Competitive analysis: do managers accurately compare their firms to competitors?

Analysis of one's competitors has long been a staple of firms' competitive preparation. Much has been written about why and how competitive analysis should be performed (Fuld, 1985; Porter, 1980). For instance, in order to select appropriate strategies, firms frequently perform analyses of their competitors' strengths, weaknesses, opportunities, and threats (SWOT). Due to the relational nature of the SWOT analysis, competitors' capabilities must be determined in order to compare them against the strengths and weaknesses of the focal firm.

Although many different competitive analysis tools exist, and there is wide variance in their use among firms (Cartwright et al, 1995), it is assumed in some of the major strategic theories that competitors know each other fairly well. Two significant views in the strategy field presume that firms actively engage in competitive analysis in order to understand how their own firm matches up against its competitors. As one significant strategic view, Institutional Theory suggests that firms become more similar over time provided they are in the same organizational field (Giddens, 1979). In contrast, the resource-based view (RBV) of the firm claims that firms look for some way to be unique in order to gain a competitive advantage (Barney, 1986, 1991). Institutional Theory and the RBV both assume that firms are able to grasp the similarities and differences between themselves and their competitors. For firms to become more similar to or more different from their competitors, they must accurately discern the specif ic areas in which they are already similar to and different from their competitors. For instance, Institutional Theory presumes that firms come to know one another through competitive and social interactions, membership in common industry associations, professional networks, and the hiring of employees from other firms in the same industry (DiMaggio and Powell, 1991; Scott, 1991). Although the Resource-based view (RBV) of the firm does not make all the same claims as to how firms get to know one another, the implication is that through normal competition and competitive analysis, firms increase their understanding of their competitors. This study aims to ascertain how well direct competitors know each other, and whether competitors of the same type are more apt to know each other better than competitors of a different type know each other.

Below, we discuss the importance of judging the competitive similarities and differences between firms and their competitors when firms perform competitive analysis and formulate strategies. Next, we discuss the presumed accuracy of competitor perceptions of similarities and differences, as suggested by Institutional Theory and the RBV. Then, we explain why perceptions of similarities and differences among competitors are more likely to be shared when the competing firms are of similar types. This is followed by a description of the empirical investigation of the preceding issues and an explanation of the results. The last section presents the limitations of the investigation and discusses the implications of the findings.

Competitive Similarities and Differences

The environment in which a firm operates influences the perceptions of managers of firms within that environment (Fombrun and Zajac, 1987; Giddens, 1979). This influence occurs as managers process the information contained in the environment in order to make decisions and guide their firms (Porac et al., 1989). Thus, the actions that firms engage in are a result of managerial interpretations of the environment (Thomas et al., 1993). Researchers have suggested that managerial interpretations can, at times, result in shared mental models within industries as competitors simultaneously observe and interpret the same environment (Porac and Thomas, 1990). However, the extent to which interpretations are shared by managers in competing firms may be influenced by the amount of objective information that is available (Chen, 1996).

One of the key areas of management perception and interpretation is the set of characteristics of direct competitors of a firm (Chen, 1996). Managerial perceptions of similarities and differences between their firm and competitors are the basis for collective recognition and action by a firm (Deephouse, 1999; Weick, 1979). If managers want their firm to be more like its competitors, and they think their firm is similar to competitors in certain areas but not others, then the firm will try to increase the similarity of some of the areas that are currently different. For example, if a firm and its competitor both cater to the high-priced segment of a market, but the competitor has a stronger reputation, the firm may try to bolster its reputation through advertising and increased emphasis on product quality in order to match its competitor's reputation. Similarly, if managers want the firm to be different from its competitors, they will increase the distinctiveness of some of the areas of the firm that are curre ntly similar to competitors. For example, the firm just mentioned may decide to offer a lower entry-price point instead of trying to match its competitor's reputation.

Firms engage in competitive analysis to gain a better understanding of their competitors' resources, capabilities, and strategies (Porter, 1980). Smith et al. (1992) detailed how firms in the airline industry initiate strategies and respond to competitors' strategies. Smith et al. portrayal of the dynamics of strategy illustrates the importance of understanding competitors. The perception of similarities and differences among competing firms can drastically affect the types of competitive behaviors in which a firm engages (Thomas et al., 1993).

According to Fox and Tversky (1995), individuals are willing to commit more funds to known risks than to lesser-known risks when both are present and payoffs are similar. The gathering of competitive intelligence, whether proactively or passively through the course of normal business dealings, should increase competitor knowledge. But how well do competitors really know each other? Because firm actions and responses influence performance (Chen and Hambrick, 1995), if firms are incorrect in their perceptions of their similarities to and differences from competitors, they can mistakenly make competitive moves that inhibit, rather than assist, their intended course of action and their future ability to compete (Farjoun and Lai, 1997).

The degree to which a firm's perceptions of similarity are shared by its competitors is also of interest. Firms that view themselves as similar to or different from their competitor may assume their competitor feels likewise. As demonstrated in game theory, when information is clearly specified and known to all parties involved, the parties can predict how the others will behave based on rational decision making (Nowak et al., 2000). However, if a firm assumes that its competitor perceives their degree of similarity the same way the firm does and the competitor does not, then strategic mistakes can be made. If competitors disagree much of the time about their similarities and differences, it can have repercussions on researchers as well. Assumptions made in Institutional Theory and the RBV about firms becoming more similar or more unique over time must be tempered with explanations of how this occurs when competitors frequently differ in their own presumptions of similarity.

Accuracy of Finns Perceptions of Competitors

How well do managers know the similarities and differences between their firm and their competitors? If agreement between the two managers of competing plants as to their plants' similarities or differences can be considered an indication of knowing, then higher levels of agreement may indicate that the firms know one another fairly well, and lower levels of agreement do not. Unfortunately, there is a paucity of research in the area of competitive knowledge. It is unclear how well competitors actually know each other. However, we argue that direct competitors spend more time paying attention to and evaluating their direct competitors than they do with other firms, and so they are likely to know their direct competitors better than they know other types of firms. This view is supported by cognitive group research where shared mental models have been predicted to develop among competing firms to a greater extent than they develop among firms in the same industry that do not actively compete (Porac and Thomas, 1 990; Porac et al., 1989). But this does not address how well direct competitors actually know each other. So, in an exploratory manner, one of the conditions that this research tries to evaluate is the degree to which direct competitors know each other.