First mover advantage

Mechanisms leading to first-mover advantages

The three primary sources of first-mover advantages are technological leadership, preemption of scarce assets, and switching costs / buyer choice under uncertainty.

Technological leadership

The first of the three is technological leadership. A firm can gain FMA when it has had a unique breakthrough in its research and development (R&D). A new, innovative technology can provide sustainable cost advantage for the early entrant; if the technology, and the learning curve to acquire it, 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, through workforce mobility, publication of research, informal technical communication, reverse engineering, and plant tours. Technological pioneers can protect their R&D through patents. 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.

Examples of technological leadership

1. In a 1981 paper Michael Spence discusses how the technological learning curve can be kept proprietary, making for a huge barrier to entry on the part of others. Although the starters in a FMA market have complete control for a period of time, the competition still remains, trying to chase 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, once established, turn the market around and control the market's cost. Though Spence states that this sort of competition reduces profitability, most of the time it is needed to break into the new markets.
2. Papers by Gilbert and Newbery (1982) and Reinganum (1983) illustrate what happens if a first-mover firm, or close followers, were to assume what each other's R&D departments are doing. This can result in the second- or third-movers surpassing the leaders because they are out-thinking their competition.
3. Procter & Gamble is an example where a company's 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 keep costs down, and allowed for selling the diapers profitably at a cheaper price.
4. Physical aspects of FMA are not the only way certain firms acquire this advantage. Managerial systems that help the organizational and behavior aspects of the company may prove to be highly beneficial to emerging companies. When a firm's management style is unlike any other, and grasps certain concepts of management and the economy that other firms do not, then they will benefit (e.g. American Tobacco, Campbell Soup, Quaker Oats, Procter & Gamble).

Preemption of scarce assets

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. 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-movers 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 sunk investment cost. When economies of scale are large, first-mover advantages are typically enhanced. The enlarged capacity of the incumbent serves as a commitment to maintain greater output following entry, with the threat of price cuts against late entrants.

Examples of preemption of scarce assets

1. Main (1955) provides an example of preemption of input factors achieved by controlling natural resources. He states that the concentration of high-grade nickel in a single geographic area made it possible for the first company in the region to gain almost all of the supply. It has since controlled a vast proportion of the world’s production and distribution of the product.
2. For the preemption of locations in geographic space, a theory developed by Prescott and Visscher (1977) and others states that the first-mover has a huge advantage in 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. When a firm establishes itself on a certain plot of land, it can gain full control of the market incorporated within that land, thereby holding on to that power for a long period of time.
3. Preemption of investment in plant and equipment can prove to be another advantage for the first-mover. Schmalensee (1981) says that when scale economies are large, FMA is usually larger and more profitable, sometimes enabling a monopoly position. He then states that advantages also arise from scale economies which provide only minor entry barriers, but also immense opportunities for future growth, development, and profit.

Switching costs and buyer choice under uncertainty

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

Switching costs play a huge role in where, what, and why consumers buy what they buy. Over time, users grow accustomed to a certain product and its functions, as well as the company that produces the products. Once consumers are comfortable and set in their ways, they apply a certain cost, which is usually fairly steep, to switching to other similar products.

Examples of switching costs

1. A switching cost where the seller actually creates the cost is described in Klemperer (1986). For instance, in the case of airline frequent-flyer miles programs, many consumers find it important that an airline provides this service; and they are actually willing to pay more for an airfare ticket if it means they will earn points towards their next flight.
2. Buyer choice under uncertainty has developed into an advantage for first-movers, who realize that by getting their brand name known quickly through advertisements, flashy displays, and possible discounts, and by getting people to try their products and becoming satisfied customers, brand loyalty will develop. A study by Ries and Trout (1986) 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 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 effects, resolution of technological or market uncertainty, shifts in technology or customer needs, and incumbent inertia.”

Free-rider effects

Secondary or late-movers to an industry or market have the ability to study 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.” 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 incur, and can also cut into the profits the pioneering firm would otherwise enjoy.

Studies of free-rider effects say the biggest benefit is riding the coattails of a company’s research and development, and learning-based productivity improvement. Other studies have looked at free rider effects in relation to labor costs, as first-movers may have to hire and train personnel to succeed, only to have the competition hire them away.

Resolution of technological or market uncertainty

First-movers must deal with the entire risk associated with developing a new technology and creating a new market for it. Late-movers have the advantage of not sustaining those risks to the same extent. 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. 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 the new standards.

Shifts in technology or customer needs

“New entrants exploit technological discontinuities to displace existing incumbents.” Late entrants are sometimes able to assess a market need that will cause an initial product to be seen as inferior. This can occur when the first-mover does not adapt or see the change in customer needs, or when a competitor develops a better, more efficient, and sometimes less-expensive product. Often this new technology is introduced while the older technology is still growing, and the new technology may not be seen as an immediate threat.

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 incumbent inertia, and occurs 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 opportunities to advance while trying to preserve what they already have.

Incumbent inertia

While firms enjoy the success of being the first entrant into the market, they can also become complacent and not fully capitalize on their opportunity. According to Lieberman and Montgomery:

Vulnerability of the first-mover is often enhanced by 'incumbent inertia'. Such inertia can have several root causes:

1. the firm may be locked into 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.

Firms that have heavily invested in fixed assets cannot readily adjust to the new challenges of the market, as they have less financial ability 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. Such firms are less likely to be able to operate in a changing and competitive environment. They may pour too much of their assets into what works in the beginning, and not project what will be needed long term.

Some studies which investigated why incumbent organizations are unable to be sustained in the face of new challenges and technology, pinpointed other aspects of incumbents' failures. 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).

All in all, some firms are too rigid and invested in the "now", and are unable to project the future to continue to maximize their current market stronghold.

Endogeneity and exogeneity of first-mover opportunities

First-mover advantages are typically the result of two things: technical proficiency (endogeneic) and luck (exogeneic).

Skill and technical proficiency can have a clear impact on profits and the success of a new product; a better product will simply sell faster. An innovative product that is the first of its kind has the potential to grow enormously. Technically competent companies are able to manufacture their products better, at a lower cost than their competitors, and have better marketing proficiency. An example of technical proficiency aiding first-mover advantage is Procter and Gamble's first disposable baby diaper. The ability to get ahead of the market through technical breakthroughs, the use of materials that were low in cost, as well as their general manufacturing proficiency and distribution channels, allowed P&G to dominate the disposable diaper 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 (serendipity), 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.

What constitutes a first-mover?

Much of the problem with the concept of first-mover advantage is that it may be hard to define. Should a first mover advantage apply to firms entering an existing market with technological discontinuity, the calculator replacing the slide rule for example, or should it apply solely be new products? The imprecision of the definition 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 of a new product into the market. Typically the definition is the latter, since plenty of firms spend millions in research and development that never result in a product entering a market. Many factors affect the answer to these questions; including the sequence of entry; elapsed time since the pioneer's first release; and categorizations such as early follower, late follower, differentiated follower, etc.

Alternative measures of first-mover advantage: profits vs. market share vs. probability of survival

A commonly accepted way of measuring a first-mover advantage by pioneering firm's profits as the consequence of its early entry. Such profits is an appropriate measure, since the sole objective of stockholders is to maximize the value of their investment.

Still, some issues have risen with this definition, specifically that dis-aggregate profit data are seldom obtainable. In turn, market shares and rates of company survival are typically used as alternative measures since both are commonly linked to profits. Still these links can be weak and lead to ambiguity. Early entrants always have a natural advantage in market share, which does not always translate to higher profits.

Magnitude and duration of first-mover advantages

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

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 following the lead of the first-mover is actually able to capture greater market share, despite having entered late.

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. A second-mover firm can learn from the experiences of the first mover firm, and may not face such high research and development costs, if it is able create its own version of a product using existing technology. 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. 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 a mass market. 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:

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 of second-mover advantage: Amazon.com

In 1994, Jeff Bezos founded Amazon.com as an online bookstore, and launched the site in 1995. The product lines were quickly expanded to VHS, DVD, CDs, computer software, video games, furniture, toys, and many other items.

Unbeknownst to many, is that Book Stacks Unlimited or books.com, was founded in 1991, and launched online in 1992. Founded by Charles M. Stack, it is considered to be the very first online bookstore. It has been stated that Bezos, who had worked on Wall Street for eight years, found that web usage was increasing 2000% each year. This inspired him to search for a web-based business. Once Bezos decided to launch the largest online bookstore, he began advertising 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 it into an S&P 100 company, and America’s largest online retailer. BookStacks was subsequently sold to Barnes and Noble.

Implications for managers

Different studies have produced varying results with respect to whether or not, on the whole, first-mover advantages 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 (Boulding and Moore). Secondly, pioneers that 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, it 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 a firm must find a way to at least limit, if not prevent, imitation, by, for example, applying for patent(s), creating a product that is too complicated to reverse engineer, or taking control of resources that are important to the production of its product and any imitation. The firm must also remember that first-mover advantages are not everlasting; eventually the competition will manage to take at least some piece of the market. Finally, a company must do its best to prevent incumbent inertia caused by self-righteousness, or possible changes in the market environment. One way to overcome such inertia is by expanding the product line. The advantages of having a wider product line are much easier to maintain compared to those of being a pioneer (Robinson).

Managers who opt to be followers have to pick the right 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 follower 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 employ the me-too strategy.

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 results so far have provided only a basic framework without any clearly defined mechanisms. There is still much more research that can be done to provide future generations of marketing teams with concrete evidence to show that first-mover advantage is well-defined.

Theoretical and conceptual Issues

The biggest issue that arises is that, despite the evidence of first-mover advantages, the fundamental question of how or why these advantages occur is still unanswered. When attempting to discover the answer, it became clear that it was too difficult to differentiate between an actual advantage and just blind luck. Before this research can be completed, crucial management decisions, such as the optimal time for to produce and market a product, need to be studied. Ultimately, some firms are more suited to be pioneers, others are more suited to wait and see how the product does and then improve upon it, releasing a slightly modified reproduction.

As of now, we have a much clearer understanding of advantages that firms who move their product much later have 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 considered to be major determinants in the optimal timing of product release. There is, also, no methodology to establish whether inertia is or is not acceptable.

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. New information is needed to support any acceptable theories relating to the mechanisms, advantages, and disadvantages that first-movers are thought to have at their disposal. Researchers in this field must avoid using the same data repeatedly, which is a trend that has crippled the progress of this investigation.

A future study should better delineate the differences between first-mover advantages and other advantages that a firm may have, such as superior manufacturing, or a better marketing scheme. Funding such a study would be extremely useful to any company that has extra money to spend for their next quarter. Furthermore, it would be useful to study how the strength of each advantage varies as it translates from industry to industry. It is quite possible that each industry has its own unique 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, better knowing the length of time that a first-mover advantage lasts would be vital to any company trying to determine whether or not it should take the chance of being the first to market a particular type of product, and how long the product would be profitable.