Only the Paranoid Survive

by Andrew S. Grove

  Two, in this hypercompetitive horizontal world, opportunity knocks when a technology break or other fundamental change comes your way. Grab it. The first mover and only the first mover, the company that acts while the others dither, has a true opportunity to gain time over its competitors—and time advantage, in this business, is the surest way to gain market share. Conversely, people who try to fight the wave of a new technology lose in spite of their best efforts because they waste valuable time.

  Three, price for what the market will bear, price for volume, then work like the devil on your costs so that you can make money at that price. This will lead you to achieve economies of scale in which the large investments that are necessary can be effective and productive and will make sense because, by being a large-volume supplier, you can spread and recoup those costs. By contrast, cost-based pricing will often lead you into a niche position, which in a mass-production-based industry is not very lucrative.

  I think these rules are pretty general for horizontally based industries. I also think that there is a general trend toward horizontally based structure in many parts of industry and commerce: As an industry becomes more competitive, companies are forced to retreat to their strongholds and specialize, in order to become world class in whatever segment they end up occupying.

  Why is this so?

  In our example, a vertical computer company had to produce computer platforms and operating systems and software. A horizontal computer company, however, supplies just one product—for example, computer platforms or operating systems or software. By virtue of the functional specialization that prevails, horizontal industries tend to be more cost-effective than their vertical equivalents. Simply put, it’s harder to be the best of class in several fields than in just one.

  As industries shift from the vertical to the horizontal model, each participant will have to work its way through a strategic inflection point. Consequently, operating by these rules will be necessary for a larger and larger class of companies as time goes on.

  They’re Everywhere

  “Strategic inflection

  points are not a

  phenomenon of the

  high-tech industry,

  nor are they

  something that

  happens to the

  other guy.”

  When a Wal-Mart moves into a small town, the environment changes for every retailer in that town. A “10X” factor has arrived. When the technology for sound in movies became popular, every silent actor and actress personally experienced the “10X” factor of technological change. When container shipping revolutionized sea transportation, a “10X” factor reordered the major ports around the world.

  Reading the daily newspapers through a “10X” lens constantly exposes potential strategic inflection points. Does the wave of bank mergers that is sweeping the United States today have anything to do with a “10X” change? Does the acquisition of ABC by Disney or Time Warner’s proposed merger with Turner Broadcasting System have anything to do with one? Does the self-imposed breakup of AT&T?

  In subsequent chapters, I will discuss common reactions and behavior that occur when strategic inflection points arise, as well as approaches and techniques for dealing with them. My purpose in this chapter is to sweep through a variety of examples of strategic inflection points drawn from different industries. By learning from the painful experience of others, we can improve our ability to recognize a strategic inflection point that’s about to affect us. And that’s half the battle.

  I’ll largely use the framework of Porter’s competitive analysis model, as most strategic inflection points originate with a large “10X” change in one of the forces affecting the business. I will describe examples that are triggered by a “10X” change in the force of the competition, a “10X” change in the technology, a “10X” change in the power of customers, a “10X” change in the power of suppliers and complementors, and a “10X” change that is due to the imposition or the removal of regulations. The pervasiveness of the “10X” factor raises the question, “Is every strategic inflection point characterized by a ‘10X’ change? And does every ‘10X’ change lead to a strategic inflection point?” I think for all practical purposes the answer to both of these questions is yes.

  “10X” Change: Competition

  There’s competition and there’s megacompetition, and when there’s megacompetition—a “10X” force—the business landscape changes. Sometimes the nature of the megacompetition is obvious, and the story of Wal-Mart that follows will give an example of that. Sometimes the megacompetition sneaks up on you. It doesn’t do business the way you are used to having business done, but it will lure your customers away just the same. The story of Next will give an example of that.

  Wal-Mart: An overwhelming force in town

  From the standpoint of a general store in a small town, a Wal-Mart store is competition. So were the other general stores that it previously had to compete with. But Wal-Mart comes to town with a superior “just-in-time” logistics system, with inventory management based on modern scanners and satellite communications; with trucks that go from store to hub to store continuously replenishing inventories; with large-volume-based purchase costs, systematic companywide training programs, and a finely tuned store location system designed to pinpoint areas where competition is generally weak. All this adds up to a “10X” factor compared to the other competition the store previously had to face. For a small-town general store, once Wal-Mart moves to town, things will have changed in a big way.

  A far superior competitor appearing on the scene is a mandate for you to change. Continuing to do what worked before doesn’t work anymore.

  What would work against a Wal-Mart? Specialization has a good chance. In-depth stocking, serving a particular market segment, as Home Depot, Office Depot, Toys “я” Us and similar “category killers” are doing, can work to offset the overall imbalance of scale. So can customized service, as Staples is implementing through an in-depth computerized customer database. Alternatively, so might redefining your business to provide an environment, rather than a product, that people value, like the example of an independent bookstore that became a coffeehouse with books to compete with the chain bookstores that brought Wal-Mart-style competitive advantages to their business.

  Next: The software company

  When Steve Jobs cofounded Apple, he created an immensely successful, fully vertical personal computer company. Apple made their own hardware, designed their own operating system software, and created their own graphical user interface (what the customer sees on the computer screen when he or she starts working with the computer). They even attempted to develop their own applications.

  When Jobs left Apple in 1985, he set out, for all intents and purposes, to recreate the same success story. He just wanted to do it better. As even the name of his new company implied, he wanted to create the “Next” generation of superbly engineered hardware, a graphical user interface that was even better than Apple’s Macintosh interface and an operating system that was capable of more advanced tasks than the Mac. The software would be built in such a way that customers could tailor applications to their own uses by rearranging chunks of existing software rather than having to write it from the ground up.

  Jobs wanted to tie all of this—the hardware, the basic software and the graphical user interface—together to create a computer system that would be in a class by itself. It took a few years, but he did something close to that. The Next computer and operating system delivered on basically all of these objectives.

  Yet while Jobs was focusing on an ambitious and complex development task, he ignored a key development that was to render most of his efforts futile. While he and his employees were spending days and nights developing the superb sleek computer, a mass-produced, broadly available graphical user interface, Microsoft Windows, had come on the market. Windows wasn’t even as good as the Mac, let alone the Next interface, and it wasn’t seamlessly integrated with
computers or applications. But it was cheap, it worked and, most importantly, it worked on the inexpensive and increasingly powerful personal computers that by the late eighties were available from hundreds of PC manufacturers.

  While Jobs was burning the midnight oil inside Next, in the outside world something changed.

  When Jobs started developing Next, the competition he had in mind was the Mac. PCs were not even a blip on his competitive radar screen. After all, at that time PCs didn’t even have an easy-to-use graphical interface.

  But by the time the Next computer system emerged three years later, Microsoft’s persistent efforts with Windows were about to change the PC environment. The world of Windows would share some of the characteristics of the Mac world in that it provided a graphical user interface, but it also retained the fundamental characteristics of the PC world, i.e., Windows worked on computers that were available anywhere in the world from hundreds of sources. As a result of fierce competition by the hundreds of Computer manufacturers supplying them, these computers became far more affordable than the Mac.

  It was as if Steve Jobs and his company had gone into a time capsule when they started Next. They worked hard for years, competing against what they thought was the competition, but by the time they emerged, the competition turned out to be something completely different and much more powerful. Although they were oblivious to it, Next found itself in the midst of a strategic inflection point.

  The Next machine never took off. In fact, despite ongoing infusions of investors’ cash, Next was hemorrhaging money. They were trying to maintain an expensive computer development operation, in addition to a state-of-the-art software development operation, plus a fully automated factory built to produce a large volume of Next computers—a large volume that never materialized. By 1991, about six years after its founding, Next was in financial difficulties.

  Some managers inside the company had advocated throwing in the towel in hardware and porting their crown jewel to mass-produced PCs. Jobs resisted this for a long time. He didn’t like PCs. He thought they were inelegant and poorly engineered, and the many players in the industry made any kind of uniformity hard to achieve. In short, Jobs thought PCs were a mess. The thing is, he was right. But what Jobs missed at the time was that the very messiness of the PC industry that he despised was the result of its power: many companies competing to offer better value to ever larger numbers of customers.

  Some of his managers got frustrated and quit, yet their idea continued to ferment. As Next’s funds grew lower and lower, Jobs finally accepted the inevitability of the inelegant, messy PC industry as his environment. He threw his weight behind the proposal he had fought. He shut down all hardware development and the spanking new automated factory, and laid off half of his staff. Bowing to the “10X” force of the PC industry, Next, the software company, was born.

  Steve Jobs is arguably the founding genius of the personal computer industry, the person who at age twenty saw what in the next decade would become a $100 billion worldwide industry. Yet ten years later, at thirty, Jobs was stuck in his own past. In his past, “insanely great computers,” a favorite phrase of his, won in the market. Graphical interfaces were powerful differentiators because PC software was clunky. As things changed, although many of his managers knew better, Jobs did not easily give up the conviction that had made him such a passionate and effective pioneer. It took facing a business survival situation for reality to win over long-held dogmas.

  “10X” Change: Technology

  Technology changes all the time. Typewriters get better, cars get better, computers get better. Most of this change is gradual: Competitors deliver the next improvement, we respond, they respond in turn and so it goes. However, every once in a while, technology changes in a dramatic way. Something can be done that could not be done before, or something can be done “10X” better, faster or cheaper than it would have been done before.

  We’ll look at a few examples that are clear because they are in the past. But even as I write this, technological developments are brewing that are likely to bring changes of the same magnitude—or bigger—in the years ahead. Will digital entertainment replace movies as we know them? Will digital information replace newspapers and magazines? Will remote banking render conventional banks relics of the past? Will the wider availability of interconnected computers bring wholesale changes to the practice of medicine?

  To be sure, not all technological possibilities have a major impact. Electric cars haven’t, nor has commercial nuclear power generation. But some have and others will.

  Sound takes over silent movies

  “Something changed” when The Jazz Singer debuted on October 6, 1927. Movies didn’t used to have sound; now they did. With that single qualitative change, the lives of many stars and many directors of the silent movies were affected in a profound way. Some made the change, while some tried to adapt and failed. Others still clung to their old trade, simply adopting an attitude of denial in the face of a major environmental change and rationalizing their actions by questioning why anyone would want talking movies.

  As late as 1931, Charlie Chaplin was still fighting the move to sound. In an interview that year, he proclaimed, “I give the talkies six months more.” Chaplin’s powerful audience appeal and craftsmanship were such that he was able to make successful silent movies throughout the 1930s. However, even Charlie Chaplin couldn’t hold out forever. Chaplin finally surrendered to spoken dialogue with The Great Dictator in 1940.

  Others adjusted with great agility. Greta Garbo was a superstar of silent movies. With the advent of sound, in 1930 her studio introduced her to speaking roles in Anna Christie. Billboards proclaiming “Garbo speaks!” advertised the movie across the country. The movie was both a critical and a commercial success and Garbo went on to establish herself as a star of silent films who made a successful transition to talkies. What company would not be envious of getting through a strategic inflection point with such alacrity?

  Yet is this industry going to be equally successful in navigating another strategic inflection point that’s caused by the advent of digital technology, by which actors can be replaced by lifelike-looking, live-sounding digital creations? Pixar’s movie Toy Story is an example of what could be done in this fashion. It’s the first feature-length result of a new technology. What will this technology be able to do three years from now, five years from now, ten years from now? I suspect this technology will bring with it another strategic inflection point. It never ends.

  Upheaval in the shipping industry

  Technology transformed the worldwide shipping industry as dramatically and decisively as sound transformed the movie industry. In the span of a decade, a virtual instant in the history of shipping, the standardization of shipbuilding designs, the creation of refrigerated transport ships and, most importantly, the evolution of containerization—a technology that permitted the easy transfer of cargo on and off ships—introduced a “10X” change in the productivity of shipping, reversing an inexorably rising trend in costs. The situation was ripe for a technological breakthrough in the way ports handled cargo—and it came.

  As with the movie industry, some ports made the change, others tried but couldn’t, and many resolutely fought this trend. Consequently, the new technologies led to a worldwide reordering of shipping ports. As of the time of this writing, Singapore, its skyline filled with the silhouettes of modern port equipment, has emerged as a major shipping center in Southeast Asia and Seattle has become one of the foremost ports for containerized cargo ships on the West Coast. Without the room to accommodate modern equipment, New York City, once a major magnet for shipping, has been steadily losing money. Ports that didn’t adopt the new technologies have become candidates for redevelopment into shopping malls, recreation areas and waterfront apartment complexes.

  After each strategic inflection point, there are winners and there are losers. Whether a port won or lost clearly depended on how it responded to the “10X” forc
e in technology that engulfed it.

  The PC revolution: A tale of denial

  A fundamental rule in technology says that whatever can be done will be done. Consequently, once the PC brought a “10X” lower cost for a given performance, it was only a matter of time before its impact would spread through the entire computing world and transform it. This change didn’t happen from one day to the next. It came gradually, as the graph below indicates with price/performance trends.

  Computer Economics: Cost Per MIPS

  (a Measure of Computing Power)

  Based on Fully Configured System Prices for Current Year

  There were people in the industry who could surmise the appearance of this trend and who concluded that the price/performance characteristics of microprocessor-based PCs would win out in time. Some companies—NCR and Hewlett-Packard come to mind—modified their strategies to take advantage of the power of microprocessors. Other companies were in denial, much as Chaplin was with talkies.

  Denial took different forms. In 1984 the then head of Digital Equipment Corporation, the largest mini-computer maker at the time, sounding a lot like Chaplin, described PCs as “cheap, shortlived and not-very-accurate machines.” This attitude was especially ironic when you consider Digital’s past. Digital broke into the world of computers, then dominated by mainframes, in the 1960s with simply designed and inexpensive mini-computers, and grew to become a very large company with that strategy. Yet when they were faced with a new technological change in their environment, Digital—once the revolutionary that attacked the mainframe world—now resisted this change along with the incumbents of the mainframe era.