Second-Mover Advantage
By Jon Birger, FORTUNE senior writer

(FORTUNE Magazine) - Who wants to be No. 1? As hot companies such as Lowe's (Research) and AMD (Research) show, second best is often better.

Anyone who watched short-track speed skating during the Winter Olympics knows that skating with the lead is no easy task. The No. 2 skater gets to conserve precious energy by drafting behind the leader. He watches the front-runner's every move, gauging when and where to make his bid for gold.

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Corporate America and speed skating have much in common these days. There are no safe leads. Fluid job markets, plugged-in consumers, and plentiful financing have ushered in an era of "perfect competition," to steal a phrase from Ed Yardeni, the veteran Wall Street strategist. In such an environment, being No. 2 has never looked better.

Just consider Lowe's. Home Depot (Research) invented the home-improvement superstore, and it's still putting up good numbers. Lowe's, though, is exploiting a calculated bet that Home Depot CEO Robert Nardelli made after taking the reins in 2000. He figured that given its size, Home Depot would do best to compete on price, cost and operational efficiency. Lowe's, with its brighter stores, wider aisles, and arguably more helpful salespeople, has positioned itself as the friendly alternative to Big Bad Orange.

It's a classic example of what game theorists call second-mover advantage: No. 2's gain an edge simply by observing what the first mover has done. For Lowe's the advantage has been substantial--and profitable. In late February, Lowe's reported that in the fourth quarter of 2005 its earnings surged 37%--compared with 23% at Home Depot. The stock market has taken notice: Shares of Lowe's returned 18% over the past year, to Home Depot's 7%.

Lowe's isn't the only No. 2 making mincemeat of the axiom that investing in industry leaders is the surest path to wealth. Target has been thumping Wal-Mart, PepsiCo is outfizzing Coca-Cola, and Advanced Micro Devices is chipping away at Intel, which lowered its sales guidance in early March. In fact, FORTUNE analyzed the stock returns of major U.S. companies in ten industries and found that the industry leaders by revenue returned a mere 2% over the past 12 months, vs. 21% for their second bananas. The gap in earnings growth--8% vs. 24%--was almost as great.

How did being No. 1 become such a downer? Geoffrey Moore, the management consultant who popularized investing in industry leaders in the 1997 bestseller The Gorilla Game, says there's been a backlash against the corporate world's alpha apes. "When I go meet with a company that's No. 1--a Microsoft or Cisco or SAP--one of the things I hear a lot is how mean it is out there," says Moore. "Being No. 1 these days means you become the natural target."

A case in point is Wal-Mart (Research). Target's employee benefits aren't much better than Wal-Mart's (see 60-Second Briefing on page 30), and like Wal-Mart, Target (Research) squeezes vendors and draws foot traffic away from Main Street shopping districts. And yet new Target stores face nowhere near the opposition that plagues proposed Wal-Marts.

"At the end of the day, it's not really about Wal-Mart," says Moore. "People are taking out a lot of their frustration against the modern age and finding a symbol. It's just one more set of problems facing the large institutional leader that the second guy doesn't have to deal with."

In the case of Intel (Research), the backlash is more than symbolic. For years computer makers bit their tongues as Intel bullied them into paying top dollar for its microprocessors. But with some AMD (Research) chips now considered superior, Intel is reaping what it's sowed. In the fourth quarter of 2005, AMD's worldwide share of the computer processor market reached 21.4%, up from 16.6% at the end of 2004, according to Mercury Research.

For its part, Intel has tried hard to expand its chip market beyond personal computers (into communications chips, for example), but so far the return on its R&D investment has been underwhelming. The problem may lie in the fluidity of today's job market. The same forces that drew top talent to Intel in the 1980s and '90s are pulling it elsewhere today. Talented young engineers are often more drawn to up-and-coming underdogs such as AMD -- as well as to smaller rivals such as Marvell and Broadcom -- than to staid old Intel.

Of course, just as in speed skating, AMD will have to make a dramatic move to pass its rival and get to the front of the pack. The question is, Why would it want to? Top of page