Playing To Win
Strategy for Natural Monopolies
Nuances for Applying Playing to Win
I received an interesting reader question from Richard: What is the best way to apply the Playing to Win Choice Cascade to a natural monopoly? He gave examples of natural monopolies including utilities, government agencies, charities, membership organizations, etc. Lots of folks work in natural monopolies (including many who don’t realize that they do), so I thought it was well worth dedicating my 50th Year III Playing to Win/Practitioner Insights piece to: Strategy for Natural Monopolies: Nuances for Applying Playing to Win. You can find the previous 160 PTW/PI here.
What is a Natural Monopoly?
This is the pithy but profound definition of natural monopoly by the late great economist William Baumol from his seminal 1977 American Economic Review article: “An industry in which multiform production is more costly than production by a monopoly.” Baumol is one of my favorite economists. Much like Peter Drucker, he lived to almost 100 years and published into his 90s. He was well-loved and made huge contributions to his field.
The industries that are usually used to exemplify natural monopolies are railways, power grids, subways, and telecom networks. In each case, the cost of building out one provider is so high that it doesn’t make economic sense for a second player to replicate the first — chances are it would go broke if it tried. Lots of natural monopolies are public (e.g., the patent and trademark office, the court system) and the ones that are private tend to be heavily regulated to stop them from extracting ‘monopoly rents’ from customers.
Natural monopolies are not necessarily permanent. They can change when the cost dynamics shift to make it feasible for additional competitors to enter. For example, for most of the 20th century, the US telecom network was seen as a natural monopoly and AT&T was the monopolist provider. It was regulated under a strict rate of return regime to constrain its pricing power. But AT&T was famously broken up in 1984 into the long-distance provider (that kept the name AT&T) and seven regional ‘Baby Bells’ (the latter of which slowly but surely merged down into two players, Southwest Bell Corporation (SBC) and Verizon). And the long-distance business was deregulated because the evolution of the cost structure in telecom had made it possible for new entrants, such as MCI and Sprint, to compete effectively.
Another Kind of Natural Monopoly
I have always believed that there is another kind of entity that operates much like a natural monopoly and that is the corporate function — i.e., corporate HR, Finance, Legal, IT, R&D, Marketing, etc. It is most efficient for a company to build one function, not many — and multi-business companies have recognized this with a major move toward Global Business Service (GBS) operations, which provide a single functional service across the businesses of the company. When a company builds a singular corporate function, it wants to use it to the maximum. This is why the individual businesses are often prohibited from utilizing outside providers for the service lines of these corporate functions. When that is the case, the corporate function is no different than a natural monopoly. Hence, I would argue that this is by far the most common form of natural monopoly across the world of business — more on them later…
Applying the Playing to Win Choice Cascade
The Strategy Choice Cascade can be applied to natural monopolies, with a couple important nuances with respect to the heart of strategy, the Where-to-Play/How-to-Win (WTP/HTW) combination.
At first blush, many people working in natural monopoly organizations think that their WTP is carved in stone by its mandate, whether it might be the Department of the Interior, the American Association of Retired Persons (AARP) or pre-deregulation AT&T. However, there is always vast possible WTP territory within any mandate. Sure, AARP serves retired people, and probably couldn’t get away with serving college kids. But it has chosen as part of its WTP to serve near-to-retirement customers to get them started earlier with AARP. In addition, it has chosen service lines including advocacy, education, and affinity purchasing services and not others. It could have chosen many different combinations.
There is always a question of whether to play at all in potential WTP possibilities and how to weight investment across various components of WTP — for instance, the weighting of AARP effort across advocacy, education, and affinity purchasing services. Pre-deregulation AT&T’s WTP weighting included investing heavily in rural areas and using its super-profitable business in dense urban areas to cross-subsidize its very unprofitable rural operations. Unfortunately for AT&T, it cross-subsidized to an extreme that contributed to its failure after it ceased to be a monopoly and began competing with competitors (MCI and Sprint) that didn’t invest at all in expensive-to-serve rural areas. In due course, AT&T sold itself to Southwest Bell Corporation (SBC) for a fraction of its former value and only exists today because SBC changed its corporate name to AT&T after purchasing it. I would argue that this sad fate was in substantial part due to its WTP choices during its natural monopoly phase.
You make those WTP choices in ways that fit with and reinforce the other choices both up and down the cascade just as you would in any business. Up-the-cascade, the chosen WTP must be consistent with and reinforcing of the Winning Aspiration (WA). What WTP would be fulfilling for you and your constituents? An electric utility might make its WTP more about helping customer conserve than selling them more power because its WA is more about conservation than scaling power generation. But if its WA entails becoming as large as possible, it would de-emphasize conservation. Again, that is a choice.
But the WTP choice also must fit with and reinforce the down-the-cascade choices starting with HTW. This is an area in which the Playing to Win Choice Cascade is a little different for natural monopolies than competitive companies. The difference is analogous to that for social service organizations, about which I have written previously in this series.
Winning doesn’t mean beating a normal competitor because there aren’t any (otherwise it wouldn’t be a natural monopoly). Instead, winning means creating dramatically more value than the resources provided. It is often the case that the resources are provided by someone other than the direct beneficiary. Taxpayers in general fund the Department of the Interior, but (among others) national park visitors are the beneficiaries (of that particular WTP offering).
Winning also means providing greater value than substitutes — including simply doing without. Pre-deregulation AT&T should have strived to have been considered by customers to be such a good value that they would want to use telephony rather than a substitute, such as mail or face-to-face meetings. AARP would strive to create such value that retirees would be compelled to join its organization and use its services rather than do without.
Whatever set of choices the natural monopoly chooses as its HTW needs to be conditioned by the reality check — the Must-have Capabilities (MHC) and Enabling Management Systems (EMS) that will make the theory of HTW a reality. If an organization can’t build the MHC necessary to create the targeted value in the chosen WTP, then the WTP must be modified.
A general strategic watch-out for natural monopolies is WTP drift — that is, letting WTP expand and expand. Just because an organization can do something doesn’t mean that it should. A natural monopoly always needs to beware of dissipating the value that it creates in its core WTP in incremental WTPs for which it has no HTW — like PC operating system monopolist Microsoft with Zune, Surface, smartphones and (probably) gaming consoles.
The Danger of Monopolies — Natural or Otherwise
The fundamental problem for monopolies, whether natural or otherwise is that they don’t receive consistent training. In the world of business, facing competition for your customers is like going to the gym every day. Customers train you by switching to the competition if they don’t think you are the best value for them. Companies in competitive markets may find it annoying, but they know they need to listen to customers to improve. That is their training.
Monopolists don’t have to train — at all. Not having to train might be enjoyable, but it isn’t good for them. It wasn’t good for AT&T. It was once the most valuable company on the planet, but it succumbed to competition and only exists today as a subsidiary of a company that has appropriated its name.
The key for monopolists, whether natural or otherwise, is to do their best to simulate competition. They should ask their customers whether they wish they had an alternative — and why. Keep trying to be responsive until they tell you that they wouldn’t wish they had an alternative. Subject yourself to a customer council. Create one and commit yourself to listening to it.
I did a version of that when I was Dean of the Rotman School of Management. The Provost of University of Toronto hired me, had the authority to fire me, and determined my compensation. The Dean’s Advisory Board had none of the authority of a real governance board. But I asked its Chair, global governance expert David Beatty, to act as if it was a real governance board, to be tough on me and beat me up if I needed it! As it would have with a monopoly, it provided me with training from which I would have otherwise not benefited.
For internal functions, it is important to leave the door to competition open a crack. If corporate functions are given an absolute monopoly right to provide their services to the operating businesses, they won’t get any training and will get horribly out of shape and bloated — which is a common complaint of operating business executives in modern companies. Allow the businesses to petition the CEO to use an outside provider. The CEO shouldn’t let them go outside often. But letting them do so occasionally makes the functions think about how they need to be better to stop the businesses from petitioning the CEO — and that keeps the corporate functions trained up.
Practitioner Insights
If you are in a natural monopoly — internal functions included — still use the Playing to Win/Strategy Choice Cascade to determine your strategy. Don’t assume that you have no choice in your WTP because it is dictated by your ‘mandate.’ There is a wide range of WTP optionality within the boundaries of your mandate. Remember that you don’t have to produce everything in your WTP. In the modern economy, there are lots of opportunities to outsource activities to someone that can do it better and/or cheaper.
As is always the case in strategy, fit and reinforcement are essential. Take the time and thinking energy to make sure that your WTP is consistent with your WA and paired with a powerful HTW (which in turn is supported by MHC/EMS). Keep toggling back and forth until you achieve alignment.
And think of being a natural monopoly as living with a disability. Being a natural monopoly will make you flabby and lazy over time — unless you work hard to get the customer training that your position won’t automatically provide you. That takes real discipline — like the discipline of going to the gym every day. But the reward will be relevance and longevity for your organization — and quality for your customers.
