Competition Counts

In the past, we've asked people. If their businesses were successful we respected their views and listened to what they said, but too often, we hear contradictory advice. We also notice that owners of successful businesses rarely attribute their good fortune to luck, whereas, owners of failing businesses often blame their bad luck for their misery.

Thomas Dean, of the University of Tennessee, took a different approach. He noticed widely varying rates of new business failure across different, closely related U.S. manufacturers. It was as though some industries welcomed new businesses and shielded them from competition while other industries devoured new businesses as soon as they emerged. Mr. Dean examined more closely.

Dean examined six business conditions that were present in all of the industries in varying degrees and he found that four of them had a significant impact on new businesses. The four conditions are: 1) niches, 2) sunk costs, 3) unionization, and 4) industry concentration.

Niches were influential. When a particular industry had a large number of product classes, Dean suspected it had many product niches. He found that new businesses in these industries had a higher success rate.

Finding a niche is one of the great challenges of entrepreneurs. Niches are relatively homogeneous groups of neglected customers. The alert business owner who identifies a niche can meet their demands, gain customer loyalty, and learn production efficiencies before anyone else has a chance to imitate him.

Dean identified manufacturing industries likely to produce product niches by noticing the number of 5-digit subclassifications listed for each of the 4-digit Department of Commerce S.I.C. industries. The higher the number, the more niches, and the greater the success of new business entrants. This is an approach we can use to identify niches.

Sunk costs were also influential. Sunk costs are durable, specific assets which commit the firm to a strategy appropriate to that investment. Dean found that the larger the investment, the higher the success rate of new entrants.

Degree of unionization in the industry was influential. Dean speculated that unions complicate decision making in firms in which they are strong, so their decisions come more slowly. Delayed decisions are an obstacle to imitation, and delayed immitation gives new firms longer to establish themselves.

Finally, industry concentration was also influential. An industry is concentrated if it is dominated by a few very large firms. Traditional belief holds that these firms exercise their considerable power to prevent new firms from entering their business, but a recent study concluded that this effort was largely reserved for other large companies who might be a real threat.

Dean found that small firms are ignored by existing large firms, and they are protected from other large firms from outside the industry that might otherwise enter the industry and compete with them. The small firms enjoyed an umbrella effect that gave them time to get established.

So there it is: niches, sunk costs, unionization, and industry concentration. Able competitors are informed competitors, and now you're better informed.

Reference: Dean, Thomas J., Craig Turner, and Charles Bamford (1997) Impediments to Imitation and Rates of New Firm Failure. Academy of Management Best Paper Proceedings from the Fifty-Seventh Annual Meeting of the Academy of Management, 103-107. www.businesspsych.org

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