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Most often, when reading about strategy, sustainable competitive advantage is touted as the key to success. It’s the essence of highly profitable businesses.

This weekend, I came across a discussion of Sustainable Competitive Disadvantage, a concept which ties into Christensen’s classic, Innovator’s Dilemma. The best way to illustrate this concept is to use an example from George Day’s Wharton on Dynamic Competitive Strategy.

HSBC vs. Citibank

Hong Kong Shanghai Banking Corporation (HBC) has about 75% market share of retail banking in Shanghai. Everyone uses HSBC for checking and savings. Like most businesses’ customer bases, the top 20% of HSBC clients generate 80% of the profits and the bottom 20% generate significant losses. Nevertheless, HSBC charges all customers equally, in a practice called average costing.

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Citibank (C), looking to enter the market in Shanghai, releases a product that better suits the needs of the top 20% of HSBC clients. They do this by first understanding the needs of the customer base. Additionally, Citibank develops a product keeping in mind the relatively larger profit margins of this user base. In this way, Citibank is able to siphon a portion of HSBC’s most profitable customers.

Rook to e1….Check!

To respond, HSBC has three potential responses, none appealing:

1.       Raise prices on all existing customers to boost profitability. This leads to additional customer attrition and is self-defeating.

2.       Move to differential pricing for each customer groups (cream, middle, bottom). Moving to differentiated pricing would serve the cream equally well as Citibank. But may cause strong backlash from less profitable customers and might be blocked by public outcry, social policy and bad PR. Imagine if Bank of America decided to charge a certain set of customers more to provide the same services as others.

3.       Develop new technologies to increase the profitability of existing customers. This takes time and has some intrinsic risk. In the meanwhile, Citibank is eating HSBC’s lunch.

4.       Lobby for regulation preventing such innovation.

To combat this effectively, HSBC must anticipate such industry changes. Anticipating these changes, however, tends to be difficult for large corporations.

Opportunity to attack your opponent’s inherent disadvantage

Understanding existing customer bases, particularly the needs of highly profitable customers of large incumbents and serving their needs better, is a strong way to enter a market.

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