competitive response to radical product innovations

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UMI Number: 3141793

Copyright 2004 by

Aboulnasr, Khaled Sherif

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COMPETITIVE RESPONSE TO RADICAL INNOVATIONS on, X œ NAA A ẤN, et om \ Arthur D, Warga p\ Dean, C T Bauer College of B Business APPROVED: ị £ Ệ ke, a f hs an Edward A Blair Professor of Marketing Chairperson of Committee \Ce, Leh Oe ` ay Keith A Professor of Marketing An, 4 — Niladri B Syam Assistant Profess of Marketing yA on 4 A Va A " đt ha Chis Be weedy ` é Rajesh Chandy Cs N

Associate Professor of Marketing

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ACKNOWLEGEMENTS

T would like to sincerely thank my advisor Dr Edward Blair for his guidance and incomparable support Without his guidance and his unique perspective, this dissertation would not have been possible I feel extremely fortunate and grateful to have had Dr Blair as my advisor and mentor through the PhD program I learned so much from working with him and I feel very indebted I would also like to thank Dr Rajesh Chandy,

Dr Niladri Syam, Dr Robert Keller, Dr Keith Cox and Dr Adwait Khalre for their

helpful and constructive remarks on this dissertation

My heartfelt appreciation goes to my beloved parents who have shown me the true meaning of unconditional love and support They are my true imspiration and they have always given me strength and encouragement They have shaped the person I am today and J feel very grateful to them I owe great appreciation to my lovely wife and kids who have endured a lot through my PhD program I want to express my gratitude to them for everything they had to go through in order for me to write this dissertation

I would also like to thank my colleagues in the marketing department for always being there when I needed them and in particular Anish Nagpal, Suresh Sundaram, Anu Sivaraman, Babu Johnmariadoss, Jaime Noreiga, Stephanie Oneto, Stephanie Fuglaar

and Vamsi Rao Venkata

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ABSTRACT

This study represents an attempt to answer previous research calling for more analysis of the competitive response process (Gatignon et al 1989; Bowman and Gatignon 1995), Our specific focus is on competitive response to new products that represent radical mnovations According to Chandy and Tellis (1998), radical imnovations differ from other new products in that they have qualitatively different technology and qualitatively different benefits compared with existing products Because of these characteristics, radical innovations are likely to be riskier than other product mtroductions (Sorescu, Chandy and Prabhu 2003), and to demand more resources They also have high potential for destabilizing the market and causing customers to reconsider existing purchase pattems They present substantial threat to existing competitive positions, but also opportunities for new market positions

The basic prenuse of this study is that competitive response to radical mnovations will be inherently different from response to imcrementally innovative products as studied in prior research We use both a resource based argument and a signaling argument to develop a theoretical structure that utilizes dominance and market dependence of both the introducing firm and the responding firm io explain competitive response to the

introduction of radical innovations Response is represented in the likelihood that competitors introduce their own products as a reaction to the introduction of a radical

1nnovation

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TABLE OF CONTENTS ACKNOWLEDGEMENTS ABSTRACT | LIST OF TABLES LIST OF FIGURES | INTRODUCTION RESEARCH QUESTION AND CONCEPTUAL UNDERSTANDING LITERATURE REVIEW | THEORETICAL OVERVIEW HYPOTHESES

| Effect of introducer dominance

Effect of introducer market dependence

Interaction effect of introducer dominance and market dependence

Effect of competitor dominance

Effect of competitor market dependence

Interaction effect of competitor dominance and market dependence METHOD Empirical context Data description and measures RESULTS Key fhadings | Predicted validation and mode! comparisons DISCUSSION ;

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TABLE 1: TABLE 2: TABLE 3: TABLE 4: TABLE 5: TABLE 6: TABLE 7: LIST OF TABLES

OPERATIONALIZATION OF RADICAL INNOVATION

VARIABLES AND DATA SOURCES |

OPERATIONALIZAITON OF VARIABLES CLASSIFICATION TABLE

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FIGURE 1: FIGURE ?: FIGURE 3: FIGURE 4: FIGURE 5: FIGURE 6: FIGURE 7: FIGURE 8: RIGURE 9: LIST OF FIGURES

COMPETITIVE RESPONSE TO RADICAL INNOVATION GRAPHICAL REPRESENTATION OF HYPOTHESES NUMBER OF RADICAL INNOVATIONS PER

INTRODUCING FIRM

NUMBER OF RADICAL INNOVATIONS PER CATEGORY

NEW DRUG DEVELOPMENT PROCESS PERCENTAGE OF COMPETITORS THAT RESPONDED TO RADICAL INNOVATIONS INTRODUCED BY MORE DOMINANT AND LESS

DOMINANT FIRMS |

PERCENTAGE OF COMPETITORS THAT RESPONDED TO RADICAL INNOVATIONS INTRODUCED BY MORE MARKET DEPENDENT AND LESS MARKET DEPENDENT FIRMS

PERCENTAGE OF RESPONSE BY MORE AND LESS DOMINANT RESPONDING FIRMS

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INTRODUCTION

In an increasingly competitive environment, the study of new product

| imtroductions and competitive response to these products has become of great strategic imaportance (Shankar, et al 1999) An understanding of the underlying bases of

competitive response is essential for forecasting future reactions in addition to including more accurate reaction uictlons Imío analytical raodels ( Bowman & Gatignon, 1995), This study represents an attempt to answer previous research calling for more analysis of the competitive response process (Gatignon et al 1980; Bowman and Gatignon 1995)

_ Onur spectfic focus in this research is on competitive response to new products that represent radical innovations “According to Chandy and Tellis (1998), radical

innovations differ from other new products in that they have qualitatively different technology and qualitatively different benefits compared with existing products Because of these characteristics, radical innovations are likely to be riskier than other product © introductions (Sorescu, Chandy and Prabhu 2003), and to demand more resources They also have high potential for destabilizing the market and causing customers to reconsider

existing purchase patterns They present substantial threat to existing competitive | positions, but also opportunities for new market positions

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in prior research We use both a resource based argument and a signaling argument to develop a theoretical structure that utilizes dominance and market dependence of both the | introducing firm and the responding firm to explain competitive response to the

introduction of radical innovations Response is represented in the likelihood that | competitors introduce their own products as a reaction to the introduction of â radical

innovation

In studying this topic, we extend the literature on competitive response, which has

previously not distinguished between radical and incremental innovations, and which has, as an empirical matter, primarily studied introductions of incremental innovations ‘(Robinson 1988; Bowman & Gatignon 1995: Shankar 1997; Shankar 1999} We also

extend the literature on radical innovations by considering competitive response ta _ innovations as opposed to innovation itself which has been the focus of previous

Titerature (Chandy and Tellis 1998)

In addition to extending and connecting two important streams of research in

marketing strategy, we add to the previous literature in three important ways First, we

posit hypotheses that go against what has been asserted in prior literature Previous | | research has suggested that ñmns with higher levels of dominance are less likely than

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Similarly, contrary to some prior literature, which argues that competitors respond less aggressively to the introduction of a new product by more dominant Versus less dominant | firms because of fear of retaliatory behavior (Shankar 1999: Bowman and Gatignon — |

1995), we argue that competitors will be more likely to respond to the introduction ofa radical innovationby a more dominant versus a less dominant firm

Second, previous research has always referred to the degree of threat represented | bya new product as a pritviary determinant of response in this study we expand this

logic by arguing that it is not only the degree of threat but also the extent of opportunity | " cmbodied in a radical innovation that underlies the ageressiveness of competitive

response Because of the market disrupting power that a new product might have, competitors can aspire for new market positions by introducing their own new products

Third, from an empirical point of view, this research addresses several method

limitations of Previous studies One limitation: has been completeness of the data; in

contrast to previous studies that considered the response of oniy a limited number of

competitors (Shankar 1997; Robinson 1988), we observe the likelihood of response for:

all incumbents in a category for the first three years following the introduction Another problem has been small sample size, cited as a general limitation by Robinson (1988) and Keuster etal { 1999) For example, Yip (1982) had 37 observations, Robinson (1988)

had 115 observations and Shankar ( 1999) had 23 new product entries and 59 responses

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generating more than 300 observations Another empirical limitation of previous research has been the possibility of self report bias im questionnaire measures (cf | Robinson 1988; Kuester et al 1999) In this study we use secondary data from the pharmaceutical industry that has been well documented by the Food and Drug Administration (FDA) (Sorescu et al 2003)

The specific research goal of this study is to empirically test several propositions _ derived from a theoretical framework concerning the impact of firm dominance and

market dependence of both the introducing and responding firms on the likelihood of competitive response to the introduction of radical product innovations

The balance of the study is organized as follows: In the next section, we define the variables of interest and present a discussion of the research problem and conceptual understanding This will be followed by a theoretical review of the relevant literature

We then present a conceptual framework that includes the set of proposed hypotheses Following this, we describe the data, methods and measures that were used in conducting this research We then present the results of the anlaysis Finally, we conclude the proposal by identifying possible limitations and discussing several implications for scholarship and practice

Terminology

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existing products In Schumpeterian terms a radical imnovation has the capacity to disrupt the market, overturming existing technology and in most cases setting new market conditions (Lawless and Anderson 1996) An example of a radical 1unovation would be the introduction of computers with integrated circuits as compared to computers operating with vacuum tubes

Firm Dominance Firm dominance refers to the extent to which a firm has market power (Chandy et al 2003; Bain 1968) More dominant firms have been shown to have

greater resources, more financial, technological and market-related assets (Sorescuet ai 2003) Dominance has been previously operationalized as corporate dominance and as category dominance In this study, we chose to operationalize dominance as corporate dominance for three reasons First, this operationalization is m line with recent literature that has defined dominance in terms ofa firm’s total sales, total profit or total assets

(Sorescu et al 2003; Chandy et al 2003; Szymanski et al 1993; Shankar 1999;

Borenstein 1990: Borenstein 1991) Second, defining domimance as corporate dominance

lowers its likelihood of being confounded with market dependence, which is defined at

the category level Third, operationalizing domimance on the corporate level is more aligned with a resource based argument, which we are going to use to explain the relationship between dominance and competitive response

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Competitive response Competitive response refers to “a set of decisions bya | - firm in response to an observed competitive action” (Kuester et al 1999) In this study we will focus on the likelihood of a competitor introducing its own product as a reaction

to the introduction of a radical innovation in the market This is in line with prior

research that suggests that response to anew product introduction will likely be on the - | product dimension (Axelrod 1984), Reciprocal retaliation is also suggested by Kuester et

| al (1989) who claimed that a competitive action vill result m 8 response on the same

dimension of the action One of their important findings was that 81.2% of competitors that did respond to new products responded on the product dimension by repositioning

their existing products or introducing new products

RESEARCH QUESTION AND CONCEPTUAL UNDERSTANDING

The main research question in this proposal focuses on the likelihood of competitive response to a radical innovation Our obj ective is to build a theoretical framework that incorporates dominance and market dependence and their interaction for

both the introducing and responding firms in order to explain the likelihood of | competitive response to radical innovation

An aggressive reaction by a competing firm flows from the principle that a radical imovation has a high relative potential for destabilizing the market and toppling

previously dominant technology Radical innovations introduce novelty into the market by disrupting its stable, incremental development linked with the existing product

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‘introduction of 4 radical mnovation, there is threat to competitors’ existing market positions but there is also opportunity for competitors to respond by introduc ing their :

own product and to have an enhanced market position Consequentiy, and based on both the resource based view of the firm and signaling theory our arguments are going to ‘center around the dual effect created by the introduction of a radical product

Accordingly, the basic argument in this research centers on the logic that competitive resporisé is a function of both the perceived threat and the perceived opportunity created by the introduction of a radical product innovation New products vary 1n terms of their hostility (Robertson et al 1995), and hostile products are more likely to entice more hostile reactions as they represent a greater potential for | destabilizing the market Heil and Walters (1993) found that new product introductions ' that are more aggressive would in turn expect more aggressive competitive reactions

A radical product would be classified as a hostile product as it threatens the stability of the market in more than one way First, radical innovations have the potential of destroying the fortunes of firms ‘Upon the introduction of a radical innovation customers may switch to the new product and abandon competing firms if the new product offers them superior performance per dollar of their money (Chandy & Tellis,

1998), | Second, radical innovations use fundamentally different technology which could

make competitors’ investments in current technology worthless Third, radical |

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_ sources, production techniques and technolo gies and also the status of distribution — - channels and service systems

Despite the threat that it represents, a radical immovation also may represent a source of opportunity to competitors, In cases where the new technobgy is unpatented, competitors can adopt and exploit the new technology and engage in the production and selling of the radical product By taking advantage of such opportunity, competitors can utilize the new technolo gy for their own advantage, thus limiting the competitive

advantage of the introducer in mdustries where the new technology is patented,

opportunity exists for competitors in two different forms First, competitors might create a product with similar functionality to the radical product and thus enhance their

conipetitive position ‘Second, the introduction ofa radical innovation has the potential

for destabilizing the market and causing customers to reconsider existing purchasing -_ patterns In the midst of a restructuring the market, the whole product category is up for

review, and hence competitors have the opportunity to aggressively pursue a better market position

in view of the aforementioned arguments, radical mnovations compared with -incremental innovations represent both a potentially greater threat and a greater

opportunity to competitors in a market and competitors are expected to react significantly different as aresult For example, the literature suggests that competitors will react less _ageressively to the introduction of an incrementaliy new product by dominant firms

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hypothesize that they will react more aggressively to dominant firms im the case of the introduction of a radical product because of either the greater perceived threat or perceived opportunity it represents

The degree of perceived threat and opportunity embodied in the introduction of

the radical product depends on several variables such as the attractiveness of the new product, industry and market characteristics and the characteristics of the introducing and

responding firms We chose to focus onthe charactenstics of the introducing and responding firms In particular we selected dominance and market dependence of both the introducing and responding firms as the major independent variables in this study

LITERATURE REVIEW

The competitive response literature has for the most part classified the antecedents of response into three broad categories: characteristics of the introduce firm, characteristics of the competitors (responding) firm and industry characteristics Shankar 1999; Bowman and Gatignon 1995; Robinson 1988)

Robinson (1988) studied competitor characteristics along with industry

characteristics and the strategy of the new entrant as predictors ofresponse His research was restricted to new products that were introduced by new market entrants One of his interesting findings is that response was raore coramion in markets on which the

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_ competitor market dependence and response Jikelihood, as reported by Robertson:et al

(1995) and Chen et al (1992)

in one of the most comprehensive studies on competitive reaction, Shankar (1999) formed an integrative framework in which he used introducer characteristics, competitor characteristics and market environment to predict both new product introduction

strategies and competitor response strategies He reported that competitor dominance is related negatively to the competitor's response across different marketing mix elements, such that more dominant firms have a lower likelihood of response to new product introductions He explained this finding in two ways First, non-dominant firms are more threatened by new product introductions than dominant firms and thus tend to respond more aggressively Second, he contended that dominant firms might face 8 loss

in profit if they respond aggressively toa new product (Shankar 1999) Alternatively Debruyne and Reibstein (2001) attributed similar response patterns to the formation of - organizational routines and decision-making myths that contribute to a dominant firm’s

inertia restricting its response capabilities Likewise, Kuester et al (1999) argued that larger firms are often bureaucratic and inflexible They also argued that dominant firms are unwilling to respond by introducing their own products because of fear of

-cannibalizing sales revenue from their existing products

As far as the characteristics of the introducing firm, market share of the

introducing firm was studied by Bowman and Gatignon (1995) They found that a new - product introducer’s market share is negatively related to the response time from

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_ competitors Along similar lines, Shankar (1999) found that the introducer’s market experience is negatively related to competitor reaction He also reported that the introducer’s marketing spending is negatively associated with competitor reaction This finding somewhat contrasts with Robertson’s (1988) finding of an inverted-U functional | form between scaie of introduction and response

The competitive structure of the market also has been found to play an important role in predicting competitive response Robinson (1988) found that there are more

frequent reactions in growing markets Similarly Kuester et al (1999) reported that competitors are more likely to defend their positions in markets characterized by a high growth rate They further found that market concentration had a negative effect on the likelihood of response, which diverges from Porter's (1980) claim that reactions are expected to mcrease with the increase in market concentration Furthermore, Bowman and Gatignon (1995) found that in markets characterized by frequent product changes, response time to competitive actions 1s much shorter

A case can be made that with a very few exceptions (Robmson 1988, Kuester et al 1999) previous empirical studies have not mcorporated product characteristics into a model that predicts competitive response The focus has been on characteristics of the introducing firm, the responding firm and the mdustry but not on characteristics of the product itself A fundamental and strategic element of a products characteristics is its degree of imovativeness A radical innovation miterrupts the current pattern of market | development and has the potential of rendering current products obsolete (Debruyne &