The Nature and Sources of
Competitive Advantage
OUTLINE
• The emergence of competitive advantage
• Sustaining competitive advantage
• Competitive advantage in different market
settings
• Types of competitive advantage: cost and
differentiation
What is competitive advantage?
• The potential to earn a persistently high rate
of profit
• Not the same as profitability
– Long term investments may not show up in
short term profits
• Investing in market share, technology, customer
loyalty or even executive perks
The Emergence of Competitive Advantage
How does competitive
advantage emerge?
External sources of
change e.g.:
•Changing customer demand
•Changing prices
•Technological change
Resource heterogeneity
among firms means
differential impact
Internal sources
of change
Some firms faster
and more effective
in exploiting change
(Time-based competition)
Some firms
have greater creative
and innovative
capability
Competitive Advantage from InternallyGenerated Change: Strategic Innovation
•
Many argue innovation is the only remaining source of competitive
advantage (e.g. Hamel)
– Kao (2007) Innovation Nation: How America is Losing its Innovation
Edge, Friedman (2005) The World is Flat
• Talent is everywhere, capital is everywhere, Silicon valley is everywhere
Characteristics of innovation strategies:
– Associated with new entrants to an industry (e.g. Nucor in steel,
–
IKEA in furniture, Home Depot in DIY, Dell in PCs, American Apparel in casual
clothing)
Reconcile conflicting performance goals (e.g. Toyota’s lean
production system combines low cost, high quality, and flexibility. Retailers
Primark and Target combine low cost with stylishness.)
– Reconfiguring the value chain e.g.--• Nike’s system for manufacturing and distributing shoes totally different from
traditional shoe manufacturer
• Southwest Airlines simplification of the normal airline value chain
• Zara’s system of design, manufacture, and distribution
Sustaining Competitive Advantage Against Imitation
REQUIREMENT FOR IMITATION
Identification
Incentives for imitation
ISOLATING MECHANISM
- Obscure superior performance
- Deterrence--signal aggressive
intentions to imitators
- Pre-emption--exploit all available
investment opportunities
Diagnosis
- Rely upon multiple sources of
competitive advantage to create
“causal ambiguity”
Resource acquisition
- Base competitive advantage upon
resources and capabilities that are
immobile and difficult to replicate
Competitive Advantage in Different Industry Settings:
Trading Markets and Production Markets
MARKET
TYPE
SOURCE OF
IMPERFECT
COMPETITION
TRADING
MARKETS
• None (efficient markets)
• Imperfect information
• Transactions costs
• Systematic behavioral trends
• Overshooting
• Barriers to imitation
PRODUCTION
MARKETS
• Barriers to innovation
OPPORTUNITY
FOR COMPETITIVE
ADVANTAGE
None
Insider trading
Cost minimization
Superior diagnosis
(e.g. chart analysis)
Contrarianism
Identify potential barriers to
imitation (e.g. deterrence,
preemption, causal ambiguity,
resource immobility, etc.) &
base strategy upon them.
Difficult to influence or
exploit.
Sources of Competitive Advantage
COST
ADVANTAGE
COMPETITIVE
ADVANTAGE
DIFFERENTIATION
ADVANTAGE
Concept of “stuck in the middle”
Porter’s Generic Strategies
SOURCE OF COMPETITIVE ADVANTAGE
Low cost
Differentiation
Industry-wide
COMPETITIVE
COST
DIFFERENTIATION
LEADERSHIP
SCOPE
Single Segment
FOCUS
Features of Cost Leadership and
Differentiation Strategies
Generic strategy
Key strategy elements
Resource & organizational
requirements
COST
LEADERSHIP
Scale-efficient plants.
Design for manufacture.
Control of overheads &
R&D. Avoidance of
marginal customer
accounts.
Access to capital. Process
engineering skills. Frequent
reports. Tight cost control.
Specialization of jobs and
functions. Incentives for
quantitative targets.
DIFFERENTIATION
Emphasis on branding
and brand advertising,
design, service, and
quality.
Marketing. Product
engineering. Creativity.
Product R&D
Qualitative measurement
and incentives. Strong
cross-functional
coordination.
Cost Advantage
OUTLINE
• Economies of experience curve and the
benefits of market share
• Sources of cost advantage
• Using the value chain to analyze costs
• Current approaches to managing costs
The Experience Curve
The “Law of Experience”
1992
1994
Cost per
unit of
output (in
real $)
The unit cost value added to a standard
product declines by a constant % (typically
20-30%) each time cumulative output doubles.
1996
1998
2000
Cumulative Output
2002
2004
Examples of Experience Curves
75%
100K 200K
500K
1,000K
Accumulated unit production
(millions)
UK refrigerators, 1957-71
Price Index
50 100 200 300
1960 Yen
15K
20K 30K
Japanese clocks & watches, 1962-72
70% slope
5
10
50
Accumulated units
(millions)
The Importance of Market Share
If all firms in an industry have the same experience curve, then:
Change in relative costs over time = f (relative market share)
ROS (%)
-2 0
5
10
This implies that market share is linked to profitability. This is
confirmed by PIMS data:
0-10
10-20 20-30 30-40
Market Share (%)
over 40
BUT: - Association does not imply causation
- Costs of acquiring market share offset the returns to market
share
Drivers of Cost Advantage
ECONOMIES OF SCALE
ECONOMIES OF LEARNING
PRODUCTION TECHNIQUES
PRODUCT DESIGN
INPUT COSTS
CAPACITY UTILIZATION
RESIDUAL EFFICIENCY
• Indivisibilities
• Specialization and division of labor
• Increased dexterity
• Improved organizational routines
• Process innovation
• Reengineering business processes
• Standardizing designs & components
• Design for manufacture
• Location advantages
• Ownership of low-cost inputs
• Non-union labor
• Bargaining power
• Ratio of fixed to variable costs
• Speed of capacity adjustment
• Organizational slack; Motivation &
culture; Managerial efficiency
Economies of Scale: The Long-Run
Cost Curve for a Plant
Sources of scale economies:
- technical input/output relationships
- indivisibilities
- specialization
Cost per
unit of
output
Minimum
Efficient Plant
Size: the point
where most
scale economies
are exhausted
Units of
output
per period
The Costs Developing New Car Models
(including plant tooling)
$ billion
Ford Mondeo / Contour
GM Saturn
Ford Taurus (1996 model)
Ford Escort (new model 1996)
Renault Clio (1999 model)
Chrysler Neon
Honda Accord (1997 model)
BMW Mini
Rolls Royce Phantom (2003 model)
6
5
2.8
2
1.3
1.3
0.6
0.5
0.3
Scale Economies in Advertising: U.S. Soft Drinks
Advertising Expenditure ($ per case)
0.20
0.15
0.10
0.05
0.02
Despite the massive advertising budgets of brand leaders Coke and Pepsi, their
main brands incur lower advertising costs per unit of sales than their smaller rivals.
Schweppe
s
SF Dr. Pepper
Diet 7-Up
Tab
Diet Pepsi
Diet Rite
Fresca
Seven Up
Dr. Pepper
Sprite
Pepsi
10
20
50
100
200
500
Annual sales volume (millions of cases)
Coke
1,000
Cost Advantage in Short-Haul
Passenger Air Transport
Costs per Available Seat-Mile
Southwest Airlines
(cents)
Wages and benefits
2.4
Fuel and oil
1.1
Aircraft ownership
0.7
Aircraft maintenance
0.6
Commissions on ticket sales
0.5
Advertising
0.2
Food and beverage
0.0
Other
1.7
Total
7.2
United Airlines
(cents)
3.5
1.1
0.8
0.3
1.0
0.2
0.5
3.1
10.5
Applying the Value Chain to Cost Analysis:
The Case of Automobile Manufacture
STAGE 1. IDENTIFY THE PRINCIPAL ACTIVITIES
PURCHASING
PARTS
INVENTORIES
R&D
TESTING,
COMPONENT
ASSEMBLY
DESIGN
QUALITY
MFR
ENGNRNG
CONTROL
GOODS
INVENTORIES
SALES DISTRI- DEALER &
&
BUTION CUSTOMER
MKITG
SUPPORT
STAGE 2. ALLOCATE TOTAL COSTS
Applying the Value Chain to Cost Analysis: The Case
of Automobile Manufacture (continued)
STAGE 3.
IDENTIFY
COST
DRIVERS
PURCHASING
PARTS
INVENTORIES
--Plant scale for each
component
-- Process technology
-- Plant location
-- Run length
-- Capacity utilization
-- Level of quality targets
-- Frequency of defects
R&D
COMPONENT ASSEMBLY TESTING,
DESIGN
QUALITY
MFR
ENGNRNG
CONTROL
Prices paid
--Size of commitment
depend on:
--Productivity of
-- Order size
R&D/design
--Purchases per
--No. & frequency of new
supplier
models
-- Bargaining power
-- Supplier location
GOODS
INVENTORIES
-- Plant scale
-- Flexibility of production
-- No. of models per plant
-- Degree of automation
-- Sales / model
-- Wage levels
-- Capacity utilization
-- No. of dealers
-- Sales / dealer
-- Level of dealer
support
-- Frequency of defects
under warranty
SALES
&
MKITG
DISTRI- DEALER &
BUTION CUSTOMER
SUPPORT
--Cyclicality &
predictability of sales
--Customers’
willingness to wait
Applying the Value Chain to Cost Analysis: The Case
of Automobile Manufacture (continued)
STAGE 4. IDENTIFY LINKAGES
Consolidation of orders to increase
discounts, increases inventories
PRCHSNG
PARTS
INVNTRS
R&D
DESIGN
Designing different models around
common components and platforms
reduces manufacturing costs
COMPONENT
MFR
Higher quality parts and materials
reduces costs of defects
at later stages
ASSEMBLY
TESTING GOODS
QUALITY
INV
SALES DSTRBTN DLR
MKTG
CTMR
Higher quality in manufacturing
reduces warranty costs
STAGE 5. RECCOMENDATIONS FOR COST REDUCTION
Dynamic vs. Static Approaches to
Manufacturing
DYNAMIC
(Artisan Mode)
PRODUCTION
SYSTEM
MANAGEMENT
OF
TECHNOLOGY
 problem solving
 people matched to tasks
 create employee knowledge
 employees control
production
 customer orientation
 continuous, incremental
improvement
 market needs pull technology
 product and process
innovation
 teamwork and crossfunctional collaboration
STATIC
(Scientific
Management Mode)
 quest for “one best way”
 planning & control by staff
 Incentives and penalties to
ensure conformity to
objectives
 science driven
 focused around
corporate R&D
departments
 emphasis on big
projects
Recent Approaches to Cost Reduction
CORPORATE
RESTRUCTURING
BUSINESS
PROCESS
REENGINEERING
“Obliterate don’t
automate”
Dramatic changes in strategy and structure
to adjust to the business conditions of the 1990’s
Key elements:
• Plant closures
• Outsourcing
• Delayering and cuts in administrative staff
The fundamental rethinking and radical
redesign of business processes to achieve
dynamic improvements in performance. e.g.:• Several jobs combined into one
• Steps of a process combined in natural order
• Minimizing steps, controls, and reconciliation
• Use case managers as single points of contact
• Hybrid centralization/ decentralization
Harley Davidson Case
• Identify Harley-Davidson’s strategy and explain its
rationale.
• Compare Harley-Davidson’s resources and capabilities
with those of Honda. What does your analysis imply for
• Harley’s potential to establish cost and differentiation
advantage over Honda?
• What threats to continued success does Harley-Davidson
face?
• How can Harley-Davidson sustain and enhance its
competitive position?