Saturday, August 20, 2011

Porter’s Theory of Market Signaling: Relevant in Contemporary Times?

Michael Porter in his work on Competitive Strategy (1980) proposes that reading of market signals be considered an essential supplement to competitor analysis and an important adjunct to making effective competitive moves. According to Porter, a market signal is any action by a competitor that provides a direct or indirect indication of its intentions, motives, goals, or internal situation. Porter accords major emphasis to market signals despite the recognition that some are bluffs, some are warnings, and some are earnest commitments to a course of action. Porter recognizes the opposite view that given the subtlety of interpreting market signals, too much attention to them can be a counterproductive distraction. Despite this feature, Porter considers that timely recognizing and accurately reading market signals is of significance to developing competitive strategy. However, like all of Porter’s theories that have been crystallized in 1980 based on research works of the 1950s to 1970s, the theory of market signaling also needs considerable refurbishing to suit contemporary business times.

Contemporary business times are marked by a massive growth of information in public domain due partly to regulatory disclosure requirements, dissemination to meet the needs of investors and analysts, information requirements of stock exchanges, governance responsibilities especially of listed companies and competitive requirements of market making. This coupled with the growth of the Internet, Search Engines and Networking Sites, information sets on thoughts, strategies and execution of corporations are now more abundantly available than ever. Corporations are both mandatorily required and voluntarily eager to disclose as much information on their strategies and results as possible. This relative transparency is also aided by the fact that protection of intellectual property is now global, providing better protection to corporations for their pre-announced product and technology moves. The massive upsurge in information also exponentially enhances the load on corporate strategy departments should they start collecting, and reading all market signals diligently. The positioning of market signals in strategy formulation clearly needs a revision.
Forms of market signals
According to Porter, market signals come in varied forms such as prior announcement of moves, announcements of results, announcement of actions after the fact, public discussions of the industry and the firm by the firms, announcement by competitors on their competitive positioning and moves, discussion on tactics that could have been pursued, early implementation actions, comparisons of results and goals, cross-parry  in related or unrelated areas, fighting brands and legal actions, including public and private antitrust suits. Amongst these, prior announcement of moves by a competitor is the most versatile form of market signaling. The purposes include capacity preemption, entry deterrence, threat of competitive response, setting or resetting industry-government equilibrium, test of competitor sentiment, red herrings of strategic deflection, subtle or open brand building in the marketplace, image building amongst stake holders. Today, several forums are available to send such market signals, from routine stock exchange notifications to exclusive media events.
Annual reports of the firms and quarterly earnings reports as well as the analyst and investor calls constitute the other important source of market signals, often mandated by stringent regulatory and investor requirements. Indian regulations have always had certain unique additional disclosure requirements regarding capacity, production, imports, exports, R&D, energy consumption, technology imports and assimilation which provide valuable signals. India, in addition, now requires comprehensive management discussion and analysis of plans and results with additional information on risk management and internal controls, in the annual reports. As firms access global markets for funds through bonds or depository receipts, comprehensive prospectuses would need to be prepared with detailed treatment of all aspects of the firm. Disclosures on environment, safety and health aspects as well as corporate social responsibility provide additional insights.  
Customer facing information undoubtedly provides the most tangible and relevant source of signal information for firms. Increasingly, firms are choosing major international conferences to showcase their developmental plans and results. In addition, the concept of regular upgrading of models and technologies, occurring in as short timeframes as six months, is now commonplace. Technologies are openly discussed and debated as well as tested and evaluated by specialist agencies. Certification processes by industry technology bodies prior to product nomenclature provide additional valuable information. Examples are ISO certification, OSHA certification, FDA certification, energy certification, Leed certification, TCO certification, CCF certification and SPC certification, and so on. These certifications are not merely product specific or plant specific but also reflective of an underlying or developing technological strength of a firm. To summarize, sources of market signals are more varied and more open than ever. The simple recognition and reading theories suggested by Porter on market signaling need to be significantly recast.
Volatility and signaling
The theory of market signaling is further vitiated by the unprecedented volatility in global economic conditions. Typically, tactics requires a one year timeline and strategy requires a three to five year timeframe for effective execution. The economic developments that take place in today’s globalized world are so profound that market signals, however, well intentioned and robustly founded, are ceasing to be any firm indicators of a durable or sustainable strategy of a corporation. It is for example, becoming impossible to predict with any degree of certainty the prices of crude, metals, commodities and agricultural products. Wild swings in the prices of basic inputs severely impact strategies that are built around such basic inputs. Market signals from industries affected by such globally volatile trends are not appropriate for any competitive analysis.
Volatility often brings in a herd behavior, which overarches the need for study of individual competitive market signals and development of individual competitive moves. Economic volatility at times has a contagion effect on social attitudes and behavior. For example, when incomes are threatened due to inflation in a recessionary environment, individuals drive up demand for precious metals through hoarding rather than prudentially conserve cash. In the process, they ignore the illiquidity they are creating in their households or the potential losses they could sustain when prices soften in future. Irrational mass behavior could extend to evolved corporations as well.  For example, when recession is severe, all companies tend to be equally severe on cutting costs, including operational and futuristic expenses. Companies thus lose the equanimity to reassess their strategy based on their reordered internal strengths and weaknesses, and external opportunities and risks. Ability to read individual market signals differently from overarching economic trends is increasingly becoming a new age requirement.
Public discussions and private inferences
Reference has been made in Porter’s work as well as in this blog post about public discussions of the industry as well as firm level developments in industry forums as well as conferences. The ability of the industry level public discussions to lead to meaningful market signaling has always been in doubt. Recent volatility in economic and political conditions has been further forcing public discussions into a format of herd behavior. Public discussions, more often than not, serve as industry signals for public policy formulation rather than for individual corporate strategy formulation. The strength of public discussions is often dependent on the extent to which the various stake holders, including the governments and firms, are willing to share their experiences and perspectives in common industry forums.
The process of market signaling through public discussions is complicated by the fact that private inferences could be quite different from public postures. In an era of escalating fuel prices, an automobile manufacturer of a full line of automobiles, from small fuel-efficient budget cars to large gas-guzzling luxury cars, may be as vociferous as a dedicated luxury car maker in decrying the adverse impact of galloping fuel prices. In reality, the full line manufacturer could privately been planning a major shift in product mix in favor of fuel-efficient cars. Similarly, public assurances of individual firms providing pan-industry services need to be reinterpreted based on their strategic moves. The acquisition by Google, which supplies open source operating system Android to all mobile device makers, of Motorola’s mobile device business configures a new, possibly adverse, strategic dimension for all Android users, notwithstanding public assurances of continuity of Android support. The views expressed by individual firms in public forums need to be interpreted in terms of technical and business characteristics of firms that express such opinions.   
Signals versus strategies
It is not that market signals by themselves lead to major competitive moves. Often companies conduct futile searches for signals when strategies stare at them in all openness. No mobile device maker, for example, took seriously the move by Samsung to develop its own operating system Bada to power a particular genre of its mobile devices. The move by Samsung was not a veiled signal; it was a clear strategy. In today’s context of Google turning a mobile device maker with the acquisition of Motorola Mobility other device makers must surely be wondering how they ignored a clear strategy from Samsung despite the strong signal it notified. The strategy of Nokia plumping for Microsoft Windows mobile operating system could be more than a signal; it could be an indicator of a clear strategy of amalgamation or acquisition. Oftentimes, therefore, by recognizing open strategies of competitors for their intrinsic competitive position, individual firms can derive a better understanding of the competitive landscape than a ‘needle in the haystack’ type of search for weak or confusing market signals.  
This is not to say that signals have no relevance once the strategy of a competitor becomes visible. On the other hand, signals amplify the strategy for a better understanding. For example, the levels of capital commitment, manpower recruitment, product renewal, technology choices, infrastructure development and pricing competitiveness could all signify the vigor with which the strategy could be pursued. Lack of overt signals cannot, however, be taken to mean that the company has no commitment to the articulated strategy. Many times, signals also reflect a recalibration of strategy to be more successful relative to experience. For example, the sale by Reliance of fifty percent stake in its oil and gas reservoirs to BP does not indicate a reversal of strategic commitment to oil and gas business; rather it recognizes the need to be more realistic in terms of resource and technology commitments for the stability and growth of that particular risky business as well as the conglomerate corporation in the overall.
Surety from subtlety
Given the emanation of market signals from multiple as well as newer and more varied sources in the contemporary business, the increased environmental volatility that dictates the fluctuating amplitude of signals, and the convergence between signals and strategies, there is a great need for subtlety in the theory of market signaling for the contemporary times. Subtlety in signaling theory enables greater surety in assessment. Subtlety arises from the adoption of a three step process: first, focusing on the strategy rather than the signals to start with; second, evaluating the strategy in terms of the external volatility and internal competencies; and third, utilizing the signals to calibrate the strength of the strategy. As opposed to the scenario decades ago, it is no longer feasible or appropriate for firms to provide random signals without a well developed strategy. Issues of materiality and corporate governance in public disclosures rule out intentional signal aberration.
Surety also emerges from the subtlety in the analysis of strategies and signals. For example, the kind of leader a firm selects to lead a new business provides a subtle but sure sign of its commitment to gaining leadership in the new business. The type of consulting organization a firm selects to chart a new growth strategy provides indicators of the firm’s commitment to develop a high quality growth paradigm. Continuance of key growth investments, say in R&D and manpower, in times of recession provide solid evidence of a firm’s desire to up the ante in the post-recession period. The technological sophistication of equipment in new projects underscores a firm’s focus on quality by design. The nature of structural changes in the organization and the pace of executive mobility in an organization reflect the firm’s willingness to be adaptive and flexible. The insights that are developed out of the recommended three step process of strategy-signal analysis would be much more useful than a vanilla reading of traditional signals recommended by Porter in his 1980 work.
Innocuous signals and incredible strategie
Many times seemingly innocuous signals are harbingers of resolutely incredible strategies. The exit of the chief executive of Google from the board of directors of Apple was a clear indicator of the strategy of Google to enter the cellular communication space, fortified further by its acquisition of the Android entity. Similarly, the company’s strategy to make a Google phone Nexus was also indicative of the desire to enter the mobile device space, now finally established in no uncertain manner by the acquisition of Motorola’s mobile device business. Strategists must brood on seemingly innocuous signals for their strategic intent. Samsung’s recent entry into the biologics business is both a confusing signal and a measured strategy. It probably needs more than hard analytics to identify which one-off signals are clear indicators of incipient moves that are backed by immaculate strategies.
Start-up companies which are hardly noticed by the general industry represent another great example of weak signals turning into strong movements. Most times, the major firms are so preoccupied with the analysis of their peers that they fail to notice the major shifts in the industrial structure that could take place with the pioneering technologies and businesses that the start-ups pursue. Whether one of the application developers in the mobile space, say Angry Birds, would be the future behemoth of the digital media industry only time will tell. May be a day could even come when Apple, Google and Microsoft regret the missed opportunity of developing their own applications divisions, and make up for the missed opportunity by making expensive acquisitions. Reading subtle signals which are actually sound strategies is an intuitive flair as much as an analytical skill!
Posted by Dr CB Rao on August 21, 2011  




Robin Stacpoole said...

I've looked at a couple of your blogs. I think that both your ideas and subject are really good. But, I never get to the end of your articles, I do not have enough time, they do not come to the point quickly enough, although they are very well written. Just a suggestion, but after you have written them, how about including a one paragraph summary and working hard to cut the rest of the article down by 50%? Feel free to ignore, after all you have your own objectives, I'm just sharing impressions

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