Actuarial Notes

Competitive Dynamics

Study guide: Exam CP-311

Competitive Dynamics is the total set of competitive actions and responses taken by all the firms competing in a market, while competitive rivalry is the ongoing exchange of actions and responses between a firm and a particular competitor. Hitt, Ireland and Hoskisson explain it through how much two firms overlap (market commonality and resource similarity), how likely each is to attack and to respond, and the speed at which advantages are imitated, which separates slow-cycle, fast-cycle and standard-cycle markets.

\Pi_{\text{hold}} = q(1 - \ell)(P - C)

\Pi_{\text{match}} = q(P - \Delta - C)

\ell^{*} = \frac{\Delta}{P - C}

  • Symbols: A rival cuts its price by \Delta per unit. The defender sells q units at price P and cost C, and expects to lose a fraction \ell of its volume if it holds its price. Matching keeps the volume at a lower margin, and \ell^* is the break-even loss above which matching earns more. This is the arithmetic behind a price response, which the behavioural factors below then tilt.
  • Market commonality and resource similarity: Market commonality is the number of markets two firms both compete in and how important each is to them. Resource similarity is how far their tangible and intangible resources match in type and amount. Firms high on both are direct competitors and expect to be drawn into rivalry, while high commonality also encourages mutual forbearance, since an attack in one market invites retaliation in another.
  • Drivers of competitive behaviour: Rivalry needs awareness of the competitor, motivation to act (what the firm gains or loses) and the ability to act (the resources and flexibility to do so). Competitor analysis of these three predicts who will move.
  • Strategic and tactical actions: A strategic action commits significant resources and is hard to reverse, such as entering a new province or building a distribution network. A tactical action is quick and cheap to reverse, such as a price change or a commission promotion. Tactical actions draw more, and faster, responses because they are easy to match.
  • Likelihood of attack: First movers take the first action to build an advantage and can earn above-average returns until rivals respond, at the cost of risk and the slack resources innovation needs. Second movers imitate after learning from the first mover's mistakes at lower cost, and late movers respond long after and usually earn below-average returns. Firm size and product quality also shape whether a firm attacks.
  • Likelihood of response: A firm is more likely to respond when the action is tactical, when the attacker has a reputation as a strong competitor whose moves succeed, and when the firm depends heavily on the attacked market for its revenue and profit (market dependence).
  • Market cycles: In slow-cycle markets, advantages are shielded from imitation for long periods by patents, scarce resources or unique history. In fast-cycle markets, capabilities are copied quickly and cheaply, so firms keep moving to stay ahead. Standard-cycle markets sit between: advantages are moderately shielded, and economies of scale and brand loyalty matter most, as in most personal lines and individual life insurance.

Classifying an Insurer's Products by Market Cycle A multi-line insurer offers three products. Its group disability book relies on 40 years of claims data and a specialist return-to-work team. Its mobile app lets customers buy travel insurance in two minutes, a feature launched six months ago. Its personal auto book is the third largest in its province, and its profit depends on scale in claims handling and on brand. Classify each market's cycle, and predict how the auto rivals respond if the insurer cuts auto rates by 5%.

Answer Group disability is the closest to slow-cycle, because its advantage rests on data and expertise that rivals cannot buy or copy quickly. The travel app is fast-cycle: a rival can build the same feature within months, so the insurer must keep innovating rather than defend it. Personal auto is standard-cycle, where scale and brand protect share but the product itself is easy to copy.

A 5% rate cut is a tactical action, quick to match and to reverse. Auto rivals with high market dependence, such as monoline auto writers, are the most likely to respond, and to respond quickly. A diversified rival with a small auto share may hold its price, accept some loss of volume, or reply in a different market where it is stronger.

Should the Defender Match a Price Cut? A defender writes 50,000 auto policies at an average premium of $1,000 and a full cost of $920. A rival with high market commonality cuts its rates by 5%, or $50 a policy. The defender expects to lose 20% of its policies if it holds its price. Compare the two responses and find the break-even loss.

Answer

\begin{align*}
\Pi_{\text{hold}} &= 50{,}000 \times 0.80 \times (1{,}000 - 920) \\
&= \$3{,}200{,}000 \\
\Pi_{\text{match}} &= 50{,}000 \times (1{,}000 - 50 - 920) \\
&= \$1{,}500{,}000 \\
\ell^{*} &= \frac{50}{80} \\
&= 62.5\%
\end{align*}

Holding the price earns more unless the defender would lose more than 62.5% of its policies, which a 5% price gap is unlikely to cause. The arithmetic ignores two things a strategist weighs. Policies lost now may be hard to win back, and the business that leaves first may be the best risks, since price-sensitive good drivers shop most. The underwriting cycle is in part this game played across a whole market.

How it appears on the exam

  • CP-311: The objective asks for the impact of competitive dynamics on strategic management. Questions describe a competitor's move and ask whether and how the firm should respond, which calls for market commonality, resource similarity, the type of action, the attacker's reputation, and the firm's market dependence.
  • CP-311: Other questions ask the candidate to classify a market as slow-, fast- or standard-cycle and recommend how to sustain an advantage in it, or to weigh the case for moving first, second or late with a new product.

Exam traps

  • Commonality is not similarity: Market commonality is about overlapping markets, and resource similarity is about overlapping capabilities. Two firms can share every market with very different resources, and the two dimensions together say how direct the rivalry is.
  • First is not always best: First movers carry the cost and the risk of getting the product wrong. A second mover that learns from those mistakes can do better, which is the usual point of the question.
  • Strategic actions are matched less often: It is tempting to predict a response to every move. Strategic actions are costly and slow to imitate, so rivals respond to them less often than to tactical moves like price cuts.
  • Fast-cycle advantage is not defended: In a fast-cycle market, the answer is to keep innovating and cannibalize one's own products, not to protect the current advantage, which will be copied anyway.