friend shaped
- It is easy to misattribute the cake (who is eating from it? what is the size of it? how many layers are there?).
- It is unintuitive to identify who the competitors are.
- Focusing on competitors is a distraction from problem-solving.
- Guess everyone's productivity.
In a market, there are substitute (replaceable) and complementary (consumed together) products. There are also competitors, who offer a similar product.
Zero sum games are conveniently easy for us to reason about, we know the products and we know the prizes. In a Formula One GP race, the drivers are obviously competing against each other for the same prize. The products (cars + driver) compete to finish the race faster, the faster they finish the larger the slice of cake awarded.
As soon as we enter a non-zero-sum game, it becomes complex to map a product to a cake for every possible product/cake combination.
This complexity leads to errors and unintuitive results in identifying important competitors.
The closest substitute is not the most important competitor
Not when there are few close substitutes, and not when there are many close substitutes.
We will start with the former, few close substitutes:
Examples:
- Italian restaurant comparing itself to the other Italian restaurant in the area, rather than all the restaurants in the area.
- Employees comparing their compensation to their immediate peers, rather than the entire field.
- High school student comparing their ability/grades to those in their class, rather than the ability/grades of everyone outside their school.
- F1 comparing itself to Nascar racing, rather than all entertainment.
If Italian restaurant A is outperforming its closest substitute Italian restaurant B, it may think it is doing good business, however both pale in comparison to the Japanese sushi restaurants which are way more fashionable in this area. A new sushi restaurant opens and suddenly Italian restaurants A and B have no more customers. In this case, the foremost competitor for Italian restaurant A was not the closest substitute.
Comparing to your closest substitute may be a useful exercise, but unchecked can become a slippery slope of distraction.
Believing your closest substitute is your foremost competitor is an easy trap to fall into that has ramifications.
Believing that your closest substitute is your foremost competitor could lead to losing sight of the bigger picture. You may begin to choose what to work on based on what they choose to work on, which could be wrong. You may also benchmark your performance relative to theirs, which could be bad.
You may also overlook the possibility of learning from or collaborating with your closest substitute. If Italian restaurants A and B worked on making Italian food more fashionable, the demand for both restaurants would increase. It almost sounds like the closest substitute is not your competitor at this stage but your complement. It's a good sign if your closest substitute is succeeding; it means you can too!
That said, having a substitute in the marketplace is usually undesirable from the point of view of the business or an employee. This undesirability perhaps explains the obsession, it's a survival instinct. It is preferable to be a monopoly. As an employee/company having many substitutes can be a concern because the product you're selling may get "commoditized" by other companies who want your product to be cheaper. As Joel Spolsky wrote:
Smart companies try to commoditize their products’ complements. Demand for a product increases when the price of its complements decreases. In general, a company’s strategic interest is going to be to get the price of their complements as low as possible.
There are layers to the cake, and "smart" businesses try to become monopolies in their "layer" or niche. Continuing our restaurant example, a Wine seller realizes sales increase when there are more Italian restaurants, so to increase wine profits, they would "try to commoditize their products' (wine) complement (Italian restaurants)". They could do this by making it easier for people to start a new Italian restaurant in the area. These smart companies would strategically act to reduce the barriers to entry of their products' complement. This is different from vertical integration (the wine company starting or acquiring restaurants themselves).
Now there are lots of Italian restaurants, lots of close substitutes for A and B, but are restaurants A and B each others foremost competitor? Or is it the wine company that is siphoning the profits whilst fostering extreme competition in A and B's layer of the cake? For these smart companies, having multiple substitutes for their products complement is great, but not necessarily for those in the competing layer. Backtracking on our initial examples, maybe the mistake is not "focusing on other Italian restaurants" or even "focusing on the entire restaurant market in the area", but perhaps the cake is the combined leisure+entertainment+food expenditure in the area, whatever it is, its dynamic and hard to pin down.
There could be other reasons besides a smart company which could cause more close substitutes to emerge. Perhaps new entrants would like a slice of the cake because they have noticed that it is growing. The cake is not fixed and as with our earlier examples, the easy misattribution of the cake could lead to misidentification of your important competitors. The fact that there are more entrants may indicate that there is more consumer surplus to capture somewhere from this cake (e.g. better drinks to sell than wine).
When in the situation of an increasing number of close substitutes, you could differentiate yourself, this may be challenging and domain specific. Differentiating on the axis of "Italian" for the restaurant may no longer be enough, you run into diminishing returns if you continue to differentiate in this way, by definition, it would not be "differentiating". You want to have no or few close substitutes.
Luckily this challenging domain specific differentiation may naturally happen by focusing on solving people's problems! Their problems/wants/needs have not been sufficiently solved yet and thus there exist axes that are less congested.
A minimum requirement for having few close substitutes is survival and productivity levels. This is one exception where comparing yourself to others is important. If someone else survives longer or is more productive, they could catch up to you on your new axis and lap you. Surviving and a productivity advantage is desirable. One low attention step is to gauge the productivity of everyone.
This depth of competition and productivity should not deter you as the best prizes are often the ones most heavily participated for.
Continue to compete by locating the problem-solving-axis.