First-mover advantage

In marketing, first-mover advantage or FMA is the advantage gained by the initial ("first-moving") significant occupant of a market segment. It may be referred to as Technological Leadership. This advantage may stem from the fact that the first entrant can gain control of resources that followers may not be able to match.^[1] Sometimes the first mover is not able to capitalize on its advantage, leaving the opportunity for another firm to gain second-mover advantage.

Originally made apparent by the ever booming Internet phenomenon, it has recently been on the decline due to the recent economic downturn. Sometimes first-movers are rewarded with huge profit margins and a monopoly-like status. Other times the first-mover is not able to capitalize on its advantage, leaving the opportunity for other firms to compete effectively and efficiently versus their earlier entrants. These individuals then gain a "second-mover advantage".

Contents 1 Mechanisms leading to first-mover advantages 1.1 Technological leadership 1.2 Examples of technological leadership 1.3 Preemption of scarce assets 1.4 Examples of preemption of scarce assets 1.5 Switching costs and buyer choice under uncertainty 1.6 Examples of switching costs 2 First-mover disadvantages 2.1 Free-rider effects 2.2 Resolution of technological or market uncertainty 2.3 Shifts in technology or customer needs 2.4 Incumbent inertia 3 General Conceptual Issues 3.1 Endogeneity of first-mover opportunities 3.2 Definitional and measurement issues 3.2.1 What constitutes a ‘first-mover’? 3.2.2 Alternatives measures of ‘first mover advantage’: profits vs. market share vs. probability of survival 3.2.3 Magnitude and duration of first mover advantages 4 Issues for future research 4.1 Theoretical and conceptual Issues 4.2 Empirical issues 5 Implications for managers 6 Second-mover advantage 6.1 Example second mover advantage: Amazon.com 7 References 8 Further reading

Mechanisms leading to first-mover advantages

First-mover advantages can arise from three primary sources. Each category is then separated into a variety of different other mechanisms. All mechanisms are theoretical and assume that other competitors trying to merge into the market are being exploited and overpowered by the first-mover company. All other things equal, the following are the three primary sources of first-mover advantages.^[2]

Technological leadership

The first of the three is technological leadership. A firm can gain FMA when it has had some sort of upper-handed breakthrough in its research and development (R&D) resulting from a direct breakthrough in technology. A learning curve can provide sustainable cost advantage for the early entrant if learning 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, and can be triggered via workforce mobility, publication of research, informal technical communication, reverse engineering, plant tours, etc. R&D expenditures can also provide technological leadership. The technological pioneers can retain their advantage if they protect their R&D through patents or if they successfully keep them as trade secrets. 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.^[2]

Examples of technological leadership

1. In a paper by Michael Spence (1981) he discusses how the learning curve can be kept proprietary, yet also still be a huge and controversial barrier to entry. Although the starters in a FMA market have complete and utter control for a period of time, the competition still remains, trying to chase ever so closely to 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, over the long-run, turn the market around and control the markets’ cost. Though Spence states that this sort of competition reduces profitability, most of the time it is needed to break in to the new markets.^[3]
2. Procter & Gamble are another example of when 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 create the diapers at a cheaper, more profitable price.
3. When the technology advantage is a function of R&D the first-movers can stay pioneers and profitable if their technology are patented and remain in-housed trade secrets. The case of Gilbert and Newbery (1982)^[4] and Reinganum (1983)^[5] illustrates what happens if the first-mover firm or close followers were to assume what each other’s R&D departments were doing. This can result in the second or third-movers actually surpassing the leaders because they are out-thinking their competition.
4. Lastly, physical aspects of FMA are not the only way certain firms acquire this advantage. Managerial systems that may help the organizational and behavior aspects of the company may prove to be highly beneficial to emerging companies. When a firms management style is unlike any other and grasps certain concepts of management and the economy that other firms do not, then they will benefit (i.e. American Tobacco, Campbell Soup, Quaker Oats, Procter & Gamble).

Preemption of scarce assets

Preemption of input factors, 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. Preemption of locations in geographic and product characteristics space, 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-mover 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 sunken investment cost. Preemptive investment in plant and equipment, the enlarged capacity of the incumbent serves as a commitment to maintain greater output following entry, with price cuts threatened to make entrants unprofitable. When scale economies are large, first-mover advantages are typically enhanced.^[2]

Examples of preemption of scarce assets

1. For the preemption of input factors a great example is the controlling natural resources in the case of Main (1955).^[6] In the case Main states that the concentration of high-grade nickel in a single geographic area made it possible for the first company in the area to declare themselves a first-mover. They then gained almost all of the supply of nickel in the area and have since controlled a vast proportion of the world’s production and distribution of the product.^[2]
2. For the preemption of locations in geographic space there was a theory developed in some papers by Prescott and Visscher (1977)^[7] and numerous other colleagues stating that the first-mover indeed has a huge advantage to 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. In essence, when a firm establishes itself on a certain plot of land it can gain full control of the market incorporated with that land, thereby holding on to that power for a vast period of time.
3. Preemption and investment in plant and equipment can prove to be another advantage for the first-mover. In the case of Schmalensee (1981)^[8] he says that when scale economies are large, FMA are usually larger and more profitable. They even sometimes grow so much that they turn into natural monopolies. He then goes on to state that further advantages arise from the aforesaid scale economies which provide only minor entry barriers and immense opportunities for future growth, development, and profit.

Switching costs and buyer choice under uncertainty

Switching costs, late entrants must invest extra resources to attract customers away from the first-mover firm. Buyer choice under uncertainty, buyers may rationally stick with the first brand they encounter that performs the job satisfactorily. For individual customers benefits of finding a superior brand are seldom great enough to justify the additional search costs that must be incurred. It can pay off for corporate buyers since they purchase in large amounts. If the pioneer is able to achieve significant consumer trial, it can define the attributes that are perceived as important within a product category.[2]

Examples of switching costs

1. Switching costs play a huge role in where, what, and why consumers buy what they buy. Users, over time, grow accustomed to a certain product and its functions, as well as the company that produces them products. Once a consumer is comfortable and set in their ways they apply a certain cost, which is usually fairly steep, to switching to other similar products (Wernerfelt 1985).^[9]
2. Another switching cost is described in Klemperer (1986)^[10] where the seller actual creates the cost. For instance in airline frequent-flyer miles many consumers find it important that an airline provides this service and are willing to actually pay more for an airfare ticket if it means they will get points towards their next flight.
3. Buyer choice under uncertainty has developed into its own little advantage for first-movers. They realize that if they get their brand name out there quickly through advertisements, flashy displays, and possible discounts then people will try their product. If the product performs their desired need satisfactorily then they will keep their brand loyalty therefore increasing the firms’ revenue (Porter 1976).^[11] Also, a study by Ries and Trout (1986)^[12] 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.

First-mover disadvantages

Although in some cases 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 affects, resolution of technological or market uncertainty, shifts in technology or customer needs, and incumbent inertia”.^[2] Delving into each of these deeper we see:

Free-rider effects

Secondary or late movers to an industry or market, have the ability to study the 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”.^[2] 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 spend, and also can cut into the profits which the pioneering firm should be enjoying.

Studies of free rider effects place the biggest implications on riding the coattails of a company’s research and development^[13] and learning based productivity improvement.^[14] Overall these studies showed the effects of free riders as they are able to make their way into the market and not spend the money or risk the failures which the first movers did. Other studies^[15] have looked at free rider effects in relation to labor costs, as first movers may have to hire and train personnel to succeed, then the competition hires them away.^[2]

Resolution of technological or market uncertainty

First movers must deal with the entire risk associated with creating a new market, as well as the technological uncertainties which will follow. Late movers are given the advantage of not sustaining the risks, mostly monetary, with creating a new market. 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 (Lieberman and Montgomery). 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 these standards.

Shifts in technology or customer needs

“New entrants exploit technological discontinuities to displace existing incumbents”.^[2] In this case of first mover disadvantages, the late entrants are able to assess a market need that will replace what is currently being offered. This takes place when the first mover does not adapt or see the change in the customer needs, but also when competitor develops a better, more efficient, and sometimes less expensive product. Oftentimes this new technology is introduced while the older technology is still growing, and in this case the new technology may not be seen as an immediate threat.^[2]

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 the incumbent inertia, and occur 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 on opportunities to advance as it can compromise what they have already.

Incumbent inertia

As firms enjoy the success of being the first entrant into the market, they can also become complacent and not fully capitalize on their opportunity. “Vulnerability of the first mover is often enhanced by ‘incumbent inertia’. Such inertia can have several root causes:

(1) the firm may be locked in to a specific set of fixed assets,

(2) the firm may be reluctant to cannibalize existing product lines, or

(3) the firm may become organizationally inflexible”.^[2]

Firms that have severe fixed assets cannot adjust to the new challenges of the market as they have no room 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. Some firms simply will not change as it will not maximize their short term profits to do so. Although these numbers will be higher in the long run, the organization will fail.^[2] These firms are sometimes unable to be sustained in a changing and competitive environment. They may pour too many of their early assets into what works in the beginning, and not project to what will need to work in the long run.

Some studies which investigated why incumbent organizations are unable to be sustained in the face of new challenges and technology, pinpointed aspects of incumbents which fail. 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). In other situations cannibalizing the company is not an option because the costs associated with it will be too much for the firm to succeed after the change. All in all some firms are too invested and rigid in the “now”, and are unable to project the future to maximize their current market stronghold.

General Conceptual Issues

Endogeneity of first-mover opportunities

First-mover advantages are typically the result of two things: technical proficiency and luck. A company does not have the ability to decide to pioneer, though high investments in research and development can help. Instead, pioneering is mainly the result of the process seen in Figure 1:

Skill and technical proficiency can have a clear impact on profits and success of a new product; a better product will simply sell faster. An innovative product that is the first in its area has the potential to grow enormously and highly technical companies are able to manufacture their products at lower costs than their competitors. A great example of proficiency aiding first mover advantage is Procter and Gamble's first disposable baby diaper. Some of their success can be attributed to their distribution channels and general manufacturing proficiency. The ability to get ahead of the market through technical breakthroughs and the use of materials that were low in price allowed P&G to dominate the industry.

Luck can also have a large effect on profits in first-mover advantage situations, specifically in terms of timing and creativity. Simple examples such as a research “mistake” turning into an incredibly successful product (luck) or a factory warehouse being burned to the ground (unlucky) can have an enormous impact in some instances. Initially Procter and Gamble's lead was aided by its ability to maintain a proprietary learning curve in manufacturing and by being the first to take over shelf space in stores. Large increases in the birth rate in the years that Procter and Gamble’s first disposable diapers were released also added to their industry profits and first-mover advantage.

Definitional and measurement issues

What constitutes a ‘first-mover’?

Much of the problem with the concept of first mover advantage is that its definition is difficult to set in stone. Should a first mover advantage apply to firms entering an existing market with technological discontinuity or should it solely be new markets? The definition vagueness has certainly named undeserving firms as pioneers in certain industries, which has led to some debate over the real concept of first mover advantage.

Another common argument is whether first mover advantage constitutes the initiation of research and development versus the entry into a new market. Typically the definition is the latter, since plenty of firms spend millions in research and development that never enters a market. Many factors should affect the answer to these questions such as the sequence of entry, elapsed time since the pioneers first release and categories such as early follower, late follower, differentiated follower, etc.

Alternatives measures of ‘first mover advantage’: profits vs. market share vs. probability of survival

A commonly accepted fact of defining first mover advantage is when a pioneering firm earns positive present value of profits as the consequence of its early entry. Thus economic profits are an appropriate measure since the sole objective of stockholders is to maximize profit as much as possible.

Still some issues have risen with this definition, specifically that disaggregate profit data are seldom obtainable.^[16] In turn, market shares and rates of company survival are typically used as alternative measures since both are commonly linked to profits. Still these measures can be weak at times and therefore become ambiguous. Early entrants always have natural advantages in market share, which do not always translate to higher profits.

Magnitude and duration of first mover advantages

Though the name “first mover advantage” hints that the pioneering firms will remain more profitable than its competitors, this is not always the case. Certainly a pioneering firm will reap the benefits of early profits, but sometimes economic profits fall close to zero as the patent expires. This commonly leads to sale of the patent or exit from the market, which shows that longevity is not a guarantee as the first mover. This commonly accepted fact has led to the concept known as “second mover advantage.”

Issues for future research

There are several problems that do arise when one attempts to clearly define “first-mover advantages”. These prevent us from entirely accepting that a company gains a clearly defined benefit from being the first to produce and market a particular product. Many studies have been done that try to identify all possible “pioneering advantages” that are available to a first-mover but the fact is that the results so far have provided only a basic framework without any clearly defined mechanisms.^[2] This is still much more research that can be done to provide future generations of marketing teams with concrete evidence to allow for the idea of first-mover advantages to be completely feasible to the world of business.

Theoretical and conceptual Issues

The biggest issue that arises from the assumptions that have already been drawn is that the despite the evidence found, the fundamental question of how or why these first-mover advantages even occur is still unanswered and unexplored to this day. When attempting to discover the answer, it became clear that it was too difficult to differentiate between an actual advantage and just blind luck.^[2] Before this research can be completed, more distinct differences between firms such as when the optimal time for a particular firm to produce and market a product should be. Ultimately, some firms are more suited to be pioneers and others are more suited to wait and see how the product does then improve upon it and release a slightly modified reproduction for sale.

As of now, we have a much clearer understanding of advantages that firms who move their product much later than those that first-movers enjoy. The biggest concern currently is that almost no effort has been put towards determining the “resolution of technological and market uncertainty” which are both consider to be major players when determining the optimal timing of product release; also no outline to establish whether inertia is or is not acceptable.^[2]

Empirical issues

Determining the differences between the advantages of followers and first-movers may be a conceptual issue, but empirical issues revolve around explicit strategies that first-movers employ to improve upon their advantage of being the first to offer a product. To support any findings, new information is needed to provide any acceptable theories relating to the mechanisms, advantages, and disadvantages that first-movers are thought to have at their disposal.^[2] The fact is that researchers in this field must avoid using the same data repeatedly which is a trend that has crippled the progress of this investigation.

An interesting study that can follow this is the differences between first-mover advantages and other advantages that a firm many have like superior manufacturing, and a better marketing scheme. Knowing how pivotal that first-mover advantages are as compared to all other advantages that a firm could have, would be extremely useful to any company that has extra money to spend for their next quarter. Furthermore, studying how the strength of each advantage varies as they translate from industry to industry. It is quite possible that each industry has its own independent benefits that have yet to be formally documented. An example of one that has, is that first-mover advantages have proven to be much more prevalent in consumer-goods as opposed to producer-goods industries. Lastly, the length of time that a first-mover advantage has until it expires would be vital to any company that is attempting to determine whether or not they should take the chance of being the first to market a particular type of product. This would help them immensely to find out if the product will be profitable for very long.

Implications for managers

Different studies have produced varying results in respect to whether or not first-mover advantages, on the whole, exist and provide a profitable result for pioneers. There have been two outstanding conclusions that have been accepted the first being that on average, first-movers tend to produce an unprofitable outcome on average (Boulding and Moore). Consequently, pioneers that do manage to survive do enjoy lasting advantages in their market share (Robinson). Thus, the pioneer strategy is not necessarily a route that just any firm can take but with the right resources and the proper marketing approach can result in lasting profits for the company.

Managers can make a big difference for a firm when deciding whether or not they should be followers or pioneers. “Good generals make their luck by shaping the odds in their favor” (MacMillan). Making good decisions and acting upon them can help a firm but in the end there are other factors that must be taken into account before making a final decision. One issue is that the firm must find a way to at least limit if not prevent imitation by applying for patent, creating a product that is too complicated to employ the use of reverse engineering on, and taking control of resources that are important to the production of their product and any imitation product.^[2] They must also remember that first-mover advantages are not everlasting; eventually the competition will manage to take at least some piece of the marketing pie. Finally, they must do their best to prevent incumbent inertia caused by self-righteousness or possible changes in the market environment; this can be prevented by expanding the product line. The advantages of having a wider product line is much easier to maintain compared to those of being a pioneer (Robinson).

The follower strategy has a flaw that arises constantly, and that is the method of attack on the pioneer of the product. Some attempt to go head-to-head against the product hoping that increased spending in advertisement is enough to counteract the first-mover advantages. This technique has proven successful but usually against smaller pioneers that lack resources and recognition in the market (Urban 1986). Otherwise this “me-too” strategy proves ineffective since the follow will most likely lack brand name and product awareness. An alternate method is to create an entirely new market segment and distribution channel to establish a foothold in the industry and then employing the “me-too” strategy.^[2]

Second-mover advantage

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 who follows the lead of the first-mover is actually able to capture greater market share, despite having entered late.^[17]

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.^[18] A second-mover firm can learn from the experiences of the first mover firm^[17] and may not face such high research and development costs if they are able create their own similar product using existing technology.^[18] 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.^[18] 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 mass markets. 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 second mover advantage: Amazon.com

Many people are familiar with the company Amazon.com, which is America’s largest online retailer. In fact, Amazon.com has over three times the internet sales revenue of runner up Staples, INC. In 1994, Jeff Bezos founded Amazon.com as an online bookstore and launched in online in 1995. The product lines were quickly expanded to VHS, DVD, CDs, computer software, video games, furniture, toys and many others.

Unbeknownst to many others is BookStacks or books.com, which was actually founded in 1991 and launched online in 1992. Founded by Charles Stack, it is considered to be the very first online bookstore known to date. It has been stated that Bezos, who had worked on Wall Street for eight years, found that web usage had increased 2000% each year in the past few years, which inspired him to search for a web-based business. Once Bezos decided on launching the largest online bookstore, he began advertisement 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 them into an S&P 100 company and has caused BookStacks to become rather unknown.

References

Further reading

• Boulding, W. and M. J. Moore, May 1987. “Pioneering and profitability: structural estimates from a nonlinear simultaneous equations model with endogenous pioneering”. Research Paper, Fuqua School of Business, Duke University.
• MacMillan, I. C., 1983. “Preemptive strategies”, Journal of Business Strategy, 16-26.
• Robinson, W. T., September 1988. “Sources of market pioneer advantage: the case of industrial goods industries”, Journal of Marketing Research.
• Urban, G. L., R. Carter, S. Gaskin and Z. Mucha, June 1986. “Market share rewards to pioneering brands: an empirical analysis and strategic implications”, Management Science, 645-659.