Are You Ready to Fight a Giant?

by Chris Harrop and Barney Hamilton

The concept of "barriers to entry" is perhaps the most daunting proposition an innovator must face. Incumbent companies run by deep, experienced management teams dominate almost every industry. Established customer relationships, tried-and-true products, powerful brands, and significant scale advantages provide these companies with a thick armor that often appears impregnable to aspiring entrants.

Yet, time and again, upstarts find a way to prevail—and not only in technology hotbeds such as Silicon Valley. Nationwide, slow-growth industries with high fixed costs—including auto manufacturing, consumer goods, and big-box retailing—may seem unassailable. But then along come such giant slayers as Toyota, Nike, and Amazon.com, each of which has transformed the business landscape of its industry.

In truth, industry incumbents are often surprisingly vulnerable. Clayton Christensen and others have shown that beating an established company at its own game requires strategies that disrupt the status quo by focusing on customers the incumbents either ignore or aren't willing to defend.

Occasionally, companies can invent a better mousetrap and challenge an incumbent head-on for its most profitable customers. But most succeed by first devising cheaper, more convenient ways to serve targeted customer niches that are below an incumbent's radar. This allows the entrant to mine profits in ways that are not cost-effective for incumbent companies, which have higher cost structures and broader focus. Over time, that strategy can migrate to other segments until the challenger's approach becomes the new status quo.

But how do innovators create disruption? Bain's experience and analysis suggest that customer focus holds the key. Successful challengers target specific segments and design propositions that address customers' unique concerns in ways incumbents don't—and very often can't. (See the sidebar "Are You Ready to Take On a Giant?") Challengers deliver a powerful customer experience by coordinating efforts across business functions, and they punch above their weight by investing selectively in what matters most to their target segments. Then they succeed over the long haul by systematically renewing their edge with customers.

All customers are not created equal
Giant slayers begin by recognizing that customers' needs and perceptions of value vary significantly across segments. Incumbents tend to give their customer segments varying amounts of attention, frequently concentrating on those that deliver the highest margin. Successful challengers often begin with a single-minded focus on delivering superior propositions to overlooked segments—addressing needs or desires that established companies don't (or can't) meet.

The European airline industry's dramatic turnabout provides a stark example of how powerful customer focus can be. Before 1995, high-cost "legacy" carriers—such as British Airways, Lufthansa, and Air France—dominated. They tried to be all things to all travelers but, for obvious reasons, spent most of their energies catering to their most profitable customers: businesspeople.

This created a bloated cost structure that opened the door for Ryanair and easyJet, two start-ups founded on the premise that many customers simply want a convenient, inexpensive way to travel. Both companies created a focused value proposition for cost-sensitive leisure and private travelers and tailored their business plans to make that model work.

The strategy began with their fleets. To gain a cost advantage, the challengers bought small, efficient aircraft and offered only one class of service. Unlike the incumbents, they standardized their fleets, reaping savings from common maintenance and training programs. And rather than maintain expensive, inconvenient hub networks, they chose high-volume, point-to-point routes from less-crowded, secondary airports.

To save on distribution costs these airlines chose their sales channels carefully. They eschewed traditional third-party travel agents and pricey booking systems and relied on direct sales channels: telephone call centers and the Internet. As a result, distribution makes up only 3 percent of total costs at Ryanair, versus 10 percent for some large carriers. The smaller carriers pass those savings on to the customer.

Both upstarts recognized quickly that online transactions were their most profitable channel. So they worked hard to steer customers to their Web sites without sacrificing service quality or convenience. EasyJet offers a discount of £10 (approximately U.S. $18.50) per round trip if customers book over the Internet. Once on the easyJet site, customers find a simple-to-use interface that downloads quickly, even on dial-up modems. Buying a ticket requires only five steps, versus ten on some legacy carriers' sites. And because easyJet collects key customer data with each booking, it is able to analyze more precisely who its customers are in order to continually hone its strategy.

Without large bureaucracies and unions, Ryanair and easyJet also benefit from low overhead and cheap labor. They have driven cost out of their supply chains and ignored the bells and whistles their customers don't value, such as free in-flight food and drinks.

Profits are plowed back into the business to continue to provide customers with a comfortable, lower-cost alternative, which in turn drives more volume. The results have been dramatic. Low-cost carriers have already taken 10 percent of the intra-Europe market and are projected to have more than 25 percent by 2010. Ryanair and easyJet together added more than £4 billion (nearly U.S. $7.5 billion) in market value between 1995 and 2003, while many large incumbent carriers have lost value.

Focus the business on delivering a powerful customer experience
The lack of corporate baggage is a key advantage for any upstart. While new entrants can design their business plans and strategies on a clean sheet of paper, older companies are saddled with systems and patterns of behavior developed over many years. This hampers their ability to deliver the sorts of end-to-end solutions challengers can devise from scratch.

A few years back, Australian telecommunications companies faced a tough growth environment after deregulation of the market led to intensified competition and price pressure. Number two player Optus Administration, which had been the first to take on the incumbent Telstra, was able to fill a good portion of its growth gap by taking a close look at key customer segments and coming up with distinctive services tailored to its customers' needs.

The flexibility to "design for purpose" led to a major promotion—called "'yes' Time"—in which Optus invited its customers to call each other for free between 8 p.m. and midnight. At the heart of the initiative was an innovative pricing strategy that used an asset that was of little expense to Optus—in this case, spare nighttime network capacity—to provide something of real value to its customers.

The promotion hit a bull's-eye, helping Optus to turn existing customers into brand promoters who encouraged friends and associates to switch to Optus's service. "'Yes' Time" was a winner on another level as well. It encouraged new and existing Optus mobile customers to use Optus at night instead of relying on Telstra's traditional landlines for their evening calls.

Optus has counted on its entrepreneurial culture to help it grow into the multibillion-dollar business it is today. For instance, in the mid-1990s it implemented a computer-sharing initiative that cut millions in IT costs and improved call-center productivity. Today the company uses innovative partnering programs, including one that pays commissions to businesses that help generate sales leads for Optus.

Viewing the marketplace through the eyes of a challenger taking on established players is "in the cultural DNA of the company," points out CEO Paul O'Sullivan in a recent interview with The Australian Financial Review. "It's not one of those top-down hierarchical corporations...This is a far more maverick…place. And we pride ourselves on that."

Building on its customer innovations and its cultural strengths, Optus has consistently grown at more than twice the rate of the market since the company started operations in 1992 and has taken market share from Australian incumbent telco Telstra. The company's revenue has grown to A$5.5 billion (U.S. $4.3 billion), up from about A$2 billion (U.S. $1.5 billion) in 2000, and it now enjoys market leadership in such customer segments as high-speed Internet access.

Renew the customer experience again and again
The ability to move quickly based on superior knowledge of customer needs is another hallmark of successful challengers. They often build tight feedback loops with their markets, taking full advantage of their flatter organizations to ensure that customer insights are identified and acted upon. This capability allows them to renew a valuable and satisfying customer experience again and again. It also gives them the ability to identify future customers and reorient their strategy to market changes.

Over the last decade, the home mortgage business in Australia has undergone a sea change brought about by upstart mortgage brokers (such as Mortgage Choice, Australian Finance Group, and Aussie Mortgage Market) and low-cost mortgage originators (such as Aussie Home Loans). As recently as 1993, traditional banks controlled all but a sliver of the mortgage market. But by listening carefully to what customers wanted and providing the increased service they sought, independent brokers forced the banks to play by a new set of rules.

By 2003, brokers were originating 30 percent of mortgages in Australia, and their share grew to around 45 percent by the end of 2004. More impressive, they have captured A$350 million of the Australian mortgage profit pool (U.S. $270 million). Concurrently, bank margins have been slipping steadily.

The independent brokers have tapped into a deep wellspring of home-buyer consternation. In a recent survey, Australian borrowers were asked if they found the mortgage process confusing: 75 percent of them said yes. A sizeable majority also preferred personal visits from mortgage brokers or even shopping for their mortgage on the Internet to visiting a bank branch for a loan. What they wanted was unbiased advice. And the brokers were providing it.

Traditional lenders tend to push proprietary products with minimal focus on an individual's circumstances, but brokers can draw from an array of lenders for the best rates and payment terms. Moreover, brokers offer expert advice to individuals who are often novices at one of the most significant and complex transactions most consumers will ever make. Banks provide limited service and customers have to shop around on their own for the best terms. Brokers, on the other hand, offer one-stop shopping and often will make house calls or office visits to explain options. And brokers provide these extra services at no additional cost to borrowers. They are funded by the very banks they compete with, through a schedule of commissions.

Why do the banks put up with it? To date, they've had no choice. Although the brokers take profits away from the banks, they provide such a compelling service that the banks have been forced to support their efforts. But the banks are fighting back. They've reduced broker payments for poor-quality loans and aligned commissions to reward more profitable types of loans, such as those that have longer terms. Their interest rates and offerings have also grown more competitive.

All of this has cut into the brokers' margins and highlighted how essential it is for challengers to use superior customer knowledge to stay ahead of the curve. Unfortunately, the brokers have missed some tricks.

Instead of relying so heavily on bank commissions, brokers could have parlayed their customer relationships into products beyond financial-planning advice. That's what Optus and the European airlines have been able to do—take their original concept and migrate it into other segments. It isn't easy. Indeed, one of the leading Australian brokers, Wizard Home Loans, recently sold out to GE Money, the consumer finance arm of General Electric, in recognition that it needed help to compete. Wizard's experience is an object lesson: Finding ways to deliver customer satisfaction again and again is crucial to making giant slaying sustainable.

Learning from the giant slayers
That a David can defeat a Goliath is no myth. Even when upstart companies lack long-standing relationships, pervasive brands, and scale advantages, they can still win big against incumbents, driving dramatic market-share shifts in just a few years.

Reproduced with permission from "Lessons from the Giant Slayers," Strategy & Innovation, May-June 2005.

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Chris Harrop is a partner with Bain & Company in Sydney, and co-leader of Bain's telecom and technology practice in Asia.

Barney Hamilton is a Bain partner in London.

They can be reached at innovation@hbsp.harvard.edu.