This week's Wiki-Wednesday topic is 'First Mover Advantage' as it applies to incumbent suppliers. An excerpt of the article is below, but you can also read the full article on Wikipedia's page by clicking here. You may also want to read yesterday's Flip Side notes on Renewal Revenue to look at this issue from the supplier side.
In business the term "incumbent" is used for the largest company in a certain industry, for instance the traditional phone company in telecommunications, typically called the "incumbent operator". In a sales process, such as public tender, incumbent may also refer to the vendor that has the largest existing commercial relationship with the issuer of the tender. (Wikipedia, Incumbent)
Switching costs and buyer choice under uncertainty
Switching costs, late entrants must invest extra resources to attract customers away from the first-mover firm. Buyer choice under uncertainty, buyers may rationally stick with the first brand they encounter that performs the job satisfactorily. For individual customers benefits of finding a superior brand are seldom great enough to justify the additional search costs that must be incurred. It can pay off for corporate buyers since they purchase in large amounts. If the pioneer is able to achieve significant consumer trial, it can define the attributes that are perceived as important within a product category.
Examples of switching costs
- Switching costs play a huge role in where, what, and why consumers buy what they buy. Users, over time, grow accustomed to a certain product and its functions, as well as the company that produces them products. Once a consumer is comfortable and set in their ways they apply a certain cost, which is usually fairly steep, to switching to other similar products (Wernerfelt 1985).
- Another switching cost is described in Klemperer (1986) where the seller actual creates the cost. For instance in airline frequent-flyer miles many consumers find it important that an airline provides this service and are willing to actually pay more for an airfare ticket if it means they will get points towards their next flight.
- Buyer choice under uncertainty has developed into its own little advantage for first-movers. They realize that if they get their brand name out there quickly through advertisements, flashy displays, and possible discounts then people will try their product. If the product performs their desired need satisfactorily then they will keep their brand loyalty therefore increasing the firms’ revenue (Porter 1976). Also, a study by Ries and Trout (1986) showed that newcomers that emerged into the market as far back as 1923 were still at the top of their specific markets almost seven decades later.
As firms enjoy the success of being the first entrant into the market, they can also become complacent and not fully capitalize on their opportunity. “Vulnerability of the first mover is often enhanced by ‘incumbent inertia’. Such inertia can have several root causes:
(1) the firm may be locked in to a specific set of fixed assets,
(2) the firm may be reluctant to cannibalize existing product lines, or
(3) the firm may become organizationally inflexible”.
Firms that have severe fixed assets cannot adjust to the new challenges of the market as they have no room to change. Firms that simply do not wish to change their strategy or products and incur sunk costs from “cannibalizing” or changing the core of their business, fall victim to this inertia. Some firms simply will not change as it will not maximize their short term profits to do so. Although these numbers will be higher in the long run, the organization will fail. These firms are sometimes unable to be sustained in a changing and competitive environment. They may pour too many of their early assets into what works in the beginning, and not project to what will need to work in the long run.
Some studies which investigated why incumbent organizations are unable to be sustained in the face of new challenges and technology, pinpointed aspects of incumbents which fail. These included: “the development of organizational routines and standards, internal political dynamics, and the development of stable exchange relations with other organizations” (Hannan and Freeman, 1984). In other situations cannibalizing the company is not an option because the costs associated with it will be too much for the firm to succeed after the change. All in all some firms are too invested and rigid in the “now”, and are unable to project the future to maximize their current market stronghold.