The Abductive Advantage - Part 5: Sustaining Equilibrium

The Design Thinking for Strategy (DTS) methodology is structured around three layers: first, setting the Foundation Layer by defining the strategic focus (e.g., Customers, Offerings, Capabilities, or Financials); second, iteratively developing the Business Model Layer by designing and validating a Detailed Business Model (DBM) that is Desirable, Feasible, and Viable (Posts 01-04); and finally, deploying the Competition Layer.

If the first two layers focus on answering the “what” and “how” of value creation from an absolute, firm-centric perspective, the Competition Layer forces a shift to a relative perspective. It asks a fundamental, existential question: How do we position our meticulously designed DBM in the competitive environment to ensure our advantage is not just temporary, but sustainable?

Business is often described as a high-stakes game. The competitive landscape is dynamic, filled with players whose actions and counteractions are not directly controlled by the firm. To succeed, a strategy must go beyond simply identifying competitive advantages; it must anticipate competitive reactions, ensuring the advantage can withstand direct assault.

This post explores the final, culminating stage of strategy design, the Competing Process (G). We demonstrate how frameworks like Porter’s Five Questions and the principles of game theory are leveraged to identify the firm’s competitive advantages and ensure they settle into a competitive equilibrium that rivals cannot afford to disrupt.

I. Defining the Competitive Edge: Differentiation vs. Superiority

Strategy development in the Competition Layer is about finding a position that provides a lasting competitive advantage. Competitive advantage is achieved through either cost leadership (often related to the Financials dimension) or differentiation.

The key challenge is answering two explicit, holistic questions: Why should a customer prefer the firm’s offering over that of its competitors? And, how will competitors react to this positioning?

This relative positioning falls into two primary categories: competing on differentiation/uniqueness or competing on superiority.

A. The Power of Uniqueness (Differentiation)

Differentiation, or uniqueness, means exhibiting traits in one or more DBM elements—related to the firm’s strategic focus—that no other competitor currently offers and that customers value.

• Customer perspective is paramount: Differentiation exists only if customers perceive it as such. If a feature is unique but customers do not see value in it, it provides no competitive advantage.
• Source of uniqueness: Uniqueness may stem from unique capabilities, unique technologies, patents, or specific access to resources.
• Hard to copy: Innovative firms typically compete through uniqueness because these traits are often hard to copy and preferred by customers over substitutes.

Case Application: Apple’s Ecosystem Differentiation

In its mobile device business, Apple emphasizes Offerings and Customers. Its competitive advantage is built on hard-to-copy uniqueness—specifically the integration of its hardware, software (iOS), and services ecosystem.

• Unique offering trait: The combination of Apple’s AirPod headphones and the Apple Watch provides a unique way to place phone calls without needing to physically retrieve the mobile phone.
• Customer value: This design directly addresses the customer job-to-be-done (JTBD) of answering phone calls in a hands-free and uncluttered environment.
• Competitive barrier: While competitors can replicate a mobile phone or wireless earbuds, replicating the seamless, proprietary integration and user experience (UX) across the entire ecosystem is virtually impossible without controlling the underlying capability (iOS development) and maintaining the strength of the brand (Customer Relationship). This combination makes the differentiation robust.

B. The Challenge of Superiority (Cost Leadership)

Superiority focuses on differentiating through the performance of DBM characteristics, rather than the characteristics themselves. A characteristic may not be unique, but it is executed better than competitors (e.g., superior product quality, faster service, or lowest price).

• Risk of imitation: Superiority characteristics are easier to copy than uniqueness. For example, offering a superior product quality is a typical superiority Value Proposition characteristic, but competitors can often raise their quality standards relatively quickly.
• The cost trade-off: Firms competing on superiority must find the optimal balance between the value delivered and the cost of achieving that superiority. Competing on price (cost leadership) is a typical superiority strategy, often found in strategies focusing on commodity offerings with little differentiation, such as discounter grocery stores (Aldi, Lidl).

C. Handling Indifference (Hygiene Factors)

Most DBM characteristics are categorized as indifferent or “hygiene factors.” These are necessary characteristics that satisfy customer jobs-to-be-done but do not influence the customer’s decision to choose one firm over another—and therefore do not warrant a premium price.

• Example: For a bank offering a checking account, the ability to withdraw cash is indifferent—it is required to satisfy the customer’s need for cash, but it does not contribute to the firm’s competitive positioning because all competitors offer it.

A strategic decision is required: which characteristics to compete on (uniqueness/superiority) and which to treat as indifferent (necessary but non-differentiating). Attempting to compete across too many dimensions leads to the “stuck in the middle” trap, diluting the firm’s competitive positioning.

II. Mapping the Battlefield: The Seven Key Players

Once a DBM prototype is finalized and its initial competitive advantages defined, the Competing Process (G) requires understanding the broader competitive landscape. Relying on the Value Net Framework, competitive analysis identifies seven categories of players whose actions may materially impact the success of the strategy.

1. Customers

Customers are perhaps the most important player. Their behavior defines the boundaries within which the firm feels valued.

• Value zone concept: Strategy designers must understand the customer’s value zone—the combination of price and features that keeps the customer from seeking out a different manufacturer. Competitive advantages must ensure the firm’s offerings remain securely within this zone.
• Customer Relationship (CR) element: The DBM’s Customer Relationship element is key to understanding the customer’s competitive sensitivity, including their willingness to switch suppliers based on price, quality, or support services.

2. Competitors

Competitors include those offering substitute products and services. Competitor reaction often follows the four DBM dimensions: improving quality (Offerings), reducing prices (Financials), increasing customer support (Customers), or improving efficiency (Capabilities).

• Case application (signaling): When Apple introduced Apple Pay in 2014, Samsung reacted swiftly in 2015 with Samsung Pay to avoid losing customers who valued the mobile payment functionality. This rapid response aimed to neutralize Apple’s new feature advantage.

3. Complementors

Complementors offer products or services that add value to customers only in conjunction with the firm’s offering. They create win-win situations, helping the firm enter a customer’s consideration set. However, they also introduce dependencies that must be monitored, as changes to a complementor’s offering can affect the value of the firm’s own products and services.

4. Suppliers

Key suppliers of raw materials or parts can introduce dependencies or possess significant bargaining power.

• Threat mitigation: To ensure the sustainability of competitive advantages reliant on suppliers, the firm must identify key suppliers and their bargaining power. This may require designing mitigation activities such as long-term price agreements, guaranteed quantity availability, or exclusivity deals.

5. Employees

Employees are pivotal, especially those performing differentiating activities (Key Activities Differentiation, KAD) or creating superiority. Strategy needs to identify and exploit this workforce advantage or design counter-measures mitigating potential negative impact from labor shortages or union actions.

6. Investors

Strategies requiring significant capital (e.g., to acquire new customers or finance production equipment) rely on investors. Having superior access to capital provides a competitive advantage. The key question is: Under what circumstances would investors switch their allegiance and invest in a competing firm?

7. Regulators

Regulators (governments, unions, etc.) ensure fair behavior and impose constraints. In highly regulated markets, strategies must address legal and regulatory requirements upfront. A competitive advantage can sometimes be built based on specific regulations or their unique interpretation.

III. The Strategic Calculus: Using Game Theory for Sustainability

The culmination of the strategy design process is ensuring the competitive advantage identified in the DBM is sustainable in the face of inevitable competitor reactions. Winning the competitive game requires being prepared and having thought-through scenarios for all major competitive threats.

This anticipatory step relies on game theory, which provides frameworks for studying competing strategy games and their impact on competitive actions. Game theory analysis is not about finding statistical proofs; it is a validation tool aimed at identifying potential flaws and preparing for competitive reactions.

DTS leverages two key game theoretical approaches: Equilibrium Theories (for differentiation) and Game Tree Theories (for superiority).

A. Competitive Equilibrium (The Nash Balance)

When firms compete primarily on differentiation (e.g., focusing on different customer segments or unique features), strategy designers look for a competitive equilibrium.

• Definition: An equilibrium state is a state where both the firm and its competitor are better off than any other alternative state. It assumes both firms operate rationally to maximize their utility.
• The rationale: If a firm can find a differentiated position—a segment, offering, or capability—where its competitor has no rational incentive to follow, they have found an equilibrium.

Case Application: Nespresso’s Patent Strategy (Switching Costs)

Nespresso’s entire initial strategy was predicated on creating a competitive equilibrium where the competitor had no option to enter the core market easily.

1. Differentiated offering: Nespresso sold not just coffee, but a complete system (machine + capsules). The Value Proposition included high-quality, portion-controlled coffee made easily at home (a high-value JTBD).
2. Competitive advantage (uniqueness): Nespresso gained a competitive advantage by patenting their coffee capsule design.
3. The equilibrium: The patent created massive switching costs for the customer and enormous entry barriers for competitors.
   • Customer: Once a customer bought a Nespresso machine (a Capital investment, KRC), the only viable consumables (Perishable Resources, KRP) were Nespresso capsules. This relationship (CR) was nurtured through their unique online club.
   • Competitor: Competing by offering an identical system was illegal due to intellectual property (KRC). Competing by offering superior coffee was costly and difficult to integrate with the installed machine base. Competing by offering a new, different system would require convincing customers to discard their existing machine and ecosystem—a costly move that competitors could not afford to execute widely.

The equilibrium was sustained for years until the patent expired, which forced Nespresso to proactively find new, hard-to-copy differentiators (e.g., brand strength, unique supply chain, club experience) to sustain its competitive positioning.

B. Game Trees (The Min-Max Approach)

Game tree theory, or the min-max approach, is used when modeling actions and reactions over time, especially when competing on superiority or price. Since superiority is easy to copy, the firm must be prepared for swift countermeasures, such as price wars or feature matching.

• Modeling: The game tree models sequential decisions by two or more players (e.g., reduce price, add features, do nothing). The tree maps out the value of each resultant state (“leaf”) based on the costs incurred and the market share gained/lost.
• Purpose: The game tree helps strategy designers think through multiple options and identify the optimal sequence of moves that minimizes their own losses while maximizing the competitor’s difficulty, assuming the competitor acts rationally to maximize its utility. This analysis dramatically reduces the risk of being caught by surprise when competitors react.

Case Application: Defending a Cost Leadership Strategy (Hardware Store AI)

In Post 04, we discussed the hardware store choosing a Financials strategic focus (cost superiority) by replacing human pre-sales staff with AI-driven kiosks. This relies on the assumption that AI kiosks (KRC) provide support quality accepted by customers (Desirability/Feasibility) at a cost low enough to maintain price leadership (Viability/FC).

A game tree analysis is required to validate the strategy’s sustainability against competitors:

This analysis confirms that the success of the AI kiosk strategy hinges less on the Feasibility of building the kiosk and more on the Desirability (customer acceptance of AI) and the Sustainability (the competitor’s inability to afford human staff if the firm maintains cost leadership). The game tree analysis proves the core strategy only works if the competition cannot afford (or chooses not) to offer superior human support at the firm’s price level.

IV. Designing for Competitive Barriers (Sustaining the Edge)

The ultimate goal of the Competition Layer is to design competitive advantages that competitors have little interest in copying or find too costly to imitate.

Competitive advantages should be few in number, well articulated, and distinct. They must be tied directly to one of the four components of the DBM based on the chosen strategic focus.

Case Application: Capability-Based Advantage (Nucor Steel)

Firms that excel along the Capabilities dimension typically rely on superior processes, resources, or unique combinations thereof, often aiming for Operational Excellence (superiority).

• Nucor’s competitive advantage: Nucor disrupted the American steel market by entering with a Capabilities-based strategic focus centered on implementing mini-mill processes.
• The barrier: Traditional steel producers relied on large, highly capitalized, integrated mills that were slow and costly (high Capital Resources, KRC). Nucor’s mini-mills required smaller, less expensive capital investment, leveraged scrap steel (a cheaper Perishable Resource, KRP), and employed a non-unionized, highly productive workforce (Labor Resources, KRL/Skill Resources, KRS).
• Sustainability: Competitors could not afford to copy Nucor because doing so required dismantling their existing, sunk-cost capital infrastructure and overcoming union resistance to adopt a completely new organizational structure and capabilities map. The competitive advantage was designed into Nucor’s value chain such that it was competitively superior, yet prohibitively expensive for rivals to replicate.

Case Application: Customer-Based Advantage (Research in Motion)

A strategy focused on Customers excels at understanding and meeting their explicit and implicit needs (Customer Intimacy).

• RIM’s strategic focus: In its early days, Research in Motion (RIM), the provider of BlackBerry phones, defined its competitive advantage by targeting business customers and their specific JTBD of secure communication.
• Differentiation: While competitors focused on providing consumer features (games, media), RIM tailored its Offerings (OPS) and Capabilities (KAD) around a unique, proprietary, and highly secure network delivery (CD).
• Sustainability: The competitive advantage was sustainable because competitors either did not value that customer segment or were unwilling to invest the immense capital and time required to build an equivalent, secure, global network capability (KRC, KRL, KRS). Their competitors were focused on buying on price rather than on specific security features.

Case Application: Financials-Based Advantage (Subscription Models)

A Financials-based advantage often involves managing costs (superiority) or unique pricing models (differentiation).

• Revenue stream innovation (FR): Moving away from one-off payments (e.g., selling a software license) to recurring subscription streams (e.g., SaaS) provides predictability and aligns the Financials element with the Customer Relationship (CR) element. This shift improves Viability by making revenues stable, and it creates a competitive advantage by aligning payment with the customer’s value perception.
• Price externalities: Strategies can be built around dealing with price externalities, such as negotiating exclusive agreements with suppliers of Perishable Resources (KRP).

V. Conclusion: The Competitive Equilibrium

In conclusion, the Competition Layer ensures that the ideal DBM is not just theoretically robust but strategically defensible. By utilizing frameworks like the Competitive Position Canvas, answering Porter’s Five Questions, and rigorously testing competitive dynamics through game theory, strategy designers can intentionally build competitive barriers—whether through unique patents, superior, hard-to-copy capabilities, or high customer switching costs—that force rivals to conclude that replicating the strategy is not a rational, financially viable, or achievable move.

This is the essence of designing for competitive equilibrium.

Summary

Series Conclusion

This five-part series has presented the Design Thinking for Strategy (DTS) methodology:

1. Part 1: The Strategy of Empathy—how Netflix disrupted Blockbuster through customer-centric observation
2. Part 2: From Whiteboard to Wallet—rapid prototyping and the 5-5-5 validation rule
3. Part 3: The Canvas and the Calculus—the Detailed Business Model as a system map
4. Part 4: Positioning for Equilibrium—managing strategic uncertainty through experiments
5. Part 5: Sustaining Equilibrium—game theory and competitive barriers

The abductive advantage belongs to firms that combine deep customer empathy with rigorous validation and strategic foresight. In a world of wicked problems and relentless change, this approach transforms strategy from a static document into a living, adaptive competitive weapon.