegrating and fragmented industry as a whole. The industry remains interdependent, but the nature of dependence is changing and participants are attempting to establish viable positions. This inevitably leads to new alliances and relationships between existing firms and new entrants. The turbulence in the industry may be seen as having its roots in the wider advances of information technology - its principle effect is to create increased levels of task ambiguity for participants. Secondly, the trend towards decreased state involvement in industry, with programmes of deregulation and privatization, permits a freer flow of Table 3. Summery of strategies end imperatives by market type.
Type 1
Strategy:
Imperative: Type 2
Strategy:
Price competition
Internal operating efficiency
Imperative:
Consolidation Domain maintenance
Type 3
Strategy: Imperative:
Developmental Resource acquisition
Type 4
Strategy: Imperative:
Cooperation
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Strategy in the telecommunications market
organizations and resources into previously prohibited market arenas. Figure 1 illustrates the dynamics of the industry. The major source of dynamism occurs in Type 3 markets. The developmental strategy in the eyes of the Austrian economists is the pursuit of a monopoly and monopoly profits. Whenever economies of scale and barriers to entry are sufficiently small, new entrants will seek to emulate or improve upon a successful development and share in the monopoly profits. Accumulating competition forces the original developer to maintain its effort and this demands a continued flow of resources. To this end, the original developer will seek to routinize and increase the efficiency of production of its initial development. At this point the product falls under Type 2 market conditions: that is, the market is concentrated (it contains the developer and early emulators and improvers), but the technology is now no longer ambiguous and other followers lacking high task knowledge expertise are able to enter on the basis of price competition and efficiency. The original developer will, of course, seek to defend its product through whatever means available (the consolidation strategy). In regulated markets, this may succeed for a considerable time. However, even the protection of regulation does not guarantee isolation from price competition. BT experienced much competition in the peripheral attachments markets long before formal liberalization, as price-competitive firms simply ignored the restrictive rules and sold their wares through a loophole in the legislation. In fact, a corollary of the intensive price competition and efficiency pressures of Type 1 markets is that firms will seek to circumvent and even break regulations which restrict access to attractive market opportunities. We might anticipate, then, a growth of "underground' economies wherever regulations are severely restrictive. Since such firms are likely to be small, the risk of detection by regulatory authorities is not high. Moreover, such semi-legal strategies are often the only ones available to firms which do not have the political support necessary to influence the regulatory process and liberalization policy. Continued regulation avoidance by entrepreneurial firms, however,
Type 4 marke~s
Type 3 markets
Development strategy
="
Resource dependence
=.
1
Routinization and reduced ambiguity
Price competition
Cooperative strategy
Assembling resources enter
~
Consolidation
strategy
Type 1 markets
Type 2 markets
Figure 1. The dynamics of strategic behaviour. 256
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tends to undermine the legitimacy of restrictive practices and may encourage a pro-market government to extend liberalization plans. Where no adequate means exist to defend a monopoly, and where innovative development opportunities become exhausted, Type 3 markets rapidly evolve towards Type 1 conditions. Alternately, where developmental strategies become more costly, a product-market area may evolve towards Type 4 conditions. Thi-ough cooperation, a group of organizations may assemble the required resources to mount an effective challenge to Type 2 monopolies. The competitive threat posed by Type 4 markets is based upon innovation leading to a period of intermodal competition. However, a consortium, having established a position in the market, will then have cause to consolidate and defend its niche against potential competition. For instance, once Project Mercury had secured its licence, it too was reported to have sought government assurances that similar licences would not be issued in the near future. 28
Conclusions
aS'Mercury granted a breathing space', Electronics Weekly, 23 November 1983.
This article has sought to explain some of the dynamics of the telecommunications industry. It has been observed that, under certain conditions, firms must devise strategies to cope with the imperatives of the product-market area. Due to the interconnections of the industry, the pursuit of a particular strategy will lead to new imperatives as competition and technologies evolve. The logic of strategic behaviour means that firms must pay attention to economic, technological and political factors in various sequences and at different times. Multiproduct firms may find themselves practising multiple strategies as they have interests in several types of market. However, there may be limits to the number and types of market areas in which any single organization may effectively participate. Management theorists have suggested that businesses build their strategies around a unique 'distinctive competence' or 'particular task knowledge'. The main effect of liberalization and technical change is that firms must modify strategies and learn new competences. Established telecommunications businesses must learn the competences of operating in more competitive markets, while new entrants must acquire the knowledge needed to cope with the political and regulatory environment of the industry. The pace at which businesses can adapt to new conditions will vary, but they should be careful in selecting areas of development. Generally, we would suggest that firms concentrate their effort and resources in areas which offer synergy; that is, where a particular competence might be most enhanced.
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