What Is the First Mover Advantage?
How Does the First Mover Advantage Help My Startup?
In marketing strategy, first-mover advantage (FMA) is the advantage gained by the initial ("first-moving") significant occupant of a market segment. First-mover advantage may be gained by technological leadership, or early purchase of resources.
A market participant has first-mover advantage if it is the first entrant and gains a competitive advantage through control of resources. With this advantage, first-movers can be rewarded with huge profit margins and a monopoly-like status.
Not all first-movers are rewarded. If the first-mover does not capitalize on its advantage, its "first-mover disadvantages" leave opportunity for new entrants to enter the market and compete more effectively and efficiently than the first-movers; such firms have "second-mover advantage."
The three primary sources of first-mover advantages are technological leadership, preemption of scarce assets, and switching costs / buyer choice under uncertainty.
The first of the three is technological leadership. A firm can gain FMA when it has had a unique breakthrough in its research and development (R&D).
A new, innovative technology can provide sustainable cost advantage for the early entrant; if the technology, and the learning curve to acquire it, can be kept proprietary, and the firm can maintain leadership in market share.
The diffusion of innovation can diminish the first-mover advantages over time, through workforce mobility, publication of research, informal technical communication, reverse engineering, and plant tours. Technological pioneers can protect their R&D through patents.
However, in most industries, patents confer only weak protection, are easy to invent around, or have transitory value given the pace of technological change. With their short life-cycles, patent-races can actually prove to be the downfall of a slower moving first-mover firm.
Examples of technological leadership
In a 1981 paper Michael Spence discusses how the technological learning curve can be kept proprietary, making for a huge barrier to entry on the part of others. Although the starters in a FMA market have complete control for a period of time, the competition still remains, trying to chase the originators.
Spence states that firms trying to emerge as first-movers will usually sell their products below cost in an effort to understand the market better (i.e. gain intelligence); and then, once established, turn the market around and control the market's cost.
Though Spence states that this sort of competition reduces profitability, most of the time it is needed to break into the new markets.
Papers by Gilbert and Newbery (1982) and Reinganum (1983) illustrate what happens if a first-mover firm, or close followers, were to assume what each other's R&D departments are doing. This can result in the second- or third-movers surpassing the leaders because they are out-thinking their competition.
Procter & Gamble is an example where a company's technology leadership helped propel their product (disposable diapers) into the US market. They used a learning-based preemption to help invest in low-priced European synthetic fiber, which helped keep costs down, and allowed for selling the diapers profitably at a cheaper price.
Physical aspects of FMA are not the only way certain firms acquire this advantage. Managerial systems that help the organizational and behavior aspects of the company may prove to be highly beneficial to emerging companies.
When a firm's management style is unlike any other, and grasps certain concepts of management and the economy that other firms do not, then they will benefit (e.g. American Tobacco, Campbell Soup, Quaker Oats, Procter & Gamble, Toyota).
Preemption of scarce assets
If the first-mover firm has superior information, it may be able to purchase assets at market prices below those that will prevail later in the evolution of the market. In many markets there is room for only a limited number of profitable firms; the first-mover can often select the most attractive niches and may be able to take strategic actions that limit the amount of space available for subsequent entrants.
First-movers can establish positions in geographic or product space such that latecomers find it unprofitable to occupy the interstices. Entry is repelled through the threat of price warfare, which is more intense when firms are positioned more closely. Incumbent commitment is provided through sunk investment cost.
When economies of scale are large, first-mover advantages are typically enhanced. The enlarged capacity of the incumbent serves as a commitment to maintain greater output following entry, with the threat of price cuts against late entrants.
Examples of preemption of scarce assets
Main (1955) provides an example of preemption of input factors achieved by controlling natural resources. He states that the concentration of high-grade nickel in a single geographic area made it possible for the first company in the region to gain almost all of the supply.
It has since controlled a vast proportion of the world’s production and distribution of the product.
For the preemption of locations in geographic space, a theory developed by Prescott and Visscher (1977) and others states that the first-mover has a huge advantage in claiming a certain geographic area so long as that area provides the firm with all the resources it needs to thrive.
If said area can be claimed and then made to flourish, then the cost of entry to other firms would be too great. When a firm establishes itself on a certain plot of land, it can gain full control of the market incorporated within that land, thereby holding on to that power for a long period of time.
Preemption of investment in plant and equipment can prove to be another advantage for the first-mover. Schmalensee (1981) says that when scale economies are large, FMA is usually larger and more profitable, sometimes enabling a monopoly position.
He then states that advantages also arise from scale economies which provide only minor entry barriers, but also immense opportunities for future growth, development, and profit.
Switching costs and buyer choice under uncertainty
Switching costs are extra resources that late entrants must invest in order to attract customers away from the first-mover firm. Buyers may rationally stick with the first brand they encounter that performs the job satisfactorily. If the pioneer is able to achieve significant consumer trial, it can define the attributes that are perceived as important within a product category.
For individual customers the benefits of finding a superior brand are seldom great enough to justify the additional search costs that must be incurred. Switching costs for corporate buyers can be more readily justified because they purchase in larger amounts.
Switching costs play a huge role in where, what, and why consumers buy what they buy. Over time, users grow accustomed to a certain product and its functions, as well as the company that produces the products. Once consumers are comfortable and set in their ways, they apply a certain cost, which is usually fairly steep, to switching to other similar products.
Examples of switching costs
A switching cost where the seller actually creates the cost is described in Klemperer (1986). For instance, in the case of airline frequent-flyer miles programs, many consumers find it important that an airline provides this service; and they are actually willing to pay more for an airfare ticket if it means they will earn points towards their next flight.
Buyer choice under uncertainty has developed into an advantage for first-movers, who realize that by getting their brand name known quickly through advertisements, flashy displays, and possible discounts, and by getting people to try their products and becoming satisfied customers, brand loyalty will develop.
A study by Ries and Trout (1986) showed that newcomers that emerged into the market as far back as 1923 were still at the top of their specific markets almost seven decades later.
Although being a first-mover can create an overwhelming advantage, in some cases products that are first to market do not succeed. These products are victims of first-mover disadvantages. These disadvantages include “free-rider effects, resolution of technological or market uncertainty, shifts in technology or customer needs, and incumbent inertia.”
Secondary or late-movers to an industry or market have the ability to study first-movers and their techniques and strategies. “Late movers may be able to ‘free-ride’ on a pioneering firms investments in a number of areas including R&D, buyer education, and infrastructure development.”
The basic principle of this effect is that the competition is allowed to benefit and not incur the costs which the first-mover has to sustain. These “imitation costs” are much lower than the “innovation costs” the first-mover had to incur, and can also cut into the profits the pioneering firm would otherwise enjoy.
Studies of free-rider effects say the biggest benefit is riding the coattails of a company’s research and development, and learning-based productivity improvement. Other studies have looked at free rider effects in relation to labor costs, as first-movers may have to hire and train personnel to succeed, only to have the competition hire them away.
Resolution of technological or market uncertainty
First-movers must deal with the entire risk associated with developing a new technology and creating a new market for it. Late-movers have the advantage of not sustaining those risks to the same extent. While first-movers have nothing to draw upon when deciding potential revenues and firm sizes, late-movers are able to follow industry standards and adjust accordingly.
The first-mover must take on all the risk as these standards are set, and in some cases they do not last long enough to operate under the new standards.
Shifts in technology or customer needs
“New entrants exploit technological discontinuities to displace existing incumbents.” Late entrants are sometimes able to assess a market need that will cause an initial product to be seen as inferior.
This can occur when the first-mover does not adapt or see the change in customer needs, or when a competitor develops a better, more efficient, and sometimes less-expensive product. Often this new technology is introduced while the older technology is still growing, and the new technology may not be seen as an immediate threat.
An example of this is the steam locomotive industry not responding to the invention and commercialization of diesel fuel (Cooper and Schendel, 1976). This disadvantage is closely related to incumbent inertia, and occurs if the firm is unable to recognize a change in the market, or if a ground-breaking technology is introduced.
In either case, the first-movers are at a disadvantage in that although they created the market, they have to sustain it, and can miss opportunities to advance while trying to preserve what they already have.
While firms enjoy the success of being the first entrant into the market, they can also become complacent and not fully capitalize on their opportunity. According to Lieberman and Montgomery:
Vulnerability of the first-mover is often enhanced by 'incumbent inertia'. Such inertia can have several root causes:
the firm may be locked into a specific set of fixed assets,
the firm may be reluctant to cannibalize existing product lines, or
the firm may become organizationally inflexible.
Firms that have heavily invested in fixed assets cannot readily adjust to the new challenges of the market, as they have less financial ability to change. Firms that simply do not wish to change their strategy or products and incur sunk costs from "cannibalizing" or changing the core of their business, fall victim to this inertia.
Such firms are less likely to be able to operate in a changing and competitive environment. They may pour too much of their assets into what works in the beginning, and not project what will be needed long term.
Some studies which investigated why incumbent organizations are unable to be sustained in the face of new challenges and technology, pinpointed other aspects of incumbents' failures.
These included: "the development of organizational routines and standards, internal political dynamics, and the development of stable exchange relations with other organizations" (Hannan and Freeman, 1984).
All in all, some firms are too rigid and invested in the "now", and are unable to project the future to continue to maximize their current market stronghold.
First-movers are not always able to benefit from being first. Whereas firms who are the first to enter the market with a new product can gain substantial market share due to lack of competition, sometimes their efforts fail.
Second-mover advantage occurs when a firm following the lead of the first-mover is actually able to capture greater market share, despite having entered late.
First-mover firms often face high research and development costs, and the marketing costs necessary to educate the public about a new type of product. A second-mover firm can learn from the experiences of the first mover firm, and may not face such high research and development costs, if it is able create its own version of a product using existing technology.
A second-mover firm also does not face the marketing task of having to educate the public about the new project because the first-mover has already done so. As a result, the second-mover can use its resources to focus on making a superior product or out-marketing the first-mover.
Often second-movers are able to overwhelm first-movers by taking the first-mover's product from a niche consumer market to a mass market. While firms may enjoy a first-mover advantage if they jump out to an early lead and hold onto it, the notion that winners are always the first to enter the market is a misconception.
Markides and Geroski's Fast Second describes this effect in further detail.
The following are a few examples of first-movers whose market share was subsequently eroded by second-movers:
Atari vs. Nintendo;
Apple’s Newton PDA vs. Palm Pilot PDA;
Charles Stack Online Bookstore vs. Amazon.com; although the public was largely unaware of Charles Stack Online Bookstore and a compelling argument can be made that Amazon has had much more success than the second-mover BarnesandNoble.com
Second-mover firms are sometimes called "fast followers".
Obviously, every market is different. Thus, while some markets may highly reward first-movers, others may not.
Second-mover advantage can be summarized by the adage: "The second mouse gets the cheese."
Example of second-mover advantage: Amazon.com
In 1994, Jeff Bezos founded Amazon.com as an online bookstore, and launched the site in 1995. The product lines were quickly expanded to VHS, DVD, CDs, computer software, video games, furniture, toys, and many other items.
Unbeknownst to many, is that Book Stacks Unlimited or books.com, was founded in 1991, and launched online in 1992. Founded by Charles M. Stack, it is considered to be the very first online bookstore. It has been stated that Bezos, who had worked on Wall Street for eight years, found that web usage was increasing 2000% each year.
This inspired him to search for a web-based business. Once Bezos decided to launch the largest online bookstore, he began advertising on over 28,000 other internet sites and has since dominated the business.
Amazon experienced what is known as a second-mover advantage, which has subsequently turned it into an S&P 100 company, and America’s largest online retailer. BookStacks was subsequently sold to Barnes and Noble.
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