Ch 2. Competitive Advantage
STRA 6201
Lecture 1
1
Plan for Today
• Internal Analysis: Preview of Strategy Execution
• Resources and Capabilities and Links to Competitive Advantage
• Competitive Advantage
•
•
•
•
Value-Cost [VC] framework
Generic strategies and Stuck in the middle
Cost & Value Drivers
Isolating Mechanisms
2
What Determines a Firm’s Profitability?
Forces in the overall economy (e.g.,
regulation, interest rates, tax policy)
Conditions specific to an industry
(e.g., presence of powerful buyers)
Leaders’
strategic choices
shaped by their
experiences,
cognition,
personality, values,
etc.
Building Sustainable Competitive Advantage
Value
Drivers
Cost
Drivers
Resources
Capabilities
Offense: Creating Superior
[V–C] Profile
Retaining
Customers
Preventing
Imitation
Defense: Protecting the [V-C]
Profile via Isolating Mechanisms
Sustainable
Competitive
Advantage
• Both offense and defense are
• Necessary for sustainable competitive advantage
• Built upon strong resources and capabilities
Internal Analysis: Resources and Capabilities
• Resources
• What firms HAVE
• The tangible and intangible assets controlled and drawn on by a firm that can
be used to plan and implement its strategies
• Can be acquired or developed
• e.g. capital, fixed assets, employees, patents, brand, knowledge
• Capabilities
• What firms CAN DO
• Managerial and organizational skills that a company uses to organize &
(re)deploy its resources
• Developed by people through coordinated action, built through specific
routines, policies and practices
• e.g. teamwork, marketing skills, supplier management skills
• A firm’s expertise in exploiting a resource strongly influences how much it is
worth to the company
5
Internal Analysis: Resources and Capabilities
• Not all resources and capabilities contribute to sustainable competitive
advantage: They must be…
•
•
•
•
•
Valuable
Rare
Costly to imitate or substitute
Non-substitutable
Appropriable
• Resource Complementarity:
• Complementarity among a firm’s resources: more effective together than
when used independently
• A firm can make better use of developed/acquired resources when they have
stronger complementarities with the existing resources of the firm
• A useful barrier to imitation
6
Building Sustainable Competitive Advantage

Value
Drivers
Cost
Drivers
Resources
Capabilities
Offense: Creating Superior
[V–C] Profile
Retaining
Customers
Preventing
Imitation
Defense: Protecting the [V-C]
Profile via Isolating Mechanisms
Sustainable
Competitive
Advantage
The Value-Cost Framework
Value (= willingness to pay)
Buyer's
Surplus:
Value – Price
Economic Value
Captured
Firm's
Surplus:
Price – Cost
(= profit)
Price
Unit Cost
Economic Value Created:
Value – Cost
Linking Value and Cost to Profit
• Why does a firm have an advantage when the difference V – C, not P – C,
is bigger than its competitors? Why does V matter?
• Profit = Q * (P – C)…
•
… where is V??
• Q = f(V, P)
• Consumer demand Q is an increasing function of [V–P]
9
Positioning for Advantage: the Value side
• Invest in resources and/or capabilities to increase value and induce
buyers to switch to your firm's offerings
• Provides 2 ways to increase V-C: Increase value and…
• Charge the same price: same unit profit but increased demand
• Increase the price: same demand but increased P-C
• Can create an advantage when:
• Increased volume (Q) due to larger relative V-P is sufficient to cover
investment (C)
• More attractive when:
• The value-improving investments produce a higher return than the efforts to
reduce costs
10
Approach 1: Increase Value, Don’t Change Price
Firm A
Firm B
V2=130, V2-P=70
V1=100, V1-P=40
V=100, V-P=40
Additional Value
Captured by the
Buyer
Price P=60
Total profit: 10*10 = 100
Total profit: 10*30 = 300
Total profit: 5*40 = 200
C3=50, P-C3=10,
V2-C3=80
C2=30, P-C2=30,
V2-C2=100
C1=20, P-C1=40
V1-C1=80
C=20, P-C=40
V-C=80
Value Creation: Larger V-P attracts value sensitive buyers  volume at time 1
(Q1) increases to volume at time 2 (Q2)
Firm A’s Value Capture: Requires sufficient volume increase to cover costs or
low enough costs to benefit from increased volume: (P-C2)Q2 > (P-C1)Q1
Approach 2: Increase Value and Price
Firm A
Firm B
V=130, V-P=70
Additional Value
Captured by
Firm A
Price
P=60
P2=90, V-P2=40
P2-C=60
C=30, P-C=30
V-C=100
V=100
V-P=40
C=20, P-C=40
V-C=80
 Value Capture by Firm A: Larger P-C per unit
 Maintain Demand: V-P is same as before, so Q2 should equal Q1
Positioning for Advantage: the Cost side
• Invest in resources/capabilities to reduce cost
• Provides 2 ways to increase V-C: Reduce cost and…
• Charge the same price: no increase in demand but larger P-C
• Reduce price: increases V-P and demand (price-sensitive buyers)
• Can create an advantage when:
• Reduced cost is low enough that P-C can cover any decrease in demand (Q)
due to compromised value
• Price is low enough to ensure a large enough V-P (buyer’s surplus) to
increase demand
• Less attractive when
• All firms in an industry can achieve process innovation (i.e., increase
efficiency) or access the same sources of low-cost inputs
13
Approach 1: Reduce Cost and Price
Firm A
V=100, V-P=40
V2 = 95
Additional Value
Captured by
the Buyer
Firm B
V=100, V-P=40
Price
P=60
P2=50, V2-P2=45
C=40, P-C=20
V-C=60
C=40, P-C=20
V-C=60
C2=30, P2-C2=20
V2-C2 = 65
 Value Creation: Larger V-P induces buyers to switch (Q2 > Q1).
 Value Capture: Margin maintained but Q2 > Q1  Firm A captures more value
Approach 2: Reduce Cost, Keep Price
Firm A
Firm B
V=100, V-P=40
V=100, V-P=40
C=40, P-C=20
V-C=60
C=40, P-C=20
V-C=60
Price
P=60
Additional Value
Captured by
Firm A
C2=30, P-C2=30
V-C2=70
 Value Creation & Value Capture: Firm A captures a larger P-C.
 Maintain Demand: V and P are same as before, so Q2 should equal Q1
Generic Strategies
• Cost-focused, or cost-leadership strategy
• A firm tries to gain competitive advantage by decreasing the cost of its
products relative to the cost of other firms' products
• By reducing the costs of its products, the firm will be able to charge a lower
price than it would otherwise  attracts price-sensitive customers
• Main focus: cost drivers
• Value-focused, or differentiation strategy
• A firm tries to gain competitive advantage by increasing the perceived value
of its products relative to the perceived value of other firms' products
• By increasing the perceived value of its products, the firm will be able to
charge a higher price than it would otherwise  attracts value-sensitive
customers
• Main focus: value drivers
16
Challenges and Risks to Generic Strategies
• Cost Leadership:
• Often requires high capital investment
• Can be more easily imitable
• Mass production can undermine value and differentiation
• Differentiation:
• Buyers’, not producers, determine the product's value – hard to predict!
• Bathroom tissue commercial
• Jimmy Kimmel Live
• Value is multi-dimensional – “quality” is not the only dimension that matters
• Producing high-value products undermines attempts to control costs
17
Substitutes or Complements?
18
Profitability when being in the Middle
• “Stuck in the Middle”
• Cannot compete on value with the differentiator or on cost with the cost
leader
• Has a customer base that is too small to allow it to improve its competitive
position
• “Middle is just right”
• ‘Value innovation’: offering a differentiated product or service at low cost;
reconcile the inherent trade-offs
• Cornerstone of Blue Ocean Strategy (new, uncontested market spaces)
• IKEA, Trader Joe’s, Toyota, Target
Common Value and Cost Drivers
• Value Drivers
•
•
•
•
•
•
•
•
Technology/Quality
Customization
Customer service
Complements
Brand
Breadth of line
Geography (location, scope)
Risk assumption (e.g., warranties)
• Cost Drivers
•
•
•
•
•
Low input costs
Scale economies
Scope economies
Learning curve
Process innovation /
Organizational practices
Building Sustainable Competitive Advantage

Value
Drivers
Cost
Drivers

Resources
Capabilities
Offense: Creating Superior
[V–C] Profile
Retaining
Customers
Preventing
Imitation
Defense: Protecting the [V-C]
Profile via Isolating Mechanisms
Sustainable
Competitive
Advantage
Retaining Customers
Improve buyer’s surplus
• Increase value and/or lower price
Build buyers’ switching costs
• Transition costs: Costs from shifting from old product to new
• Learning costs: Costs incurred in learning a new process
• Customer loyalty
Preventing Imitation
• Property rights
• Patents, Trademarks
• Turning external resources into Dedicated Assets
• Tying up suppliers of low cost inputs
• Partnerships, Long-term Contracts
• Causal ambiguity
• Multiple resources and/or their interconnections disguise the source of an
advantage
• Example: Southwest Airlines
• Time compression diseconomies
• Building advantage often takes time
• One-time investments with continuing economic benefits: brand (e.g.,
advertisement: Coke/Pepsi), R&D (e.g., drugs)