The Carrot and the Stick uses detailed examples and case studies ranging from historic cases like Vanderbilt's railroad in New York to current cases like Amazon's control of the value chain to explain how finding and leveraging points of strategic control can be the key to success in today's convergent, fast-paced markets. The book focuses on how to spot and own potential points of strategic control, how to extend them to multiple markets, what tools and processes can be implemented in order to utilize the principle in practice, and how to "pry loose" existing points of strategic control owned by others. Applicable to all industries, this book can help alter business outcomes.
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Understanding Strategic Control Points ("The Stick")
The Story of Cornelius Vanderbilt's Hudson River Bridge
Jack Welch once said about Vanderbilt and all great executives: "They have the ability to see around corners." At the start of the Civil War, Vanderbilt realized that a transcontinental railroad could slash coast-to-coast travel times by a matter of months. As a result of this vision, he sold virtually all of his shipping interests in order to invest in railroads. By the end of the war, his vision had resulted in a railroad empire that was worth the equivalent of $75 billion today. However, he was soon challenged for being "soft" when he was pushed by rival rail companies during tough negotiations. He fought back, looking for a key strategic control point to leverage against his rivals. Since he owned the only rail bridge in and out of New York City (the Hudson River Bridge, pictured in figure 1.1), he owned the gateway to the country's largest port. Without access to the bridge, every other railroad would be effectively shut out of New York City.
Vanderbilt, like many after him, realized that he owned a crucial strategic control point, one where all rail traffic flowed between a crucial port in New York City and the rest of the country. The Hudson River Bridge was that strategic control point.
Accordingly, after Vanderbilt's rivals failed to give him the deal he wanted, he cut off the bridge to them and then famously asserted, "We're going to watch them bleed ..." Vanderbilt singlehandedly created a blockade around the nation's busiest port and the rest of the country (long before many of today's antitrust laws were created). When a rival railroad, New York Central, started to "bleed" and shares fell precipitously on the New York Stock Exchange, Vanderbilt bought up every share he could and, in just a few days, took control of the rival railroad. He eventually went on to own 40 percent of the nation's rail lines and built Grand Central Depot (now Grand Central Station, the largest building in New York at the time) to bring together his three new lines: the Harlem, Hudson, and NY Central.
A few decades later, John D. Rockefeller knew that he needed leverage when he was faced with a coordinated effort to raise passage rates for shipping oil out of Standard Oil refineries in and around Cleveland; the railroad companies owned the lines (a classic strategic control point) and he needed to transport his oil. Consequently, he decided he needed an alternative and thus built a network of oil pipelines to circumvent the need to transport via rail. Rockefeller knew that he would be squeezed for higher rates by the railroads that owned the only viable way to transport oil – unless he could break this control point. His pipeline enabled him to work around an existing point of strategic control – although it took him years to construct it.
DEFINITION: STRATEGIC CONTROL POINT
A strategic control point is a part of a market that, if controlled by one party, can be used to leverage power elsewhere; this can be throughout the supply chain, in a related business, or even in an unrelated market. A classic example might include patented intellectual property or the supply of a critical input in the supply chain. By controlling the supply of a critical input, for example, a firm may be able to extract extraordinary margins in other parts of the supply chain or across other industries as a result.
We will see that a common theme of successful companies today (e.g., Alphabet, Apple, Amazon, Alibaba) is not just that they exert the power derived from owning a point of strategic control but that they have the foresight to own the point of strategic control in the first place. This affords them the ability to exert pressure on an as-needed basis later on – much as Vanderbilt did during the Industrial Revolution. Remember this as we work through the book. You will discover that a plan to leverage strategic control, through various methods, is one of the key components of successful strategies in today's environment.
Sources of Strategic Control
We will develop the concept more fully throughout the book; as we proceed, you will find that there are many different potential sources of strategic control. We divide them into six main sources:3
b. Information More Generally
4 Raw Material and Input Factors of Production
5 Intellectual Property and Regulatory-based Market Access
6 Key Manufacturing Components
In this chapter, we delve into the details of how to spot, access, and utilize points of strategic control. In order to illustrate how this plays out in practice, we will begin by presenting examples of each of these six main sources of strategic control.
Source 1. Distribution/Access
Locking up Distribution Effectively Keeps Competitors at Bay
Distribution is perhaps one of the most common sources of strategic control; lock up distribution and it can be exceedingly difficult for someone else to gain access to the market.
The story of Vanderbilt – and how the Hudson River Bridge afforded him a stranglehold on the transport of goods during the Industrial Revolution – is a classic example of how distribution and market access can be used as a strategic control point. The ownership of the bridge out of Manhattan enabled Vanderbilt to control the terms of shipping in and out of the nation's busiest port because access to New York went across his bridge.
Some more recent examples include eyewear, men's razors, taxi cabs, and shelf space at DIY (Do It Yourself) retail, each of which is being or has been disrupted in recent years (the stories of how each of these industries is being disrupted today are told later in the book):
The market for eyewear. One major supplier of eyeglasses and sunglasses controls multiple brand names and owns most retail distribution outlets throughout much of the world. Prior to a 2017 merger that brought the two largest players together, Milan-based Luxottica owned more than 8,000 retail locations in over 150 countries and had a dominant 50 percent market share in sunglasses. French company Essilor owned 45 percent of the prescription lenses market and 15 percent of the sunglasses market in 2015. In January 2017, the two companies announced that they were merging (the merger was approved by U.S. and EU regulators in March of 2018). The combined entity now owns over 50 percent of the prescription eyewear and over 65 percent of the sunglasses market. Add in the only other significant player, Safilo, with a 14 percent market share in sunglasses and a 3.7 percent market share in prescription lenses, and the two companies own a staggering percentage of the retail eyewear market with tight retail distribution control. Significant new competitive entry through retail distribution would be exceedingly difficult and certainly fought tooth-and-nail.
Men's razors. Gillette's and Schick's traditional dominance of the men's shaver market is another classic example. Gillette alone had over a 70 percent market share as recently as 2010, and they routinely introduced relatively minor product variants to occupy most of the available retail shelf space. Entering the market with a new razor with an additional blade and pushing behemoth Gillette off pre-existing allocated shelf space has been exceedingly difficult for any potential new entrant over the years. Who truly needs the fifth, sixth, or seventh blade anyway?
Taxi cabs. The monopoly traditionally afforded to taxi cabs by local municipalities vis-à-vis the medallion program (a system whereby a vehicle needs a "medallion," often posted on the vehicle itself, in order to legally operate a taxi cab under local jurisdiction) is yet another example. In cities like New York and San Francisco, the right to own and operate a taxi cab has been historically tightly regulated by local governments. For example, in New York, the medallion program began in 1937 when the supply of taxi cabs was significantly greater than demand. Medallions in New York were selling for $2,500 in 1947 and peaked in 2013 at a hefty price tag of $1.3 million. A limited number of medallions were approved by the City of New York, and competition – at least prior to ride-sharing companies such as Uber and Lyft – was prohibited. This was obviously a very strong point of strategic control.
Windows, faucets. In DIY (Do It Yourself) "big box" retail (e.g., Lowe's, Home Depot, Menards), Anderson and Pella dominate windows, while Kohler, Moen, and Delta dominate faucet shelf space. Combined, Kohler, Moen, Delta, and American Standard own a 78 percent market share in the United States in the construction market. In retail, shelf space allocation is almost everything, and manufacturers routinely pay "slotting allowances" (paying to get on the shelf) and are required to guarantee sales performance (known as "failure fees").
The list of companies that have successfully locked up distribution and precluded entry by rivals is long and varied. Examples ranging from Microsoft's inclusion of Internet Explorer as a feature "tied" to its Windows operating system to Vanderbilt's bridge have been covered in depth in antitrust-law classes and business school MBA classes. The use of distribution as a "stick" (under the advice of legal counsel) for excluding competition via distribution can be viewed with admiration (in some business classes) or as a risky and potentially illegal strategy (in some antitrust-law classes).
We can summarize distribution-based strategic control points as follows:
Distribution is an area where companies can gain strategic advantage (e.g., Luxottica, Moen, or Delta) or be strategically disadvantaged, but it is also an area ripe for disruption.
Later in the book, we will discuss strategies for
dislodging distribution-based sources of strategic control. The identification of strategies for overcoming a rival's distribution-based point of strategic control can often be the difference between success and failure in many industries today.
Source 2a. Information: Hardware/Software (Today's Version of Give Away the Razor to Sell the Razor Blades)
Information as a Source of Strategic Control: The Battle for Data – in the Wind and the Cloud
Windmill technology has dramatically improved over the past few decades. For example, GE has developed blades and rotors that sense the wind direction and adjust a windmill's tilt/shift in order to optimize its ability to catch the wind. In addition, many windmill "farms" (i.e., groups of windmills in close proximity) optimize the way they work together, since one windmill's direction and tilt affects the downwind performance of the other windmills. Thus, a group of windmills, operating together, is more efficient than individual windmills operating separately; as a result, when one windmill fails, the efficiency of the entire farm can be adversely affected.
Industry leaders (e.g., GE and Siemens) have developed their own optimization and monitoring services that use the data coming off the windmills to send performance data to the cloud and, using this data, remotely monitor performance and proactively do repairs to maximize windmill uptime. However, the market for windmills is fragmented, with a few large players and a series of smaller players – many of whom are lower-cost manufacturers from Asia who do not have the scale and/or capabilities to develop and maintain such services.
In response to GE's and Siemens's control of this space, a few ingenious companies are in the process of installing – for free – sensors in both new and existing (i.e., retrofitted) windmills. These sensors (see figure 1.2) monitor motor vibration and temperature so that they can predict motor failure before it happens. The data are broadcast to the cloud in real time, and predictive failure analytics are conducted on the data. Once a motor's spec goes out of tolerance zones, a team is dispatched to "repair" the motor before it fails – not only to maximize the "up time" of the windmill but also to provide peak efficiency for the entire farm (see figure 1.3).
This can enable the smaller players to compete effectively with the larger firms; for example, for smaller Chinese manufacturers trying to compete with GE and Siemens, being able to provide this service is often the difference between making the sale and losing it.
So, how do you make money by installing sensors for free? The key is to own exclusive access to the data generated via the sensors and leverage it by selling higher-margin maintenance contracts back to windmill manufacturers (for newly built windmills) and to farm owners (for retrofitted, existing windmills). In order to understand how and why this works, note that the smaller players are more than willing to allow the sensors to be installed, to grant access to the data, and to pay for higher margin maintenance, since they can't efficiently do this themselves (due to their size and scale). Further, they gain the ability to compete with the GEs and Siemenses of the world on services, while simultaneously maintaining their cost advantages. In doing so, they can eliminate downtime to at or near zero by offloading this to the sensor supplier. Therefore, it's a win-win arrangement for all parties.
DEFINITIONS: IOT, INTEROPERABILITY, AND THE CLOUD
In this example, it is worth noting that the ability to remotely monitor a device and allow different parts of the value chain to "interoperate" (here, sensors that allow remote monitoring to make all windmills on a farm collectively more efficient) is often referred to as IoT (internet of things) interoperability. This is just a fancy term for enabling parts of a firm's supply or value chain to work together by connecting different parts via the internet. We use the term "IoT interoperability" here, but note that this simply means that a device (e.g., a windmill) is connected to the internet (e.g., via sensors on a windmill) and sends data to a central data facility (i.e., the cloud).
This is the modern-day equivalent of the "give away the razor to sell the razor blades" story. Today, the razor equivalent (the sensors) is of value because of the (i) ability to monitor motor performance remotely via the cloud, (ii) ability of the system ("the farm") to interoperate, and (iii) ability of failure mode analysis to predict failure before it happens. Indeed, in today's world, it is often beneficial to give away the hardware but own the data. Data is the new currency and often the point of strategic control in many industries.
Source 2b. Information More Generally (Ownership of / Access to Information, and Privacy Concerns)
Wearables and the Internet Access Wars: Why the Battle for the Last Foot between You and Your Internet Is So Valuable
There is a battle raging that most of us don't know about: the battle to "own" our internet connections. Whatever company owns the data coming off a device (e.g., a smartphone, router, or interconnected machines on a factory floor) will own a huge point of strategic control in future competitive value chains – within and across industries.
In order to illustrate this point, think back to the story of Google and the Latin American insurance executive (in the introduction). What enabled Google to "extort" (according to the executive) margins from the insurance company? Google controlled information on driver position, speed, and acceleration via a device and internet connection associated with each of the insurer's insured drivers. Thus, by owning the connection and the key app (i.e., Google Maps and the Android OS), Google has access to all of the information generated via the vast majority of smartphones in this region: with 88 percent of the worldwide smartphone operating system installed base in calendar year 2018, the Android operating system provides a treasure trove of data for Google to leverage.(Continues…)
Excerpted from "The Carrot and the Stick"
Copyright © 2020 University of Toronto Press.
Excerpted by permission of University of Toronto Press.
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Table of Contents1. Introduction
Part 1. Strategic Control in a Single Market Context
2. Understanding Strategic Control Points (“The Stick”)
3. How to Spot Strategic Control Points
Part 2: Extending Strategic Control to Multiple Markets
4. Extending the Concepts to Multiple Markets
5. On the Outside Looking In: What Happens When Someone Else Owns a Strategic Control Point?
6. What Can Go Wrong When You Own a Point of Strategic Control?
Part 3: The Carrot and the Stick: Strategies for Today's Interconnected Environment
7.The Concept of Aligning Incentives (“The Carrot”)
8. Why the Carrot and the Stick Matter
9. Game Theory, Signaling, and the Strategic Use of Information
What People are Saying About This
"This book is a must-read if you want to compete and win in the markets of today and tomorrow. Success requires understanding how to think in both win-lose and win-win ways. William Putsis lays out a rigorous framework with clever real-world examples to help understand how sustainable profits depend upon ownership of strategic points of control and win-win incentives along the value chain."
"I especially appreciated that The Carrot and the Stick did not 'talk at me' with a series of lessons, but through simple exercises guided me to explore and discover what will make our own unique businesses more valuable. Providing more than just the 'what' and the 'why,' William Putsis most importantly lays out the 'how' of executing a value creation strategy based on building critical importance to customers."
"There is no business leader or business student who won't find themselves riveted to the perspectives this book offers on the strategic thinking and execution behind the technologies which have profoundly reshaped industry and transformed the way we live. Thus everyone in legislatures and the media needs this book as well. At a time when appropriate critiques of the unchecked power of big tech abound, this book instead explains how such enterprises flourish, drawing upon examples from our past and present that foreshadow our future as well as key concepts in strategic, marketing, entrepreneurship, innovation, and technology. All this with an engaging writing style. Every page makes you feel 10 percent smarter."
"In his first book, Compete Smarter, Not Harder, William Putsis presents a process to strategically prioritize market opportunities. In The Carrot and the Stick, he follows up on this by extending the concept of strategic control to multiple market opportunities. We have found his process to be instrumental to the success we have been having in growing our markets and to our move to adjacent market opportunities. Highly recommend the book to anyone interested in growing their business."
"After reading The Carrot and the Stick, you will start to look at everyday situations differently. William Putsis provides a compelling narrative across industries and time periods showing how considering strategic control points can swing business outcomes. William Putsis's role as a strategic advisor to many global brand-name corporations that allows him to go beyond what would otherwise be theory and academic and connect it to the practitioner."
"William Putsis takes all the small things happening on the periphery of our vision and brings them into focus. He deploys stories from companies in wildly different historical contexts and industries from Amazon to Owens Corning forcing us to relinquish the tiresome trope, 'but things are different in my industry.' Everyone has a carrot, and everyone has a stick. If you don't see yourself in this book, you're not reading closely enough."
"The central premise is critical maintain strategic control and foster proper incentives. The book empowers the reader with method and principles to understand and address strategic control points and to align needed incentives to guarantee success. His storytelling brings the success and failures of the past to the context of the new market realities. An excellent and rewarding read for any leader in the new realities of platforms and ecosystems being shaped by current realities."