Defense Is Not a Strategy

The next big story we’re reading about is linked to China. This is themed defense is not a strategy. A recent decision was made by Panasonic to exit certain parts of the renewables value chain—the manufacturing of solar panels and solar cells—because it cannot compete with low-cost Chinese providers. I’ve been in consulting my entire career, all the way from business analyst to senior partner, I worked with many companies. And it’s very common. I’ve seen this with many Western companies. Normally, when a low-cost provider arrives with great fanfare, the company announces that they’ve made a decision to create value by exiting the low-end part of the value chain and focusing on the high-end part of the value chain. Of course, the share price goes up and everyone gets happy about it, but there are some important things to consider. For one, they didn’t make the decision—it was made for them. In almost all cases, they didn’t have a choice. It’s not as if they did something so philanthropic and made a charitable donation to the low-cost provider and they can have a tax write-off. They were bleeding money because they could not compete. A better way of saying it is that they have no way of winning in this market, so they just have to leave because they’re going to lose everything. It’s not that they’ve made a decision to exit—the decision has been made for them. They have no choice.

The next big insight is that when you leave this market—in this case, the value side of solar panel manufacturing—you’re leaving a market that has paying customers. When you’re exiting a market, you’re leaving it to the incumbents or the companies that stay behind—in this case, the Chinese manufacturers—to have very little competition and the ability to extract profits from that market. The question becomes, what are they going to do with those profits?

This leads to the third insight: there’s a very big difference between exiting the low-end side of solar panels and retreating because that’s what they’re doing, versus stopping the low-cost manufacturers from advancing. Think about that. When you exit the low-end side of the market, you are pulling your troops back. You’re retreating so far up the value chain that you really can’t see the low-cost competitors. Maybe you’ll forget about them, but they haven’t disappeared. Like Game of Thrones, just because nobody could see the dragon lady and her dragons doesn’t mean they weren’t trying to find a ship and build an army to cross the ocean and eat everyone.

A big mistake companies make when they withdraw or are forced to withdraw from a portion of the value chain is that it’s a tactical and strategic retreat, but they’ve done nothing to blunt the enemy. If anything, they’ve basically given more energy and fuel to the enemy because the enemy now have a market with fewer competitors, and they can use that profit to stage the attack on the more valuable part of the value chain, which is what is going to happen. Every time you cede ground on the low-end part of the value chain, unless you’ve blunted the competition, you’ve simply given them a reservoir of cash to fund the assault on the high-end part of the value chain, and that assault will come. In every industry I’ve worked in, in every company I’ve worked in, it always comes. You can’t avoid it.

That’s the circle of life. You start by creating some kind of product, and it attracts competitors. Unless you have a cost advantage you can play, you have to move up the value chain to the more valuable part of the value chain. But you can’t stay there forever because the guys at the low-end see where the value lies, and they keep marching up. Eventually, you have to exit the value chain or keep creating so much value that you stay ahead of the low-cost players. You always keep them low cost. But at some point, they’re going to figure out how to catch you, and they’re going to catch you, which means you either have to create more value, or you have to exit the value chain in total. And that’s the deep insight.

This is an excerpt from Monday Morning 8 a.m. newsletter, issue #14.