The Balance of Power

When orchestrating their portfolios of businesses and geographic market positions, many companies have tried, with only partial success, to develop a financial logic — transferring funds from cash generators to high-upside enterprises while divesting themselves of losing businesses. But many now recognize that these financial models do not capture the full opportunities for value creation and have looked for technological, marketing and operational synergies as well. But because such synergies are difficult to achieve, especially in complex businesses, still other companies have pursued a portfolio-building logic characterized by tight focus, leveraging a small set of competencies in a narrowly focused set of businesses to build economies of scale and market power. All these approaches, however, either ignore competitors or, at best, treat them lightly. A stick-to-your-knitting approach or a synergy-seeking strategy provides little insight into how a company’s geographic and product positioning can allow it to build power over rivals and to use this power to generate profits by dominating the competitive space.

There is a deeper logic to building strong portfolios than simply leveraging competencies or assembling related businesses, one that, while taking into consideration economies of scale and synergies, is based upon the overall strategic intent and competitive impact of a set of market positions. (See “About the Research.”) The sphere of influence is a concept borrowed from geopolitics1 and has been the subject of recent research in the management literature.2 It offers a framework for examining the strategic intent of the company’s portfolio3 and its implications for competitive strategy. A corporate sphere is a product and geographic portfolio with the power to influence where and how competitors fight within their competitive space.

Like nations, companies build spheres of influence that protect their cores, project their power outward to weaken rivals and prepare the way for future moves. In business, a well-constructed sphere of influence can maneuver competitors into a corner, reduce price wars through the business equivalent of “mutually assured destruction” and shape the industry to the players’ mutual advantage.

Designing a sphere requires assigning a role or strategic intent to each part of the portfolio. To be effective, the sphere must contain a secure power base — a core market — that can be used as a platform. In addition to core geographic and product markets, there are vital interests, buffer zones, pivotal zones and forward positions, each serving a specific strategic intent. There also are potentially important power vacuums that may lie just outside a sphere of influence.

The core of a sphere is the product or geographic market that is the basis of the company’s power because it generates the vast majority of its revenues and profits. Having a core competence is not enough to create a sphere of influence. It requires dominance over, and value leadership in, a core market.

Vital interests are geographic or product markets that provide the core with critical, often complementary, strengths that create economies of scope and integration. They also support or leverage core initiatives and competencies. These interests might be complementary products or businesses that provide resources such as know-how, raw materials or skilled labor. Vital interests supplement or enhance the power of a firm’s core.

Buffer zones provide insulation against attack by another player that might enter the core. They include blocking brands and products used to create barriers to entry. Buffer zones are expendable (unlike vital interests) because they make up a small percentage of a company’s revenues. If battles must be fought and territory lost, it’s better done in the buffer zone than in the core. Buffers protect the power inherent in a firm’s core.

Pivotal zones are market areas in which the future balance of power may reside. Taking a position in a pivotal zone is making a bet on the future, although not necessarily with a specific rival in mind. These zones develop possible sources of power in the future. Forward positions are offensive, front-line positions typically located near the vital interests or core of a specific identifiable competitor. They can be used to weaken the core of a rival, but they can also be used to create stability when each rival maintains a forward position in the other’s core. Forward positions counter the power of rival spheres of influence.

Power vacuums, while not actually part of a company’s portfolio, are parts of the competitive space that might not be controlled by any major player. These power vacuums are not yet pivotal zones, but it is important to be aware of and monitor them. Defining the role for each part of a company’s portfolio can force it to clarify its portfolio strategy, but a corporate sphere of influence is not just a platform for a company’s offensive or defensive maneuvers. It is the basis upon which a company advances its “grand strategy,” building market power over rivals so it can continue to maneuver freely without fear of retaliation. If well designed, a company’s sphere of influence can mold its rivals’ future geographic and product selections, fashioning for itself a favorable industry structure.

Assessing the Relative Power of Rival Spheres

Examining the spheres of influence of competitors can offer insights about the relative balance of power in an industry. Consider, for example, the dynamic between Toyota Motor Corp. and General Motors Corp. (See “Toyota vs. General Motors: The Relative Balance of Power.”) GM’s core is in the large-car and pickup truck categories in North America, but it has built strength in the small-car market to create a buffer against Japanese competitors. Toyota used its small-car core in Japan to enter that market in North America and then expanded its offerings to include larger cars, luxury cars and pickup trucks. Overall, Toyota has attacked General Motors’ core much more aggressively than GM has been able to attack Toyota (as indicated by the relative thickness of the arrows in the figure).

While the balance of power seems to be tipped in Toyota’s favor today, the future is much less certain. Both companies have established vital interests in Europe, although GM’s Opel division had a much longer lead in building its market there. In the long run, both companies’ positions in pivotal zones such as China may upset the balance of power in the automotive industry. General Motors has become No. 2 in China, while Toyota is not strongly positioned in that pivotal zone. Toyota also faces the challenge of aging demographics in its home market, which will decrease the demand for its cars in its profitable core. Meanwhile, in the United States, GM has experienced a resurgence due to its OnStar system, its favorable financing and its migration to the sport-utility vehicle market. Even though Toyota’s brand is entrenched among baby boomers, GM has introduced several luxury products that are recapturing that cohort as it ages and has simultaneously introduced a number of products targeting the youth market.

In addition to the strengths of companies’ cores and pivotal zones, the effectiveness of buffer zones and forward positions and the management of threats also affect the relative power of spheres. (See “Assessing the Power of Rival Spheres.”) Establishing a Stable Balance of Power Companies of equal size and power can establish a stable balance by taking opposing positions — balanced deep overlaps — that threaten the spheres of their rivals without aggressively attacking them.4 In effect, each has an arrow aimed at the heart of the other’s core, and this creates tacit cooperation. (See “Balanced Deep Overlaps Create Stability.”) In contrast, unbalanced overlaps, in which one company’s threat is stronger than the other’s, are less stable.

By 2003, for example, three players had divided the U.S. market for contact lenses. Industry leader Johnson & Johnson’s Vistakon division dominated the large, price-sensitive commodity segment, established as J&J’s core. CIBA Vision led in the much smaller market of cosmetic lenses that change the color of the user’s eyes. CooperVision Inc. dominated the small “toric” market for customers with astigmatism. CIBA Vision and Cooper- Vision avoided a direct all-out confrontation by locating their cores outside J&J’s. J&J maintained this favorable power position due in part to strong barriers to entry and first-mover advantages in the commodity segment.

J&J and CIBA Vision held footholds (forward positions) in each other’s cores, creating the potential to retaliate against each other, but the mutual threats were not equivalent, favoring J&J. This power imbalance allowed J&J to establish a vital interest in the higher-growth, more profitable multifocal market (equivalent to bifocals), which it now shared with CIBA, while still preventing CIBA from moving aggressively into its core. In addition, CooperVision’s core in toric lenses was inside one of CIBA’s vital interests, further weakening CIBA’s sphere and effectively making Cooper a tacit ally of J&J. But J&J’s favorable balance of power was soon to be disrupted.

Tipping the Balance of Power In 2003, Bausch & Lomb entered aggressively into the multifocal and toric markets, seizing 25% of new customers in each segment. (See “Bausch & Lomb Disrupts the Balance of Power.”) These moves threatened J&J’s and CIBA’s positions in the vital multifocal market and, even more critically, CooperVision’s vulnerable core in toric lenses. In the face of this new threat, CooperVision attacked outward into the cosmetic and commodity lens markets. CooperVision seized 23% of new customers in cosmetic lenses, threatening CIBA Vision’s core and further weakening CIBA’s sphere. Cooper also took 15% of new commodity customers, eroding J&J’s core with an innovative product that was higher priced but much better for night vision, comfort and dry eyes — especially important features for older users.

The overall impact of Bausch & Lomb’s moves and its rivals’ reactions was to destabilize the favorable balance of power once held by J&J. To avoid appearing weak and to rebalance its deteriorating power, CIBA Vision moved aggressively into J&J’s core with a new marketing campaign. J&J responded by launching new products in CIBA Vision’s core of cosmetic lenses. The result was that J&J and CIBA both lost share in their cores or vital interests, and a full-scale conflict broke out among the various players. The old spheres of influence and J&J’s favorable balance of power were disrupted as competitors worked to establish a new distribution of power in the industry.

This sort of disruption in the balance of power occurs when rivals’moves and countermoves create pressure on one another’s spheres. The “attacking sphere” — in this case, Bausch & Lomb — expands, while the sphere(s) under pressure reshape or contract. This can be thought of metaphorically as a “balloon theory” of power balance, in which the shape of a company’s sphere of influence is influenced by rivals around it,5 like a balloon being squeezed from the side. (See “Spheres Put Pressure on Each Other.”) Leading companies use this kind of pressure to protect turf, encourage cooperation or mold the evolutionary structure of the industry as the spheres of various rivals constantly seek to re-establish equilibrium.

Smaller players in a market also play a clear role in establishing or changing the balance of power. They can protect themselves by avoiding the cores of larger rivals (as CIBA and CooperVision initially did). They can act in tacit alliance with the industry leader (as Cooper eventually did). Or they can attack the cores of less powerful competitors (as Bausch & Lomb did), forcing those competitors to focus resources on each other rather than on the original aggressor.

Bausch and Lomb’s attack on the toric and multifocal segments was not accidental. Having lost an earlier bid in the commodity market, Bausch & Lomb knew Johnson & Johnson’s power. So Bausch & Lomb targeted the weaker spheres of CIBA and Cooper, which in turn provoked them to attack J&J. The ripple effects of these disruptions softened the ground for Bausch & Lomb’s expansion into the contact lens market by weakening all the players, in essence by using the power of others. However, this strategy was not without risk and might have provoked an aggressive reaction by J&J against Bausch & Lomb. Companies that wish to affect the balance of power while minimizing such potential backlash must clearly analyze all their potential targeting strategies.

Targeting Strategies The contact lens case illustrates that companies seeking to change the balance of power in their industries must consider the entire playing field when deciding where to exert competitive pressure against rivals. They have the option to build forward positions and buffers to address the player(s) with the weakest sphere(s), or they can target the sphere that represents the biggest or most disruptive threat, the ascending or fastest-growing sphere, or the sphere located in the most attractive markets. Companies must also consider geography and the use of alliances. For example, a company may align with other strong players to target a single major global player, pursuing the attack in multiple geographic markets from multiple directions. Conversely, a company with a strong sphere can sometimes target different competitors in each geographic market. Each of these strategies, or combinations of strategies, presents different challenges.

In the global automotive industry, for example, General Motors has several options. It could pursue a global strategy, targeting the weakest of the four major companies, Daimler- Chrysler, or taking on the strongest player, Toyota, in the manner discussed above. Or GM could employ a multiregional strategy, targeting its strongest rival on each continent (Ford in North America, DaimlerChrysler in Europe and Toyota in Asia).

Each targeting strategy would create a different industry structure with a very different balance of power. Successful global targeting of the weakest player, DaimlerChrysler, would leave GM in a world with two major rivals, Ford Motor Co. and Toyota. However, this would not help GM secure its U.S. core against Ford unless GM captured the majority of Chrysler’s U.S. customers. Targeting Toyota, the strongest player, would risk severe retaliation and still would leave GM with a strong rival, Ford, in its U.S. core. On the other hand, multiregional targeting against the strongest player on each continent would leave GM facing three weakened spheres, improving its overall power. However, this strategy would take a lot of available resources or require allies on each continent to attack the targeted player from multiple directions. Otherwise, GM could overstretch its resources and lose power in the long run.

Balancing Ambitions, Resources and Threats

As the contact lens and automotive cases show, managing a sphere of influence requires a delicate balance of competing pressures both within and outside the organization.Managers must consider the impact of their chosen targeting strategies on the resources needed to pursue the company’s geographic and product ambitions, while managing the existing and newly resulting threats.

The grand strategy of the company must preserve its market power. If the core’s ability to generate resources is not protected or if existing or newly provoked threats are too many or too great, the company’s sphere of influence will be vulnerable to attack or its ambitions stunted. Resources must be conserved or generated and threats managed so that ambitions can be maximized. On the other hand, if resources are limited or threats swell, ambitions must be reduced to fit the constraints before the company’s resources are depleted. When ambitions for wider market and geographic scope outstrip resources, it leads to overstretch.

Limiting Ambitions To Avoid Overstretch In expanding its sphere of influence, the British Empire tried to manage colonies in India and Africa, eventually spreading its resources too thinly to maintain its power, especially in light of its need to fight two world wars in Europe. Historian Paul Kennedy called this “imperial overstretch.”6 Corporate spheres are vulnerable to this as well. For example, Motorola Inc. focused on leveraging its capabilities in radio-frequency technology and computer chips into a wide variety of markets: wireless handsets, wireless telecom infrastructure, emergency radios, set-top boxes for cable TV, automotive applications and military equipment. As a result, the company was spread too thinly to have an identifiable core and keep technological leadership in that core. It did not develop defensive positions to protect a core market in the United States, nor did it develop forward positions to attack Nokia Corp. in Europe. Furthermore, it failed to adequately invest in pivotal zones in Asia. Many parts of Motorola’s portfolio served no purpose in staking out a defensible segment of the industry, and its lack of clarity about the strategic purpose of each part of the portfolio led to its loss of industry leadership. Consequently,Motorola lost its power over the cellular industry.

Major mergers such as that of America Online Inc. and Time Warner Inc. often create conditions that are ripe for overstretch. In these kinds of scenarios, ambitions are great and often quickly outstrip resources. Further, they instantly create expanded product or geographic scope that offers more exposed fronts that rivals can attack.

In most cases, the first purpose of a sphere of influence is to protect and preserve the power of its core.While a company must maintain buffer zones, forward positions and pivotal zones, it must be prudent about its ambitions for growth outside the core. There is no general rule about what percentage of a portfolio should comprise core and vital interests versus more peripheral interests. The best guideline is to reinvest as much as is needed to maintain value leadership in the core market unless there is a strong and explicit reason to migrate the core to a new position. Only after this first purpose is achieved can a firm think about using its power to weaken the power of rival spheres.

Some companies overstretch by trying to manage too many cores at once. Only companies with very exceptional management teams and very deep pockets have successfully managed multicore spheres. General Electric Co., for instance, has three cores — electrical equipment, plastics and financial services. With the acquisition of Vivendi Universal Entertainment (in May 2004) to complement its ownership of NBC, creating NBC Universal, GE added a fourth core in media. However, almost no other company has been successful with such a model in the long run. PepsiCo Inc., for example, attempted to manage the dual cores of beverages and fast-food restaurants but was forced to divest itself of the fastfood business because it was draining the resources of the beverage business, hurting Pepsi’s ability to grow its sphere internationally.

On the other hand, having dual cores is helpful, even necessary, during a transition phase from one core to another, such as when IBM Corp. migrated from hardware (personal computers and mainframes) to computer outsourcing services and associated software and consulting. However, the transition must be explicit and fast to be successful. Otherwise, the old core lingers in a slow death and the new one never gets built adequately, leaving the company confused about what core to build its sphere around.

Conserving Resources Using Alliances Although the British Empire and other European powers found themselves overstretched in the age of colonial expansion, the United States depended much more on treaties and alliances than military force during the Cold War, conserving its resources while spreading its influence around the globe. Similarly, businesses have been able to use alliances to extend their spheres of influence, while conserving resources. Alliance partners can serve a variety of purposes. (See “Use Alliances To Fill Gaps in Your Sphere.”) They can serve as surrogate attackers to move into a rival’s core or can offer passive support by not coming to a rival’s defense. They can provide critical support by supplying resources or can protect flanks to shore up exposed weaknesses.

A powerful ally can even provide the protection of a strategic umbrella. Alliance with Intel Corp., for example, provided Microsoft Corp. with shelter from IBM’s potentially withering competition until the growing software company was eventually powerful enough in its own right to vie for industry dominance.

Conserving resources is vital for small players but also can be valuable for larger players who need to devote resources to other battles. Companies often eliminate or reduce a threat on one front in order to concentrate resources on another. For example, faced with a threat to its core from Linux-based, open-source software and a battle with consumerelectronics makers for the new home server market, Microsoft decided to settle its lawsuit with AOL/Netscape Communications and make it easier to use AOL software with Windows. By making peace with AOL, Microsoft freed resources for taking a forward position such as with its Xbox gaming system or a pivotal, perhaps core-building, position with its “Longhorn” operating system, which moves away from the desktop analogy and creates a faster and more seamless interface for users.

Although they conserve resources, alliances can have negative impacts.When it enters into an alliance, a company constrains its ambitions by agreeing not to attack that partner or move in ways that would negatively affect its ally. But allies sometimes use the relationship to rise to power and pose their own threat.

Managing Threats There are many ways to deal with the threats posed by rivals — or even allies — without the head-on battle that requires a great deal of resources or excessive investment in buffer zones and forward positions. Threat management can be achieved in four ways: elimination, selection, influence and avoidance.

Threat elimination can be achieved by cultivating balanced deep overlaps that create mutual deterrence without requiring significant resources for a direct confrontation. Or threats can be absorbed through merger or acquisition. For example, the Regional Bell operating companies have acquired or merged with companies that have threatening technologies or market positions. The creation of Verizon Communications, the merger of two East Coast Bell companies (NYNEX and Bell Atlantic) and GTE, prevented a conflict among the three companies over wireless services on the East Coast. This threat absorption allowed the newly consolidated local telephone and wireless service provider to focus on competing with the long-distance players that were poised to enter local telephone markets.

Threat selection by market or by competitor narrows a sphere’s competitive focus, thereby requiring fewer resources for defense. Ironically, focusing on fewer markets (rather than fighting on a wide range of fronts) can spur growth and further ambitions to enhance a sphere’s size and power. Nokia, for example, was involved in industries ranging from paper to chemicals and rubber before it streamlined its business in the 1990s to focus on one highgrowth core of wireless handheld devices. It divested itself of businesses that accounted for two-thirds of its revenues to concentrate all of its attention and resources on manufacturing mobile cellular phones and related telecommunications equipment. The company’s revenues grew at a compound annual rate of more than 20% from 1992 to 1996, rising from $3.5 billion to $8.5 billion, with almost all the revenues coming from its narrowed scope.

Threat influence can be employed when it isn’t possible for a company to pick its battles. Sometimes rivals select a company as a target for attack.When this is the case, it is possible to use rewards and signals to influence the threatening party to constrain the intensity of its attack. Perhaps the easiest way to co-opt a competitor is to form an alliance with that company, implicitly constraining that rival’s willingness to use price wars in its ally’s sphere. This method, however, can sometimes cross the line into collusion. Because price wars can be devastating to all participants, players sometimes voluntarily regulate their own behavior as a signal to stop the escalation. For example, companies can signal by offering to (1) match any and all price cuts, (2) provide everyday low pricing or (3) reveal the size of their own cost advantage (if one exists) so that the aggressor will realize the potential cost of its tactic and back off. Allies — especially tacit ones that share a common enemy — can influence threats. When several companies attack a threatening rival on its flanks, it will be distracted and its resources will be diverted toward different markets

Threat avoidance may be the only viable strategy when the threatening player can’t be influenced because it is too big or too committed to its attack. In other words: When all else fails, run. General Electric provides an example of a company that migrated its core with great success. GE shifted into financial services and plastics, abandoning many electric-product markets, including consumer electronics, small home appliances, computers and computer chips. Nevertheless, the company is one of the U.S. stock market’s top performers with the majority of its profit growth today coming from financial services. General Electric is one of only a few Fortune 100 companies that would have been on the Fortune 100 list at both the beginning and the end of the 20th century if there had been such a list in 1900. Yet the company’s core migrated so much that its founder, Thomas Edison, would likely have been shocked to find that his company is no longer “generally” electric or maybe not even “electric” at all in its core interests.

The choice among the four threat-management strategies depends upon the cause and location of the threat to be faced. (See “Assessing the Threat Level Facing a Sphere.”) And, of course, combinations of the four can be used in complex or dire situations.When there are a number of threatening competitors in a given market, threat elimination is best. When there are a number of markets under threat in one sphere and resources are spread thin, threat selection is called for. When one competitor is intensely aggressive, threat influence is preferred. And when the core market is under siege on a number of fronts or simply weakening, threat avoidance is best and migration of the core may be desirable.

Core Migration Core migration strategies to avoid threats, such as was used by General Electric, can take different forms. Sometimes the old core is abandoned completely. The Williams Companies Inc., for example, which operated a nationwide gas distribution network, completely avoided the threats from bigger and better gas pipelines by remaking its business and creatively redeploying its assets. Williams decided to run fiber-optic cable through its obsolete gas pipelines, creating the fourth largest fiber-optic network in the United States for about half the cost of constructing a network from scratch. It even converted its old gas pumping stations into fiber-optic amplification stations. Other times, the old core is not immediately abandoned but de-emphasized to make way for a new one.As Morton International Inc. (as it is now known) watched revenues from its core salt business trickle away due to intense threats from rivals, the company chose to look for ways to shift into higher-growth areas. Its merger with Thiokol Corp. in 1982 gave it a platform for growth by applying propulsion technology to manufacturing automotive airbags. With the imposition of new safety standards in the United States mandating the use of airbags, Thiokol’s airbag-related revenues took off. By the mid-1990s, Morton’s revenues surpassed $1 billion, with more than 40% coming from airbags and only 20% from salt. Although this migration was successful, slow or partial transitions often fail because they drain resources and create confusion about the company’s strategic intent.

Some companies even avoid threats by shifting their cores several times to create new growth platforms. With the mass production of penicillin, Pfizer Inc. migrated its core from bulk chemicals in the early 1900s to antibiotics in the 1940s. By the 1960s, it had developed a broad range of antibiotics. It then migrated its profit base to cardiovascular drugs in the 1970s and 1980s, along with anti-inflammatory medications such as Feldene. In the 1990s, it continued to expand in this area, but it also added a major new profit base of antidepressants such as Zoloft and opened the market for new lifestyle-enhancing drugs such as Viagra.

The core is at the center of the sphere of influence. While migrating the core should not be undertaken lightly, it is often necessary. Managers need to look carefully at the competitive price of holding onto a core. (See “Reality Check — Is the Power of Your Sphere Declining?”) Are revolutionary rivals fighting fiercely for this core, and are they better positioned to win? Is the core market growing or declining due to changes in the customer base or its tastes? Are there other opportunities that offer ways to leverage the company’s strengths in its core in new directions? Although migrating or transforming the core requires rethinking the entire sphere of influence and can mean abandoning hard-won market positions, it can sometimes be the best course of action.

IN THE FINAL ANALYSIS, the conglomerate model of holding loosely connected portfolios of businesses isn’t the best use of capital because it fails to capture synergies. On the other hand, portfolios that are too tightly focused often leave the company vulnerable to external shocks and attacks. Like ecological systems without sufficient diversity, these focused businesses can become inflexible and susceptible to shifts in the environment. The sphere of influence provides a framework to consider a deeper logic for a company’s portfolio that goes beyond the complexity of financially linked conglomerates or the simplicity of a narrow focus. The synergies that are identified through the sphere of influence are not merely financial or operational but are strategic and related to the underlying intent of each part of the portfolio and how they collectively create market power over rivals.