Creating Competitive Advantage

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Creating Competitive Advantage

• Ghemawat, Chapter Three Notes

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Average Economic Profits in the Steel Industry,
1978 -1996
Source Compustat, Value Line, Marakon Associates
Analysis
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Average Economic Profits in the Drug Industry,
1978 -1996
Source Compustat, Value Line, Marakon Associates
Analysis
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Calibrating Profit Drivers
Source Richard P. Rumelt, How Much Does
Industry Matter?, Strategic Management Journal,
1991 12167-185
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Added Value
Added value total industry value created with
the firm in the game - total value created
without the firm in the game OR EQUIVALENTLY the
value that would be lost to the industry if the
firm disappeared

• Under unrestricted bargaining, a firm cannot
  capture more than its added value
• If you (in your relationships with customers and
  suppliers) create no value, you can capture no
  value
• More generally, if a firm (in its relationships)
  creates no new value, it had better have some
  clever way of claiming value

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Value Creation

• Value is created by a business operating together
  with its customers and its suppliers
• A firm does not create value in isolation
• Willingness to pay the most that a customer
  will pay for a firms product
• Supplier opportunity cost willingness to
  receive the least that a supplier will accept
  for the resources required to make a product
• The value created by a transaction is the
  difference between the customers willingness to
  pay and the opportunity cost of the resources

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Value Division
Customer Firm Supplier
Willingness to pay
Value captured by customer
Price
Value captured by firm
Cost
Value captured by supplier
Supplier opportunity cost
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Activity Analysis of Competitive Advantage

• Added value gt goal is to drive a wedge between
  willingness to pay and (supplier opportunity)
  cost
• Indeed, a wider wedge than competitors achieve
• Problem a firm must often incur higher costs to
  deliver a better product or service
• Partial solution use activity analysis to spot
  opportunities to widen the wedge

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McKinseys Business System
Source Carter F. Bales, P.C. Chatterjee, Donald
J. Gogel, and Anapam P. Puri, Competitive Cost
Analysis, McKinsey Co. Staff Paper (January
1980)
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Value Chain for an Internet Start-Up
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Porters Generic Strategies
STRATEGIC ADVANTAGE
Stuck in The middle
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Small group exercise Name the generic
strategies in our cases

• Coca Cola
• PepsiCo
• Continental Can
• Crown Cork and Seal

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Interplay between Cost and Differentiation
price

cost
1.
3.
Industry average competitor
2.
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Porters Generic Strategies
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Cost Leadership Strategy

• Deliver a GOOD product or service at the lowest
  possible cost
• Open a significant and sustainable cost gap over
  all competitors
• Create advantage through superior management of
  key cost drivers
• Translates into above-average profits with
  industry-average prices
• BUT
• Cost leaders must maintain product parity or
  proximity in satisfying buyer needs
• Cost leadership often requires making trade-offs
  with differentiation

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Cost Drivers

• Scale
• Learning
• Pattern of capacity utilization
• Linkages
• Interrelationships

• Integration
• Timing
• Policies
• Location
• Institutional factors

Source Michael E. Porter, Competitive
Advantage (New York Free Press, 1985)
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Common Pitfalls in Cost Leadership

• Misunderstanding of actual costs
• False perception of cost drivers
• Focus on manufacturing
• Failure to exploit linkages
• Inadequate proximity to differentiators
• Ignoring competitor behavior
• Poor implementation
• Acting incrementally
• No cost management program

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The Differentiation Strategy

• Select one or more needs that are valued by buyer
• Achieve and sustain superior performance by
  meeting these needs uniquely
• Selectively add costs if necessary to do so
• Successful differentiation leads to premium prices

• Differentiators must pick cost-effective forms of
  differentiation
• Differentiation leads to above-average
  profitability provided the firm maintains cost
  parity or proximity to competitors

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Common Pitfalls in Differentiation

• Creating differentiation that buyers do not value
• Over-fulfilling buyer needs
• Looking too narrowly at the sources of
  differentiation
• Charging an excessive price premium
• Failing to understand costs of differentiation
• Ignoring signals of value
• Failing to recognize buyer segments
• Creating differentiation that competitors can
  emulate quickly or cheaply

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Focus Strategy

• Exploits the same fundamental types of
  competitive advantage
• Selects narrow target segment(s) with unusual
  needs
• Creates optimal strategy for the target

Narrowing of scope creates cost
or differentiation advantage
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Can business do more than one?

• Overall Cost
• Leadership
• Differentiation

OR

• Focus

• Sometimes consistent
• But requires defense against a competitor
  achieving one or the other

• Can have multiply-focused entities in one company

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Stuck in the middle

• A company can be stuck in the middle if
• A differentiator attempts to cut costs that are
  essential to its differentiation
• A low cost leader incurs costs, above those which
  are essential to its low cost position, which do
  not differentiate the product
• A focus company attempts to broaden its strategic
  target beyond the segments in which it has an
  advantage
• In other words, by incurring costs, or by cutting
  costs, or by pursuing markets that reduce the
  wedge

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An Expanded Version of Generic Strategies

• Extend BCG framework to include a broader set of
  cost structures
• Extend Porters five forces to recognize a more
  diverse set of competitive environments
• Apply the economic theory of long run average cost

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LRAC Review
Experience advantages decline with volume, Scale
advantages exhausted at optimal scale, If no
change in technology, no advantage to volume
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Strategy and long-run average cost
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Competitive Strategy and Long Run
Cost/Differentiation I

• Volume Industry
• Low cost leadership type markets
• There is an advantage in scale or technology
• Stalemate Industry
• Cant differentiate
• Economies of scale, experience common to
  competitors
• No process innovation

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Competitive Strategy and Long Run
Cost/Differentiation II

• Fragmented Industry
• Differentiation is key competitive factor
• Niche strategy
• Volume in niches inadequate to achieve volume
  cost advantages
• Profitable and defensible industry
• Differentiated product
• Customer preference
• Low cost producer of differentiated product
• Transitory industry
• Cost advantage based on labor
• Cost advantage based on any other temporary
  advantage

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Small group exercise Provide an example of a
cost leadership strategy in one of our cases
(identify the company and provide some detail)

• Cola wars and beverage industry
• Coors and brewing industry
• Crown Cork and Seal
• DeBeers and the diamond industry

• Egghead and the retail industry
• Barnes and Noble, Amazon and the retail book
  industry

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Small group exercise Provide an example of a
differentiation strategy in one of our cases
(identify the company and provide some detail)

• Cola wars and beverage industry
• Coors and brewing industry
• Crown Cork and Seal
• DeBeers and the diamond industry

• Egghead and the retail industry
• Barnes and Noble, Amazon and the retail book
  industry

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Small group exercise Provide an example of a
focus strategy (either cost or differentiation)
strategy in one of our cases (identify the
company and provide some detail)

• Cola wars and beverage industry
• Coors and brewing industry
• Crown Cork and Seal
• DeBeers and the diamond industry

• Egghead and the retail industry
• Barnes and Noble, Amazon and the retail book
  industry