Formulating Business Strategy
Chapter 6
Team 6
Jessica Aragon
Raynee Bradley
John Cayo
Lawrence Griffith
Cole Naylor
Jessica Wilson
Brandy Wolfe
Introduction
• 3 Types of Strategy:
– Competitive Strategy (AKA Business Unit Strategy)
• Focus on creating a profitable competitive position and how
a firm will compete
– Overarching Corporate Strategy
• Focus on where a company can compete successfully and
how it can add value to its strategic business units, or SBUs
– Optimal Strategies
• More complex and relies on many factors, such as: nature of
the industry, the company’s mission, goals and objectives,
core competencies and its current position, and major
competitors’ strategic moves
Material To Be Covered…
• Foundation
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How success is measured
How much industry matters
Firm’s positioning choices
Market share vs. profitability
The Harvard Business School’s PIMS Project and research
findings
• Formulating a Competitive Strategy
– Four key challenges in formulating competitive strategy
– Aspects of creating, sustaining and understanding
competitive advantage, and use of value analysis
– The value chain and value chain analysis
Material To Be Covered…
• Porter’s Generic Business Unit Strategies
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Two generic competitive strategies: low cost and differentiation
Requirements for success
Risks of each generic position
Dell example
Critiques of Porter’s Generic Strategies
• Value Disciplines
– Three generic strategies:
• Product leadership and the four principles
• Operational excellence
• Customer intimacy
• Designing a Profitable Business Model
– Adrian Slywotzky and David Morrison’s 11 profitability business
models
Foundations
• This section will discuss the following
questions:
– What are the principal factors behind a business
unit’s relative profitability?
– How important are product superiority, cost,
marketing and distribution effectiveness, and
other factors?
– How important is the nature of the industry?
Strategic Logic at the Business Unit
Level
• Much has been learned about what drives
competitive success at the business unit level.
• At the broadest level there are two factors:
1. The attractiveness of the industry in which a firm
competes.
2. Its relative positioning within that industry.
How Much Does Industry Matter?
• Anita McGahan and Michael Porter provided
and answer to this question in a
comprehensive study of business performance
in four-digit SIC industry categories.
– Industry accounted for 32%
– Industry Segment accounted for 4%
– Corporate Parent accounted for 19%
Relative Positioning
• The relative profitability of rival firms depends
on the nature of their competitive positioning.
– Competitive advantage based on lower delivered
cost.
– Based on the ability to differentiate products or
services from those of competitors and command
a price premium relative to the cost incurred.
Choice of Competitive Scope
• When a firm is choosing a competitive strategy their
scope certain elements are considered:
– The number of product and buyer segments served.
– The number of geographical locations in which the firm
competes.
– The extent to which it is vertically integrated.
– The degree to which it must coordinate its positioning with
related businesses in which the firm is invested.
The Importance of the Market Share
• This has been the subject of considerable
controversy.
• Should profitability be the primary goal of
strategy?
– Some analysts believe that firms have been lead
astray by the principal pursuit of market share.
– Executives must ask themselves “Are we managing for
volume growth or value growth?”
The PIMS Project
• Although no manager should pursue growth for
growth’s sake, evidence suggests that in some
industries market share is an important determinant of
long-term profitability.
• The Marketing Science Institute at the Harvard
Business School undertook research in the relative
profitability of different market strategies.
• The PIMS (profit impact of market strategy) project
involved more than 600 businesses over a period of
more than 15 years.
Major Findings of the PIMS Study
• Absolute and relative market share are strongly correlated with ROI.
• Product quality is key to market leadership and allows companies with
larger market shares to charge higher prices and, therefore, achieve higher
margins.
• ROI is positively correlated with market growth.
• Vertical integration can be beneficial later in the product life cycle.
Forward integration is more profitable that backward integration.
• High investment intensity tends to depress ROI, as do high inventory
levels.
• Capacity use is critical for businesses with a high level of capital intensity;
companies with small market shares are particularly vulnerable.
• These findings help to explain many business
success stories through the 1980’s and many
business performance declines of the 1990’s.
• These findings were beneficial at the time, but
because of the increase in technology over the
past 20 years these findings are becoming less
and less relevant.
• This observation, basically, highlights the need for
executives to continually update their
assumptions about key strategic relationships.
Formulating A Competitive Strategy
• Key challenges
• Creating a competitive advantage
• Value Chain Analysis
Key Challenges
• Managers face four key challenges in formulating competitive
strategy.
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1) Analyzing the competitive environment
2) Anticipating key competitors’ actions
3) Generating strategic options
4) Choosing among alternatives
What is a Competitive Advantage?
• A firm has a competitive advantage when it is successful in
designing and implementing a value-creating strategy that
competitors are not currently using.
• The competitive advantage is sustainable when current or
new competitors are not able to imitate or supplant it.
• A competitive advantage often is created by combining
strengths.
• Southwest Airlines leads the industry with a 15-minute turn
around time for getting the planes back in the air. This saves
the firm $175 million annually in capital expenditures and
differentiates the firm by allowing it to offer more flights per
plane per day.
Competitive Advantage
(continued)
• Building a competitive advantage is best achieved by
identifying, practicing, strengthening, and instilling
throughout the organization those leadership traits that
improve the firm’s reputation among its stakeholders.
• A focus on organizational learning and on creating, retaining,
and motivating a skilled and knowledgeable work-force may
be the best way for executives to maintain competitive
advantages in a rapidly changing business environment
Value Chain Analysis
• A value chain is a model of a business process. It depicts the
value creation process as a series of activities, beginning with
processing raw materials and ending with sales and service to
end users.
• Value chain analysis involves the study of costs and elements
of product or service differentiation throughout the chain of
activities and linkages to determine present and potential
sources of competitive advantage.
• The value chain divides a firm’s business process into
component activities that add value: primary activities that
contribute to the physical creation of the product and support
activities that assist the primary activities and each other.
Value Chain (continued)
• A firm differentiates itself from its competitors when it provides
something unique that is valuable to buyers beyond a low price.
• For example, Dell’s ability to sell, build-to-order, and ship a
computer to the customer within a few days is a unique
differentiator of its value chain.
• Analyzing the value chains of competitors customers, and suppliers
can help a firm add value by focusing on the needs of downstream
customers or the weaknesses of upstream suppliers.
• For example, BASF adds value by leveraging its core competencies
in the paint-coating process by painting car doors for auto
manufacturers, instead of just selling them paint.
Value Chain (continued)
• Approaching value chain analysis as a shared process involving
the different members of the chain can optimize a firm’s value
creation by minimizing collective costs.
• For example, Home Depot and General Electric established an
alliance between their value chains that reduces direct and
indirect costs for each firm. They accomplished this by a web
based application that links Home Depot’s point of purchase
data to GE’s e-business system which enables Home Depot to
ship directly to its customers from GE.
• With advances in IT and through the internet companies can
monitor value creation across many activities and linkages.
Porter’s Generic Business
Strategies
Differentiation or Low Cost?
• Low Cost Strategies:
– Cost leaders generally charge less for their products and
services than do rivals, and aim for a substantial share of
the market by appealing to budget-sensitive customers.
– These strategies are complimented by cheap supplies and
well-defined market segments.
Differentiation or Low Cost?
• Differentiation Strategies:
– Aimed at a broad, mass market and seeks to create
uniqueness on an industry-wide basis.
– Broad scale differentiation can be achieved through
product design, brand image, technology, distribution,
service, or a combination of these elements.
– This strategy is also aimed at a well-defined market
segment.
Requirements for Success
Strategic Advantage
Strategic Target
Uniqueness perceived by the
customer
Industry-wide
Particular
segment only
Differentiation
Low-cost Position
Overall Cost Leadership
Focus
Risks
• Each generic posture carries unique risks
– Cost leaders must concern themselves with technological change
which can nullify past investments.
– Differentiators have to look out for imitation.
• The goal of each strategic generic posture is to create
sustainability
– For cost leaders, sustainability requires continually improving
efficiency.
– For differentiators, it requires the firm to erect barriers to entry
around their uniqueness.
Critique of Porter’s Generic Strategies
• Evidence suggests that executives reject Porter’s generic strategies in favor
of strategies that combine elements of cost leadership, differentiation,
and flexibility to meet customer demands.
• The most common arguments against these strategies is that cost
leadership and differentiation are not mutually exclusive and that when
they can exist together in a firm’s strategy, they result in sustained
profitability.
• Each strategy can compliment the other, and improve the overall firm
strategy by pursuing both.
Value Discipline
• Product leadership
• Operational excellence
• Customer intimacy
• Most companies try to excel at one of these
strategies and be competitive at the others
Product Leadership
• Companies produce a continuous stream of
state-of-the-art products and services
• Raise the bar for competitors
• Based on 4 principles:
– Encouragement of innovation
– Risk-oriented management style
– Success depends on talented product design
people
– Need to educate and lead the market
Operational Excellence
• Aimed at better production and delivery of
mechanisms
• Wal-mart, American Airlines, FedEx, Starwood
Hotels & Resorts Worldwide
Customer Intimacy
• Concentrates on building customer loyalty
• Nordstrom & Home Depot
• 2 Requirements:
– Quick movement in developing markets
– Efficient operations as markets mature
Competencies
Strategic Focus
Work Environment
Employee Competencies
Customer Intimacy
Values-driven, dynamic,
challenging, informal,
service-oriented,
qualitative, employee as
a customer, “whatever it
takes”
Relationship-building,
listening, rapid problemsolving, independent
action, initiative,
collaboration, qualityfocused
Operational Excellence
Predictable, measurable,
hierarchical, costconscious, team-based,
formal
Process control,
continuous improvement,
teamwork, analysis,
financial/operational
understanding
Product Leadership
Experimental, learningfocused, technical,
informal, fast-paced,
resource-rich
Information sharing,
creativity, group problem
solving, breakthrough
thinking, artistic,
visionary
Designing a Profitable Business Model
• Critical in formulating a business unit strategy
• Adrian Slywotsky and David Morrison
– 22 models to generate profits in a unique way
• Two most productive questions:
1. What is our business model?
2. How do we make a profit?
• Classic Strategy: “Gain market share and
profits will follow” --- Collapsed Correlation
– Globalization & Technological Advancement
How can businesses earn sustainable
profits?
• Analyzing the following questions:
– Where will the firm be able to make a profit in this
industry?
– How should the business model be designed so
that the firm will be profitable?
• Answer:
– 11 Profitability business models
Customer Solutions Profit Model
• Identify.Learn.Create. --- Move “Beyond the Box”
– Profit Zone: Selling Additional P/S
Internet retailing, consulting, and
adding financial services.
Product Pyramid Profit Model
• Customers have strong preferences for product
characteristics (variety, style, color, and price).
Top: High priced, low volume
*Profit Concentration
Base: Low Priced, high volume
*Strategic Firewall
Banana
Republic
Old Navy
Multicomponent System Profit Model
• Multiple products, but only some represent
the bulk of profitability.
Maintain position/Deepen Loyalty
= Low-margin grocery store
Profit Zone
= Fountain and Vending/InstoreModel
Switchboard Profit
• Connecting multiple sellers to multiple buyers
which leads to lower costs for both parties.
“Dream Package: Hollywood agent who
represents stars, writers and directors.
High bargaining power.
Time Profit Model
• Innovators with a time-limited competitive
advantage (First mover advantage)
– Relies on continuous innovation
Earns highest profits on processors that are fresh out
of the gate and unparalleled by the competition.
Blockbuster Profit Model
• Big profits from few mega-sale blockbusters.
(high R&D – high revenue that pays many times over)
Profit Multiplier Model
• Reaps gains, again and again, from the same
product, character, trademark, or service.
– Powerful engine for strong consumer brands
Entrepreneurial Profit Model
• Stresses: Diseconomies of scale
Base
Business
Spinouts
– As companies grow, overhead and expenses increase, and
customers become remote.
– Counteract: Organize the company into smaller profit centers to
maintain closeness with customers.
Specialization Profit Model
• Stresses growth through sequenced
specialization.
• Profitability of Specialists > Generalists
- “Killer Categories” (strong reputation)
Installed Base Profit Model
• Well established user base buys the
company’s brand of “follow-on” products.
De Facto Standard Profit Model
• A variant of the Installed Base Profit Model
– Appropriate when the Installed Base model
becomes the de facto standard that governs
competitive behavior in the industry.
• Able to “Plan” the industry
– Lower Marketing costs due to high consumer base
Review
• 3 Types of Strategy
– Competitive strategy
– Overarching Corporate Strategy
– Optimal Strategies
• Foundations
– Two factors explain success
– How much industry matters
– PIMS Project
• Formulating a Competitive Strategy
– Key challenge
– Competitive Advantage
– Value Chain Analysis
• Porter’s Generic Business Unit Strategies
– Low cost and differentiation
• Requirements for success
• Risks
– Critique of Porter’s Generic Strategies
• Value Disciplines
– Product leadership
– Operational excellence
– Customer Intimacy
• Designing a Profitable Business Model
– 11 profit models