At Wharton’s management strategy and business environment conference on March 26 and 27, scholars from around the world discussed an often-overlooked but critical variable in business – how law affects the competitive process.
In one session, Eric Novotny, vice president of Lockheed Martin, explained the regulatory and competitive minefields that lay in the path of some of the most successful collaborations to emerge from the Cold War – joint ventures between former Soviet countries (mainly Russia and the Ukraine ) and U.S. partners to market missile technology for commercial use. In another session, Richard Shell, legal studies professor at Wharton, presented the general framework he has developed for analyzing many different kinds of what he calls “competitive legal strategies.” His research is contained in a new book to be published later this month entitled, Make the Rules or Your Rivals Will.
Peace in the Satellite Launch Market
Novotny noted in his presentation that rocketry had long been one of the strengths of the former Soviet Union. Once that entity was dismantled and Russia veered toward a free market system, the country’s scientists and newly-minted entrepreneurs were eager to commercialize their technological expertise. Using world-class rockets to launch commercial satellites offered an appealing business opportunity. “The political constraints and the international regime that had governed missile technology were no longer appropriate to deal with the fact that the Russians simply wanted to sell their technology around the world,” said Novotny, who is also an adjunct professor at American University. “The same ballistic missiles that carry nuclear warheads can also launch communications satellites.”
But that presented both the U.S. government and U.S. missile manufacturers with a dilemma. The U.S. wanted to encourage the growth of capitalism in the former Soviet Union but feared security risks from the unregulated sale of Russian missile technology. U.S. rocket companies, meanwhile, feared new, low-price competitors. What was needed was a new set of rules. The only question was: Who would make them?
The two main parties to the negotiation – the governments of the United States and Russia – had both contradictory and complementary interests. Besides its security concerns, the United States wanted to stabilize the Russian economy and protect its own domestic launch businesses. “The Russians could have under-priced the established providers” because their costs, starting with labor, were so much lower, Novotny pointed out. The Russians, for their part, needed to generate foreign exchange and acquire the business expertise to market their launch services worldwide. And they didn’t want to antagonize the United States government.
The two governments, in cooperation with the main players in the satellite launch market, sat down and hammered out an approach that was acceptable to both sides. The result was two agreements, one in 1992 and one in 1994, establishing new rules for commercial satellite launches. The rules let Russian and Ukrainian companies enter the launch business – but in a controlled way. First, they could do so only through joint ventures with American companies. Next, the agreement established an annual quota for launches and price controls to prevent the new ventures from underselling established companies.
The quota was easy to enforce because missile launches are easy to count. Price limits proved thornier. “In a competitive bidding situation, you couldn’t really know whether you had met the differential of being no more than 15% below a Western supplier,” Novotny noted. “So that was quickly dropped, but the quota was kept until the year 2000 when the Clinton administration let it lapse.”
Novotny argued that the rules have been a success, giving all parties what they needed. The U.S. government channeled Cold War technology to peaceful ends while boosting a promising industry and the Russian economy. The Russians and Ukrainians got access to Western business expertise and much-needed foreign exchange. U.S. launch companies haven’t been overrun by cheap competition and satellite owners have more choices among launch providers.
Buying a Six-Pack
The idea that business needs to pay chose attention when market rules are written – and can garner profits through skilled interaction with legal and regulatory institutions – was underlined during Shell’s presentation during which he emphasized that business people too often give short shrift to legal matters and thus ignore their strategic importance. “The law’s complexity and a dislike of dealing with lawyers and government officials lead many to neglect the law as a competitive tool,” Shell argued. But legal strategy can give companies just as durable an advantage over competitors as, say, a new product or a captive supplier. And legal strategy, he said, means more than just the regulatory and political matters that made the Russian rocket venture work. It also includes litigation and strategic contracting.
Conversely, he noted, companies ignore legal strategy at their peril. Laws are the rules by which the game of business is played. Sometimes, they level the playing field. More often, they tilt it in favor of one group of companies or sector – typically the one that has been cunning enough to involve itself in the rule-making process by lobbying legislators and regulators. As was the case in the Russian rocket venture, Shell noted, “Someone is going to make the rules. The only question is who.”
Another example of this strategy, written about in Shell’s book, has to do with beer. Buying a six-pack of beer can be a costly hassle in Pennsylvania, which is just how local bar owners want it – and planned for it. Under Pennsylvania law, a consumer can’t buy a six-pack from a grocery or convenience store or even a beer distributor. Only bars and delis can sell them. Just as restaurants serve takeout food, bars sell takeout beer. And they charge premium prices. Distributors can sell beer, but by the case, not the six-pack. Tavern owners and their hirelings in Pennsylvania ’s state capital, Harrisburg, lobby to maintain these rules.
Shell’s goal is to give business people a road map for making strategic legal decisions. He had found in his research that “what was missing was a set of simple but accurate rules to show how this stuff might apply as a business strategy variable.” By studying struggles ranging from Henry Ford’s battle with an automobile cartel in 1903 to the trials and tribulations of Microsoft and Napster, Shell identified five factors that the best legal minds take into account using the law as a strategic tool which he outlined for conference participants.
The five factors are: the legal merits, public legitimacy, strategic position, resources and access. The meaning of a given legal issue’s merits is obvious: It’s the strength of a company’s legal or political case; the stronger one should win and usually does. But Shell pointed out that how a case plays in the court of public opinion – its public legitimacy – can be just as important as the legal arguments. The music industry’s lawsuit against college students and other music downloaders on the Internet, for example, have cost it enormous good will, even though the cases are slam dunks under copyright law.
Strategic position is Shell’s way of taking into account the sorts of things other strategists often examine – market dominance, for example. A dominant firm can use nonlegal means such as pricing power to pressure its adversary in a legal dispute. Resources often flow from strategic position – bigger, dominant firms typically have more money. As Shell says in his book, “David rarely beats Goliath in corporate legal wars.”
Access means, in essence, the ability to get important people – lawmakers and regulators – to return your calls and support your position. While it should flow naturally from company size, it doesn’t. Some big companies invest heavily in lobbying. Others don’t. Microsoft, for example, was famously stingy with political contributions and spending on lobbying until its antitrust tangle with the Justice Department, Shell says. These days, it has a sizable staff of lobbyists and generously doles out political contributions. Microsoft’s earlier stance demonstrates how paying insufficient attention to legal strategy can hurt a company.
Sometimes, ill-considered legal strategies can have long-lasting implications. Shell illustrated this point by telling a story about Coke and its relationship with its bottlers. In 1899, two lawyers approached Asa Candler, then president of Coca-Cola Co., with a proposition. They wanted the exclusive right to bottle and distribute Coke, which was then sold mainly at soda fountains. Candler didn’t have much faith in bottling and signed a contract under which he agreed to sell the lawyers Coke syrup for $1 a gallon and gave them the right to use the Coca-Cola trademark on the drink. According to Shell, the contract included no provision for renegotiation or termination; Coke was locked in as long as the bottlers kept living up to their end of the deal.
This strategic contract created a money machine for the two Memphis-based lawyers. They would buy the syrup for $1 a gallon and resell it for $1.25 to companies they licensed to do the bottling. “Some business historians think this contract inadvertently established Coke as America ’s first national drink because it gave the bottlers so much to gain,” Shell explained. “With profits literally pouring in, the bottlers spread the brand to every corner of America as fast as their trucks could carry them.”
Coke challenged the contract in court in 1920 but lost. It remains in force today. In other words, legal strategy – or, in this case, a legal strategic mistake – can play a hefty role in even a lightly regulated industry such as soft drinks.
Shell suggested that participants think of ways to make competitive legal strategy more accessible to business managers and leaders. “The smartest people – like Bill Gates, Rupert Murdoch, and Sumner Redstone – are experienced hands at legal maneuvers,” he said. “But we need to help newcomers gain this knowledge so they can learn their lessons without losing their companies.”