Competitive Advantage

Chapter

One

Strategic

Leadership:

Managing the

Strategy-Making

Process for

Competitive

Advantage

授課老師：蘇哲仁

Why do some organizations succeed while others fail?

Strategy is a set of related actions that managers take to increase their company’s performance.

 Strategic Leadership

• Task of most effectively managing a company’s strategy-making process

 Strategy Formulation

• Task of determining and selecting strategies

 Strategy Implementation

• Task of putting strategies into action to improve a company’s efficiency and effectiveness

Competitive Advantage

Results when a company’s strategies lead to superior performance compared to competitors

Copyright © Houghton Mifflin Company. All rights reserved.

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Superior Performance and

Sustainable Competitive Advantage



Superior Performance

• One company’s profitability relative to that of other companies in the same or similar business or industry

• Maximizing shareholder value is the ultimate goal of profit making companies

ROIC ( Profitability) = R eturn O n I nvested C apital

•

ROIC

Net profit Net income after tax

=




• When a company’s profitability is greater than the average of all other companies in the same industry & competing for the same customers

Sustainable Competitive Advantage

When a company’s strategies enable it to maintain above average profitability for a number of years


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Determinants of

Shareholder Value

Figure 1.1

To increase shareholder value, managers must pursue strategies that increase the profitability of the company and grow the profits.


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Company’s Business Model

Management’s model of how strategy will allow the company to gain competitive advantage and achieve superior profitability

•

A business model encompasses how the company will:

Select its customers

• Define and differentiate its product offerings

• Create value for its customers

•

•

• Deliver those goods and services to the market

Organize activities within the company

Configure its resources

• Acquire and keep customers

• Produce goods or services

•

• Achieve and sustain a high level of profitability

Grow the business over time


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Differences in Industry and Company Performance

A Company’s Profitability and

Profit Growth are determined by two main factors:



The overall performance of its industry relative to other industries



Its relative success in its industry as compared to the competitors


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Return on Invested Capital in Selected Industries, 1997 –2003

Figure 1.2


Data Source: Value Line Investment Survey

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Performance in Nonprofit

Enterprises

Nonprofit entities such as government agencies, universities, and charities:

• Are not in business to make a profit

• Should use their resources efficiently and effectively

• Set performance goals unique to the organization

• Set strategies to achieve goals and compete with other nonprofits for scarce resources

A successful strategy gives potential donors a compelling message as to why they should contribute.


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Strategic Managers

 Corporate Level Managers

• Oversee the development of strategies for the whole organization

• The CEO is the principle general manager who consults with other senior executives

 General Managers

• Responsible for overall company, business unit, or divisional performance

 Functional Managers

• Responsible for supervising a particular task or operation e.g. marketing, operations, accounting, human resources


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Levels of Strategic Management

Figure 1.3


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The Five Steps of the

Strategy Making Process



Select the corporate vision, mission, and values and the major corporate goals and objectives .



Analyze the external competitive environment to identify opportunities and threats.

 Analyze the organization’s internal environment to identify its strengths and weaknesses.



Select strategies that:

• Build on the organization’s strengths and correct its weaknesses – in order to take advantage of external opportunities and counter external threats

• Are consistent with organization’s vision, mission, and values and major goals and objectives

• Are congruent and constitute a viable business model



Implement the strategies.


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Figure 1.4

Main

Components of the

Strategy-

Making

Process












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

Crafting the Organization’s

Mission Statement

Provides a framework or context within which strategies are formulated, including:

 Mission –

The reason for existence – what an organization does

 Vision –

A statement of some desired future state

 Values –

A statement of key values that an organization is committed to

 Major Goals –

The measurable desired future state that an organization attempts to realize


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The Mission

The mission

is a statement of a company’s

raison d’etre, its reason for existence today.

 What is it that the company does?

 What is the companies business?

• Who is being satisfied

(what customer groups) ?

• What is being satisfied

(what customer needs) ?

• How customer needs are being satisfied

(by what skills, knowledge, or distinctive competencies) ?

A company’s mission is best approached from a customer-oriented business definition.


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The Mission

Customer-Oriented Examples

The mission of Kodak is to provide “customers with the solutions they need to capture, store, process, output, and communicate images – anywhere, anytime.”

Ford Motor Company describes itself as a company that is “passionately committed to providing personal mobility for people around the world….We anticipate consumer need and deliver outstanding produces and services that improve people’s lives.”


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Abell’s Framework for Defining the Business

Figure 1.5

Source: D. F. Abell, Defining the Business: The Starting Point of

Strategic Planning (Englewood Cliffs, Prentice Hall, 1980), p. 7.


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The Vision

What would the company like to achieve?

A good vision is meant to stretch a company by articulating an ambitious but attainable future state.

The vision of Ford is “to become the world’s leading consumer company for automotive products and services.”

Nokia is the world’s largest manufacturer of mobile phones and operates with a simple but powerful vision: “If it can go mobile, it will!”


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Values

The values of a company should state:

 How managers and employees should conduct themselves

 How they should do business

 What kind of organization they need to build to help achieve the company’s mission

 Organizational culture

• The set of values, norms, and standards that control how employees work to achieve an organization’s mission and goals

• Often seen as an important source of competitive advantage

In high-performance organizations, values respect the interests of key stakeholders.


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Values at Nucor

 “ Management is obligated to manage Nucor in such a way that employees will have the opportunity to earn according to their productivity.”

 “Employees should be able to feel confident that if they do their jobs properly, they will have a job tomorrow.”

 “Employees have the right to be treated fairly and must believe that they will be.”

 “Employees must have an avenue of appeal when they believe they are being treated unfairly.”

At Nucor, values emphasizing pay for performance, job security, and fair treatment for employees help to create an atmosphere that leads to high employee productivity.


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Major Goals

A goal is a precise and measurable desired future state that a company must realize if it is to attain its vision or mission.

Key characteristics of well-constructed goals:

1.

Precise and measurable – to provide a yardstick or standard to judge performance

2.

Address crucial issues – with a limited number of key goals that help to maintain focus

3.

Challenging but realistic – to provide employees with incentive for improving

4.

Specify a time period – to motivate and inject a sense of urgency into goal attainment

Focus on long-run performance and competitiveness.


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

External Analysis

Purpose is to identify the strategic opportunities and threats in the organization’s operating environment that will affect how it pursues its mission.

External Analysis requires an assessment of:

 Industry environment in which company operates

• Competitive structure of industry

• Competitive position of the company

• Competitiveness and position of major rivals

 The country or national environments in which company competes

 The wider socioeconomic or macroenvironment that may affect the company and its industry

• Social

• Government

• Legal

• International

• Technological


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

Internal Analysis

Purpose is to pinpoint the strengths and weaknesses of the organization. Strengths lead to superior performance and weaknesses to inferior performance.

Internal analysis includes an assessment of:

 Quantity and quality of a company’s resources and capabilities

 Ways of building unique skills and company-specific or distinctive competencies

Building & sustaining a competitive advantage requires a company to achieve superior:

•

Efficiency

• Quality

•

Innovations

• Responsiveness to customers


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

Selecting Strategies: SWOT

Analysis and Business Model

 SWOT analyses help to identify strategies that align a company’s resources and capabilities to its environment – in order to create and sustain a competitive advantage.

 Functional strategies should be consistent with and support the company’s business level and global strategies.

• Functional-level strategy

– directed at operational effectiveness

• Business-level strategy – businesses’ overall competitive themes

• Global strategy – expand, grow and prosper at a global level

• Corporate-level strategy – to maximize profitability and profit growth

When taken together, the various strategies pursued by a company must lead to a viable business model.


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

Strategy Implementation

 After choosing a set of congruent strategies to achieve competitive advantage, managers must put those strategies into action:

• Implementation and execution of the strategic plans

• Design of the best organization structure

• Consistency of strategy with company culture

• Control systems to measure and monitor progress

• Governance systems for legal and ethical compliance

• Consistency with maximizing profit and profit growth

 The feedback loop – strategic planning is ongoing

• Managers must monitor strategy execution:

» To determine if strategic goals and objectives are being achieved

» To evaluate to what extent competitive advantage is being created and sustained

• Managers must monitor and reevaluate for the next round of strategy formulation and implementation


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Planned, Deliberate, Emergent and Realized Strategies

Figure 1.6

Source: Adapted from H. Mintzberg and

A. McGugh, Administrative Science

Quarterly, Vol. 30. No. 2, June 1985.


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Intended and Emergent Strategies

 Intended or Planned Strategies

• Strategies an organization plans to put into action

• Typically the result of a formal planning process

• Unrealized strategies are the result of unprecedented changes and unplanned events after the formal planning is completed

 Emergent Strategies

• Unplanned responses to unforeseen circumstances

• Serendipitous discoveries and events may emerge that can open up new unplanned opportunities

• Must assess whether the emergent strategy fits the company’s needs and capabilities

 Realized Strategies

• The product of whatever intended strategies are actually put into action and of any emergent strategies that evolve


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Strategic Planning in Practice

Recent studies suggest that formal planning does have a positive impact on company performance – and should include the current and future competitive environments.

 Scenario Planning

• Recognizes that the future is inherently unpredictable

• Develops strategies for possible future scenarios

 Decentralized Planning

• Involves the functional managers

• Avoids the ivory tower approach

• Perceives procedural justice in the decision making

 Strategic Intent

• Avoids the strategic fit model, which focuses too much on the current state

• Sets ambitious vision and goals that stretch a company and then finds ways to build to attain those goals


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Strategic Decision Making

In spite of systematic planning, companies may adopt poor strategies if groupthink or individual cognitive biases are allowed to intrude into the decision-making process:

 Cognitive biases:

Rules of thumb or heuristics resulting in systematic errors

• Prior hypothesis bias

• Escalating commitment

• Reasoning by analogy

• Representativeness

• Illusion of control

 Groupthink:

Decisionmakers embark on a course of action without questioning the underlying assumptions

• Group coalesces around a person or policy

• Decisions based on an emotional rather than an objective assessment of the correct course of action


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Processes for Improving

Decision Making

Figure 1.7

To bring out all the reasons that might make the proposal unacceptable


Reveals problems with definitions, assumptions,

& recommended courses of action

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Strategic Leadership

Good leaders of the strategy-making process have a number of key attributes:

 Vision, eloquence, and consistency

 Commitment

 Being well informed

 Willingness to delegate and empower

 The astute use of power

 Emotional intelligence

• Self-awareness

• Self-regulation

• Motivation

•

Empathy

• Social skills


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Chapter

Two

External

Analysis:

The

Identification of

Opportunities and Threats

External Analysis

The purpose of external analysis is to identify the strategic opportunities and threats in the organization’s operating environment that will affect how it pursues its mission.

External Analysis requires an assessment of:

 Industry environment in which company operates

• Competitive structure of industry

• Competitive position of the company

• Competitiveness and position of major rivals

 The country or national environments in which company competes

 The wider socioeconomic or macroenvironment that may affect the company and its industry

• Social

• Government

• Legal

• International

• Technological


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External Analysis:

Opportunities and Threats

Analyzing the dynamics of the industry in which an organization competes to help identify:

Opportunities Threats

Conditions in the environment that a company can take advantage of to become more profitable

Conditions in the environment that endanger the integrity and profitability of the company’s business


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Industry Analysis:

Defining an Industry

 I ndustry

• A group of companies offering products or services that are close substitutes for each other and that satisfy the same basic customer needs

• Industry boundaries may change as customer needs evolve and technology changes

 Sector

• A group of closely related industries

 Market Segments

• Distinct groups of customers within an industry

• Can be differentiated from each other with distinct attributes and specific demands

Industry analysis begins by focusing on the overall industry – before considering market segment or sector-level issues


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The Computer Sector:

Industries and Market Segments

Figure 2.1


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Porter’s Five Forces Model

Figure 2.2

Source: Adapted and reprinted by permission of Harvard Business Review.

From “How Competitive Forces Shape Strategy,” by

Michael E. Porter, Harvard Business Review, March/April 1979 © by the President and Fellows of Harvard College. All rights reserved.


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

Risk of Entry by Potential

Competitors

Potential Competitors are companies that are not currently competing in an industry but have the capability to do so if they choose. Barriers to new entrants include:

1.

Economies of Scale – as firms expand output unit costs fall via:

 Cost reductions – through mass production



Discounts on bulk purchases

– of raw material and standard parts

 Cost advantages

– of spreading fixed and marketing costs over large volume

2.

Brand Loyalty

 Achieved by creating well-established customer preferences

 Difficult for new entrants to take market share from established brands

3.

Absolute Cost Advantages – relative to new entrants

 Accumulated experience – in production and key business processes



Control of particular inputs required for production



Lower financial risks

– access to cheaper funds

4.

Customer Switching Costs for Buyers – where significant

5.

Government Regulation



May be a barrier to enter certain industries


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

Rivalry Among Established

Companies

Competitive Rivalry refers to the competitive struggle between companies in the same industry to gain market share from each other. Intensity of rivalry is a function of:

1.

Industry Competitive Structure



Number and size distribution of companies

 Consolidated versus fragmented industries

2.

Demand Conditions



Growing demand

– tends to moderate competition and reduce rivalry

 Declining demand – encourages rivalry for market share and revenue

3.

Cost Conditions



High fixed costs

– profitability leveraged by sales volume

 Slow demand and growth – can result in intense rivalry and lower profits

4.

Height of Exit Barriers – prevents companies from leaving industry

 Write-off of investment in assets

 Economic dependence on industry



Maintain assets to participate

 High fixed costs of exit

 Emotional attachment to industry



Bankruptcy regulations

– allowing effectively in an industry unprofitable assets to remain


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

Bargaining Power of Buyers

Industry Buyers may be the consumers or end-users who ultimately use the product or intermediaries that distribute or retail the products. These buyers are most powerful when:

1.

Buyers are dominant.



Buyers are large and few in number.

 The industry supplying the product is composed of many small companies.

2.

Buyers purchase in large quantities.



Buyers have purchasing power as leverage for price reductions.

3.

The industry is dependant on the buyers.

 Buyers purchase a large percentage of a company’s total orders.

4.

Switching costs for buyers are low.

 Buyers can play off the supplying companies against each other.

5.

Buyers can purchase from several supplying companies at once.

6.

Buyers can threaten to enter the industry themselves.

 Buyers produce themselves and supply their own product.

 Buyers can use threat of entry as a tactic to drive prices down.


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

Bargaining Power of Suppliers

Suppliers are organizations that provide inputs such as material and labor into the industry. These suppliers are most powerful when:

1.

The product supplied is vital to the industry and has few substitutes.

2.

The industry is not an important customer to suppliers.

 Suppliers are not significantly affected by the industry.

3.

Switching costs for companies in the industry are significant.

 Companies in the industry cannot play suppliers against each other.

4.

Suppliers can threaten to enter their customers’ industry.

 Suppliers can use their inputs to produce and compete with companies already in the industry.

5.

Companies in the industry cannot threaten to enter suppliers’ industry.


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

Substitute Products

Substitute Products are the products from different businesses or industries that can satisfy similar customer needs.

1.

The existence of close substitutes is a strong competitive threat.

 Substitutes limit the price that companies can charge for their product.

2.

Substitutes are a weak competitive force if an industry’s products have few close substitutes.

 Other things being equal, companies in the industry have the opportunity to raise prices and earn additional profits.


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Strategic Groups

Within Industries

Strategic Groups are groups of companies that follow a business model similar to other companies within their strategic group – but are different from that of other companies in other strategic groups.

The basic differences between business models in different strategic groups can be captured by a relatively small number of strategic factors.

 Implications of Strategic Groups –

1.

The closest competitors are within the same Strategic Group and may be viewed by customers as substitutes for each other.

2.

Each Strategic Group can have different competitive forces and may face a different set of opportunities and threats.

 Mobility Barriers – factors within an industry that inhibit the movement of companies between strategic groups

• Include barriers to enter another group or exit existing group


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Strategic Groups in the

Pharmaceutical Industry

Figure 2.3


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Industry Life Cycle Analysis

Industry Life Cycle Model analyzes the affects of industry evolution on competitive forces over time and is characterized by five distinct life cycle stages:

1.

Embryonic – industry just beginning to develop



Rivalry based on perfecting products, educating customers, and opening up distribution channels.

2.

Growth – first-time demand takes-off with new customers



Low rivalry as focus is on keeping up with high industry growth.

3.

Shakeout – demand approaches saturation, replacements



Rivalry intensifies with emergence of excess productive capacity.

4.

Mature – market totally saturated with low to no growth



Industry consolidation based on market share, driving down price.

5.

Decline – industry growth becomes negative



Rivalry further intensifies based on rate of decline and exit barriers.


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Stages in the Industry Life Cycle

Strength and nature of five forces change as industry evolves Figure 2.4

    


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Growth in Demand and Capacity

Anticipate how forces will change and formulate appropriate strategy Figure 2.5

Industry Shakeout:

Rivalry Intensifies with growth in excess capacity


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Limitations of Models for Industry Analysis







Life Cycle Issues

• Industry cycles do not always follow the life cycle generalization.

• In rapid growth situations embryonic stage is sometimes skipped.

• Industry growth revitalized through innovation or social change.

• The time span of the stages can vary from industry to industry.

Innovation and Change

• Punctuated Equilibrium occurs when an industry’s long term stable structure is punctuated with periods of rapid change by innovation.

• Hypercompetitive industries are characterized by permanent and ongoing innovation and competitive change.

Company Differences

• There can be significant variances in the profit rates of individual companies within an industry.

• In addition to industry attractiveness, company resources and capabilities are also important determinants of its profitability.

Models provide useful ways of thinking about competition within an industry – but be aware of their limitations.


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Punctuated Equilibrium and Competitive Structure

Figure 2.6

Periods of long term stability

Industry

Structure revolutionized by innovation

Periods of long term stability


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The Role of the

Macroenvironment

Figure 2.7

Changes in the forces in the macroenvironment can directly impact:

•

The Five Forces

• Relative Strengths

• Industry

Attractiveness


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Chapter

Three

Internal

Analysis:

Distinctive

Competencies,

Competitive

Advantage, and

Profitability

Internal Analysis

The purpose of internal analysis is to pinpoint the strengths and weaknesses of the organization.

Strengths lead to superior performance.

Weaknesses lead to inferior performance.

Internal Analysis includes an assessment of:

 Quantity and quality of a company’s resources and capabilities

 Ways of building unique skills and company-specific or distinctive competencies

Building and sustaining a competitive advantage requires a company to achieve superior:

•

Efficiency

• Quality

•

Innovations

• Responsiveness to customers


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Internal Analysis:

Strengths and Weaknesses

Internal analysis - along with the external analysis of the company’s environment gives managers the information to choose the strategies and business model to attain a sustained competitive advantage.

Strengths Weaknesses

Of the enterprise are assets that boost profitability

Of the enterprise are liabilities that lead to lower profitability


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Internal Analysis:

A Three-Step Process

1.

Understand the process by which companies create value for customers and profit for themselves.

 Resources

 Capabilities

 Distinctive competencies

2.

Understand the importance of superiority in creating value and generating high profitability.

 Efficiency  Innovation

 Quality  Responsiveness to Customers

3.

Analyze the sources of the company’s competitive advantage.

 Strengths – that are driving profitability

 Weaknesses – opportunities for improvement


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 Competitive Advantage

• A firm’s profitability is greater than the average profitability for all firms in its industry.

 Sustained Competitive Advantage

• A firm maintains above average and superior profitability and profit growth for a number of years.

The Primary Objective of Strategy

is to achieve a

Sustained Competitive Advantage

which in turn results in

Superior Profit and Profit Growth.


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Strategy, Resources,

Capabilities, and Competencies

Figure 3.1


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Competitive Advantage,

Value Creation, and Profitability

How profitable a company becomes depends on three basic factors:

1.

VALUE or UTILITY the customer gets from owning the product

2.

PRICE that a company charges for its products

3.

COSTS of creating those products



Consumer surplus is the “excess” utility a consumer captures beyond the price paid.

Basic Principle: the more utility that consumers get from a company’s products or services, the more pricing options the company has.


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Value Creation per Unit

Figure 3.2


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Value Creation and Pricing Options

Figure 3.3

There is a dynamic relationship among utility,

pricing, demand, and costs.


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Comparing Toyota and

General Motors

Figure 3.4

Superior value creation requires that the gap between perceived utility (U) and costs of production (C) be greater than that obtained by competitors.


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The Value Chain

Figure 3.5

A company is a chain of activities for transforming inputs into outputs that customers value – including the primary and support activities.


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Building Blocks of Competitive Advantage

 Figure 3.6

The Generic

Distinctive Competencies

Allow a company to:

• Differentiate product offering

• Offer more utility to customer

• Lower the cost structure regardless of the industry, its products, or its services

 




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

Efficiency

 Measured by the quantity of inputs it takes to produce a given output:

Efficiency = Outputs / Inputs

 Productivity leads to greater efficiency and lower costs:

• Employee productivity

• Capital productivity

Superior efficiency helps a company attain a competitive advantage through a lower cost structure.


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

Quality

Quality products are goods and services that are:

• Reliable and

• Differentiated by attributes that customers perceive to have higher value



The impact of quality on competitive advantage:

• High-quality products differentiate and increase the value of the products in customers’ eyes.

• Greater efficiency and lower unit costs are associated with reliable products.

Superior quality = customer perception of greater value in a product’s attributes

Form, features, performance, durability, reliability, style, design


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A Quality Map for Automobiles

Figure 3.7

When customers evaluate the quality of a product, they commonly measure it against two kinds of attributes:

1. Quality as Excellence

2. Quality as Reliability


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

Innovation

Innovation

is the act of creating new products or new processes

• Product innovation

» Creates products that customers perceive as more valuable and

» Increases the company’s pricing options

• Process innovation

» Creates value by lowering production costs

Successful innovation can be a major source of competitive advantage – by giving a company something unique, something its competitors lack.


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

Responsiveness to Customers

Identifying and satisfying customers’ needs – better than the competitors

 Superior quality and innovation are integral to superior responsiveness to customers.

 Customizing goods and services to the unique demands of individual customers or customer groups.



Enhanced customer responsiveness

Customer response time, design, service, after-sales service and support

Superior responsiveness to customers differentiates a company’s products and services and leads to brand loyalty and premium pricing.


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Competitive Advantage:

The Value Creation Cycle

Figure 3.8


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Analyzing Competitive

Advantage and Profitability

 Competitive Advantage

• When a companies profitability is greater than the average of all other companies in the same industry that compete for the same customers

 Benchmarking

• Comparing company performance against that of competitors and the company’s historic performance

 Measures of Profitability

•

• R eturn O n I nvested C apital ( ROIC )

Net profit Net income after tax

ROIC =

• Net Profit

Net Profit = Total revenues – Total costs


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Definitions of

Basic Accounting Terms

Table 3.1


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Drivers of Profitability (ROIC)

Figure 3.9


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Comparing Wal-Mart to Target

Figure 3.10


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The Durability of Competitive

Advantage

The DURABILITY of a company’s competitive advantage over its competitors depends on:

1.

Barriers to Imitation

Making it difficult to copy a company’s distinctive competencies

 Imitating Resources

 Imitating Capabilities

2.

Capability of Competitors

 Strategic commitment

C ommitment to a particular way of doing business

 Absorptive capacity

Ability to identify, value, assimilate, and use knowledge

3.

Industry Dynamism

Ability of an industry to change rapidly

Competitors are also seeking to develop distinctive competencies that will give them a competitive edge.


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Why Companies Fail

 Inertia

• Companies find it difficult to change their strategies and structures

 Prior Strategic Commitments

• Limit a company’s ability to imitate and cause competitive disadvantage

 The Icarus Paradox

• A company can become so specialized and inner directed based on past success that it loses sight of market realities

• Categories of rising and falling companies:

• Craftsmen • Builders • Pioneers • Salespeople

When a company loses its competitive advantage, its profitability falls below that of the industry.



It loses the ability to attract and generate resources.



Profit margins and invested capital shrink rapidly.


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Avoiding Failure:

Sustaining Competitive Advantage

1.

Focus on the Building Blocks of Competitive

Advantage

Develop distinctive competencies and superior performance in:

 Efficiency  Quality

 Innovation  Responsiveness to Customers

2.

Institute Continuous Improvement and Learning

Recognize the importance of continuous learning within the organization

3.

Track Best Practices and Use Benchmarking

Measure against the products and practices of the most efficient global competitors

4.

Overcome Inertia

Overcome the internal forces that are barriers to change

Luck may play a role in success, so always exploit a lucky break - but remember:

“The harder I work, the luckier I seem to get.”

J P Morgan


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Chapter

Four

Building

Competitive

Advantage

Through

Functional-

Level Strategy

Functional-Level Strategies

Functional-level strategies are strategies aimed at improving the effectiveness of a company’s operations.

Improves company’s ability to attain superior:

1.

Efficiency 2.

Quality



3.

Innovation 4.

Customer responsiveness

Increases the utility that customers receive:

• Through differentiation  Creating more value

• Lower cost structure than rivals

This leads to a competitive advantage and superior profitability and profit growth.


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Achieving Superior Efficiency

Functional steps to increasing efficiency:



Economies of Scale



Learning Effects



Experience Curve



Flexible Manufacturing and Mass Customization



Marketing



Materials Management and Supply Chain



R&D Strategy



Human Resource Strategy



Information Systems



Infrastructure


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

Economies of Scale

 Economies of scale

Unit cost reductions associated with a large scale of output

• Ability to spread fixed costs over a large production volume

• Ability of companies producing in large volumes to achieve a greater division of labor and specialization

• Specialization has favorable impact on productivity by enabling employees to become very skilled at performing a particular task

 Diseconomies of scale

Unit cost increases associated with a large scale of output

• Increased bureaucracy associated with large-scale enterprises

• Resulting managerial inefficiencies


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Economies and Diseconomies of Scale

Figure 4.2


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

Learning Effects

Learning Effects are:

Cost savings that come from learning by doing

• Labor productivity

Learn by repetition how to best carry out the task

• Management efficiency

Learn over time how to best run the operation

• Realization of learning effects implies a downward shift of the entire unit cost curve

As labor and management become more efficient over time at every level of output

When changes occur in a company’s production system, learning has to begin again.


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The Impact of Learning and

Scale Economies on Unit Costs

Figure 4.3


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

The Experience Curve


The systematic lowering of the cost structure and consequent unit cost reductions that occur over the life of a product

• Economies of scale and learning effects underlie the experience curve phenomenon

• Once down the experience curve, the company is likely to have a significant cost advantage over its competitors

Strategic significance of the experience curve:

Increasing a company’s product volume and market share will lower its cost structure relative to its rivals.


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Figure 4.4


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Dangers of Complacency Derived from Experience Effects

Managers should not become complacent about efficiency-based cost advantages derived from experience effects:

1.

The experience curve is likely to bottom out

So further unit cost reductions may be hard to come by

2.

New technologies can make experience effects obsolete

From changes always taking place in the external environment

3.

Flexible manufacturing technologies may allow small manufacturers to produce at low unit costs

Achieving both low cost and differentiation through customization

4.

Some technologies may not produce lower costs with higher volumes of output


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

Flexible Manufacturing and Mass Customization

 Flexible Manufacturing Technology

A range of manufacturing technologies that:

• Reduce setup times for complex equipment

• Improves scheduling to increase use of individual machines

• Improves quality control at all stages of the manufacturing process

• Increases efficiency and lowers unit costs

 Mass Customization

Ability to use flexible manufacturing technology to reconcile two goals that were once thought incompatible :

• Low cost and

• Differentiation through product customization


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Tradeoff Between Costs and Product Variety

Figure 4.5


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

Marketing

Marketing

• Marketing strategy

Refers to the position that a company takes regarding

• Pricing  Promotion  Advertising

• Distribution  Product design

• Customer defection rates

Percentage of customers who defect every year

• Defection rates are determined by customer loyalty

• Loyalty is a function of the ability to satisfy customers

Reducing customer defection rates and building customer loyalty can be major sources of a lower cost structure.


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Relationship between Customer

Loyalty and Profit per Customer

Figure 4.6

The longer a company holds on to a customer the greater the volume of customer-generated unit sales that offset fixed marketing costs and lowers the average cost of each sale.


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

Materials Management and

Supply Chain

 Materials Management

The activities necessary to get inputs and components to a production facility, through the production process, and through the distribution system to the end-user

• Many sources of cost in this process

• Significant opportunities for cost reduction through more efficient materials management

• Just-in-Time (JIT) Inventory System

System designed to economize on inventory holding costs:

• Have components arrive to manufacturing just prior to need in production process

• Have finished goods arrive at retail just prior to stock out

 Supply Chain Management

Task of managing the flow of inputs to a company’s processes to minimize inventory holding and maximize inventory turnover


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

R&D Strategy

 Research and Development (R&D)

Roles of R&D in helping a company achieve greater efficiency and lower cost structure:

1.

Boost efficiency by designing products that are easy to manufacture

• Reduce the number of parts that make up a product – reduces assembly time

• Design for manufacturing – requires close coordination with production and R&D

2.

Help a company have a lower cost structure by pioneering process innovations

• Reduce process setup times

• Flexible manufacturing

• An important source of competitive advantage


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

Human Resource Strategy

The key challenge of the Human Resource function: improve employee productivity.

 Hiring strategy

Assures that the people a company hires have the attributes that match the strategic objectives of the company

 Employee training

Upgrades employee skills to perform tasks faster and more accurately

 Self-managing teams

Members coordinate their own activities and make their own hiring, training, work, and reward decisions.

 Pay for performance

Linking pay to individual and team performance can help to increase employee productivity


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

Information Systems

Information systems’ impact on productivity is wide-ranging:

 Web-based information systems can automate many of the company activities

 Potentially affects all the activities of a company

 Automates interactions between

• Company and customers

• Company and suppliers


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

Infrastructure

A Company’s Infrastructure:

The company’s structure, culture, style of strategic leadership, and control system:

• Determines the context within which all other value creation activities take place

• Strategic leadership is especially important in building a companywide commitment to efficiency

• The leadership task is to articulate a vision for all functions and coordinate across functions

Achieving superior performance requires an organization-wide commitment.

Top management plays a major role in this process.


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Primary Roles of

Value-Creation Functions

Table 4.1


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Achieving Superior Quality

Quality can be thought of in terms of two dimensions and gives a company two advantages:

Quality as reliability

They do the jobs they were designed for and do it well

Quality as excellence

Perceived by customers to have superior attributes

1.

A strong reputation for quality allows a company to differentiate its products.

2.

Eliminating defects or errors reduces waste, increases efficiency, and lowers the cost structure – increasing profitability.


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Improving Quality as Reliability

Six Sigma methodology: the principal tool now used to increase reliability and is a direct descendant of Total Quality Management (TQM)

TQM is based on the following five-step chain reaction:

1.

Improved quality means that costs decrease.

2.

As a result, productivity also improves.

3.

Better quality leads to higher market share and allows increased prices.

4.

This increases a company’s profitability.

5.

Thus the company creates more jobs.


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Deming’s Steps in a

Quality Improvement Program

1.

A company should have a clear business model.

2.

Management should embrace philosophy that mistakes, defects, and poor quality are not acceptable.

3.

Quality of supervision should be improved.

4.

Management should create an environment in which employees will not be fearful of reporting problem or making suggestions.

5.

Work standards should include some notion of quality to promote defect-free output.

6.

Employees should be trained in new skills.

7.

Better quality requires the commitment of everyone in the workplace.


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Roles Played in Implementing

Reliability Improvement Methods

Table 4.2


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Implementing Reliability

Improvement Methodologies

Imperatives that stand out among companies that have successfully adopted quality improvement methods:



Build organizational commitment to quality

 Create quality leaders

 Focus on the customer

 Identify processes and the source of defects

 Find ways to measure quality



Set goals and create incentives

 Solicit input from employees

 Build long-term relationships with suppliers

 Design for ease of manufacture

 Break down barriers among functions


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Improving Quality as Excellence

A product is a bundle of attributes and can be differentiated by attributes that collectively define product excellence.

Developing Superior Attributes:

• Learn which attributes are most important to customers

• Design products and associate services to embody the important attributes

• Decide which attributes to promote and how best to position them in consumers’ minds

• Continual improvement in attributes and development of new-product attributes


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Attributes Associated with a

Product Offering

Table 4.3


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Achieving Superior Innovation

Building distinctive competencies that result in innovation is the most important source of competitive advantage.

 Innovation can:

• Result in new products that satisfy customer needs better

• Improve the quality of existing products

• Reduce costs

 Innovation can be imitated -

 So it must be continuous

Successful new product launches are major drivers of superior profitability.


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The High Failure Rate of Innovation

Failure rate of innovative new products is high with evidence suggesting that only 10 to 20% of major

R&D projects give rise to a commercially viable product.

Most common explanations for failure:

 Uncertainty

• Quantum innovation – radical departure with higher risk

• Incremental innovation – extension of existing technology

 Poor commercialization

• Definite demand for product

• Product not well adapted to customer needs

 Poor positioning strategy

• Good product but poorly positioned in the marketplace

 Technological myopia

• Technological “wizardry” vs. meeting market requirements

 Slow to market


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Building Competencies in

Innovation

Companies can take a number of steps to build competencies in innovation and reduce failures:

1.

Building skills in basic and applied research

2.

Project selection and management

Using the product development funnel

»

Idea generation

»

Project refinement

»

Project execution

3.

Achieving cross-functional integration

1.

Driven by customer needs 2.

Design for manufacturing

3.

Track development costs 4.

Minimize time-to-market

5.

Close integration between R&D & marketing

4.

Using product development teams

5.

Partly-parallel development process



To compress development time & time-to-market


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The Development Funnel

Figure 4.7


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Sequential and Partly Parallel

Development Processes

Figure 4.8


Reduced development time

& time-to-market

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Achieving Superior

Responsiveness to Customers

Customer responsiveness: giving customers what they want, when they want it, and at a price they are willing to pay as long as the company’s long-term profitability is not compromised.

 Focusing on the customer

• Demonstrating leadership

• Shaping employee attitudes

• Bringing customers into the company



Satisfying customer needs

• Customization

» Tailor to unique needs of groups of customers

• Response time

» Increase speed » Premium pricing


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Primary Roles of Functions in Achieving

Superior Responsiveness to Customers

Table 4.5


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Chapter

Five

Building

Competitive

Advantage

Through

Business-

Level Strategy

Business-Level Strategy

A successful business model results from business level strategies that create a competitive advantage over its rivals.

They must decide on:

1.

Customer needs –

WHAT is to be satisfied

2.

Customer groups –

WHO is to be satisfied

3.

Distinctive competencies –

HOW customers are to be satisfied

These decisions determine which strategies are formulated & implemented to put a business model into action.


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Customer Needs:

Product Differentiation

 Customer needs

The desires, wants, or cravings that can be satisfied through product attributes

 Customers choose a product based on:

1.

The way the product is differentiated from other products of its type

2.

The price of the product

 Product differentiation

Designing products to satisfy customers’ needs in ways that competing products cannot:

• Different ways to achieve distinctiveness

• Balancing differentiation with costs

• Ability to charge a higher or premium price


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Customer Needs:

Market Segmentation

 Market Segmentation

The way customers can be grouped based on important differences in their needs or preferences



In order to gain a competitive advantage

 Main Approaches to Segmenting Markets

1.

Ignore differences in customer segments –

Make a product for the typical or average customer

2.

Recognize differences between customer groups –

Make products that meet the needs of all or most customer groups

3.

Target specific segments –

Choose to focus on and serve just one or two selected segment


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Identifying Customer Groups and Market Segments

Figure 5.1


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Three Approaches to Market Segmentation

Figure 5.2


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Implementing the Business Model

To develop a successful business model, strategic managers must devise a set of strategies that determine:

• How to DIFFERENTIATE their product

• How to PRICE their product

• How to SEGMENT their markets

• How WIDE A RANGE of products to develop

A profitable business model depends on providing the customer with the most value while keeping cost structures viable.


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WalMart’s Business Model

Figure 5.3


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Competitive Positioning at the Business Level

Maximizing the profitability of the company’s business model is about making the right choices with regard to value creation through differentiation, costs, and pricing.

Figure 5.4


Source: Copyright © C. W. L. Hill & G. R. Jones,

“The Dynamics of Business-Level Strategy,”

(unpublished manuscript, 2002).

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Generic

Business-Level Strategies

Specific business-level strategies that give a company a specific competitive position and advantage visà-vis its rivals

Characteristics of Generic Strategies

• Can be pursued by all businesses regardless of whether they are manufacturing, service, or nonprofit

• Can be pursued in different kinds of industry environments

• Results from a company’s consistent choices on product, market, and distinctive competencies


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The Four Principal Generic

Business-Level Strategies

1.

Cost Leadership

Lowest cost structure visà-vis competitors allowing price flexibility & higher profitability

2.

Focused Cost Leadership

Cost leadership in selected market niches where it has a local or unique cost advantage

3.

Differentiation

Features important to customers & distinct from competitors that allow premium pricing

4.

Focused Differentiation

Distinctiveness in selected market niches where it better meets the needs of customers than the broad differentiators


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Cost Leadership

Generic Business-Level Strategies

Cost leaders establish a cost structure that allows them to provide goods and services at lower unit costs than competitors .

Strategic Choices

• The cost leader does not try to be the industry innovator.

• The cost leader positions its products to appeal to the “average” or typical customer.

• The overriding goal of the cost leader is to increase efficiency and lower its costs relative to industry rivals.


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Advantages of

Cost Leadership Strategies

 Protected from industry competitors by cost advantage

 Less affected by increased prices of inputs if there are powerful suppliers

 Less affected by a fall in price of inputs if there are powerful buyers

 Purchases in large quantities increase bargaining power over suppliers

 Ability to reduce price to compete with substitute products

 Low costs and prices are a barrier to entry

Cost leader is able to charge a lower price or is able to achieve superior profitability than its competitors at the same price.


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Disadvantages

Cost Leadership Strategies



Competitors may lower their cost structures.



Competitors may imitate the cost leader’s methods.



Cost reductions may affect demand.


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Figure 5.7

Why Focus Strategies

Are Different

 

 


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Focus


The focuser strives to serve the need of a targeted niche market segment where it has either a low-cost or differentiated competitive advantage.


• The focuser selects a specific market niche that may be based on:

 Geography

 Type of customer

 Segment of product line

• Focused company positions itself as either:

 Low-Cost or

 Differentiator


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Advantages:

Focus Strategies

 The focuser is protected from rivals to the extent it can provide a product or service they cannot.

 The focuser has power over buyers because they cannot get the same thing from anyone else.

 The threat of new entrants is limited by customer loyalty to the focuser.

 Customer loyalty lessens the threat from substitutes.

 The focuser stays close to its customers and their changing needs.


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Disadvantages:

Focus Strategies

 The focuser is at a disadvantage with regard to powerful suppliers because it buys in small volume but it may be able to pass costs along to loyal customers.

 Because of low volume, a focuser may have higher costs than a low-cost company.

 The focuser’s niche may disappear because of technological change or changes in customers’ tastes.

 Differentiators will compete for a focuser’s niche.


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Differentiation:


Companies with a differentiation strategy create a product that is different or distinct from its competitors in an important way.


• A differentiator strives to differentiate itself on as many dimensions as possible.

• Differentiator focuses on quality, innovation, and responsiveness to customer needs.

• May segment the market in many niches.

• A differentiated company concentrates on the organizational functions that provide a source of distinct advantages.


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Advantages of

Differentiation Strategies

 Customers develop brand loyalty.

 Powerful suppliers are not a problem because the company is geared more toward the price it can charge than its costs.

 Differentiators can pass price increases on to customers.

 Powerful buyers are not a problem because the product is distinct.

 Differentiation and brand loyalty are barriers to entry.

 The threat of substitute products depends on competitors’ ability to meet customer needs.

Differentiators can create demand for their distinct products and charge a premium price, resulting in greater revenue and higher profitability.


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Disadvantages of

Differentiation Strategies

 Difficulty maintaining long-term distinctiveness in customers’ eyes.

• Agile competitors can quickly imitate.

• Patents and first-mover advantage are limited.

 Difficulty maintaining premium price.


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Broad Differentiation:

Cost Leadership and Differentiation

A broad differentiation business model may result when a successful differentiator has pursued its strategy in a way that has also allowed it to lower its cost structure:

 Using robots and flexible manufacturing cells reduces costs while producing different products.

 Standardizing component parts used in different end products can achieve economies of scale.

 Limiting customer options reduces production and marketing costs.

 JIT inventory can reduce costs and improve quality and reliability.

 Using the Internet and e-commerce can provide information to customers and reduce costs.

 Low-cost and differentiated products are often both produced in countries with low labor costs.


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Competitive Positioning:

Strategic Groups

Strategic Groups are groups of companies that follow a business model similar to other companies within their strategic group, but are different from that of other companies in other strategic groups.

Implications of Strategic Groups for Competitive Positioning:

1.

Strategic managers must map their competitors:

• Map according to their choice of business model

• Use this knowledge to position themselves closer to customers

• Differentiate themselves from their competitors

2.

Use the map to better understand changes in the industry

• Affecting its relative position visà-vis differentiation & cost structure

•

To identify opportunities and threats

• Identify emerging threats from companies outside the strategic group

3.

Determine which strategies are successful



Why certain business models are working or not

4.

Fine tune or radically alter business models and strategies to improve competitive position


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Failures in

Competitive Positioning

Successful competitive positioning requires that a company achieve a fit between its strategies and its business model.

 Many companies, through neglect, ignorance or error:

• Do not work continually to improve their business model

• Do not perform strategic group analysis

• Often fail to identify and respond to changing opportunities and threats in the industry environment

 Companies lose their position on the value frontier –

• They have lost their source of competitive advantage

• Their rivals have found ways to push out the value-creation frontier and leave them behind

There is no more important task than ensuring that the company is optimally positioned against its rivals to compete for customers.


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Chapter

Six

Business-

Level Strategy and the

Industry

Environment

The Industry Environment

There is the need to continually formulate and implement business-level strategies to sustain competitive advantage over time in different industry environments.

 Different industry environments present different opportunities and threats.

 A company’s business model and strategies have to change to meet the environment.

 Companies must face the challenges of developing and maintaining a competitive strategy in:

•

Fragmented Industries • Mature Industries

•

Embryonic Industries • Declining Industries

•

Growth Industries


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Fragmented Industries

A fragmented industry is one composed of a large number of small and medium-sized companies.

 Reasons for fragmented industries

• Low barriers to entry due to lack of economies of scale

• Low entry barriers permit constant entry by new companies

• Specialized customer needs require small job lots of products no room for a mass-production

• Diseconomies of scale

 Strategies

•

Chaining

– networks of linked outlets to achieve cost leadership

• Franchising – for rapid growth with proven business concepts, reputation, management skills and economies of scale

• Horizontal Merger – acquisition to obtain economies and growth

• IT and Internet – to develop new business models


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Embryonic and Growth Industries

An embryonic industry is one that is just beginning to develop when technological innovation creates new market or product opportunities.

A growth industry is one in which firsttime demand is expanding rapidly as many new customers enter the market.

Strategy is determined by market demand

• Innovators and early adopters have different needs from the early and late majority

• Company must be prepared to cross the chasm between the early adopters and the later majority

Companies must understand the factors that affect a market’s growth rate – in order to tailor the business model to the changing industry environment.


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Market Characteristics:

Embryonic and Growth Industries

 Reasons for slow growth in market demand

• Limited performance and poor quality of the first products

• Customer unfamiliarity with what the new product can do for them

• Poorly developed distribution channels

• Lack of complementary products

• High production costs

 Mass markets typically start to develop when:

• Technological progress makes a product easier to use and increases its value to the average customer.

• Key complementary products are developed that do the same.

• Companies find ways to reduce production costs allowing them to lower prices.


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Market Development and Customer Groups

Both innovators and early adopters enter the market while the industry is in its embryonic state.

Figure 6.1


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Market Share of Different

Customer Segments

Most market demand and industry profits arise during the early and late majority customer segments.

Figure 6.2


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Strategic Implications:

Crossing the Chasm

 Innovators and Early Adopters are

(While the Early Majority are NOT) :

• Technologically sophisticated and tolerant of engineering imperfections

• Typically reached through specialized distribution channels

• Relatively few in number and not particularly price-sensitive

 To cross the chasm between the

Early Adopters and the Early Majority

• Correctly identify the needs of the first wave of early majority users.

• Alter the business model in response.

• Alter the value chain and distribution channels to reach the early majority.

• Design the product to meet the needs of the early majority so that the product can be modified and produced or provided at low cost.

• Anticipate the moves of competitors.


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The Chasm: AOL and Prodigy

Figure 6.3

The business model and strategies required to compete in an embryonic market populated by Early Adopters and

Innovators are very different than those required to compete in a high-growth mass market populated by the Early Majority.


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Strategic Implications of Market Growth Rates

 Different markets develop at different rates.



Growth rate measures the rate at which the industry’s product spreads in the marketplace.

 Growth rates for new kinds of products seem to have accelerated over time:

•

Use of mass media • Low-cost mass production

 Factors affecting market growth rates:

•

Relative advantage • Complexity

•

Compatibility • Observability

•

Availability of • Trialability complementary products

Business-level strategy is a major determinant of industry profitability. The choice of business model and strategies can accelerate or retard market growth.


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Differences in Diffusion Rates

Figure 6.4

Different markets develop at different growth rates.

Source: Peter Brimelow, “The Silent Boom,” Forbes, July 7, 1997, pp. 170-171. Reprinted by permission of Forbes Magazine © 2002 Forbes, Inc.


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Navigating Through the Life Cycle to Maturity

The amount and type of resources and capital needed to pursue a company’s business model depends on two crucial factors:

1.

Competitive advantage of company’s business model

2.

Stage of the industry life cycle

 Embryonic stages – share building strategies

• Development of distinctive competencies and competitive advantage.

• Requires capital to develop R&D and sales/service competencies.

 Growth stages – maintain relative competitive position

• Strengthen business model to prepare to survive industry shakeout.

• Requires investment to keep up with rapid growth of the market.

 Shakeout stage – increase share during fierce competition

• Invest in share-increasing strategies at expense of weak competitors.

• Weak companies should exit the industry during the harvest stage.

 Maturity stage – hold-and-maintain to defend business model

• Dominant companies want to reap the reward of prior investments.

• A company’s investment depends on the level of competition and source of the company’s competitive advantage.


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Mature Industries

A mature industry is dominated by a small number of large companies whose actions are so highly interdependent that success of one company’s strategy depends on the response of its rivals.



Evolution of mature industries

• Industry becomes consolidated as a result of the fierce competition during the shakeout stage.

• Business level strategy is based on how established companies collectively try to reduce strength of competition.

• Interdependent companies try to protect industry profitability.



Strategies

• Deter entry into industry

 Product proliferation  Maintaining

 Price cutting excess capacity

• Manage industry rivalry

 Price signaling  Capacity control

 Price leadership  Nonprice competition


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Product Proliferation in the

Restaurant Industry

Figure 6.6

Where the product spaces have been filled, it is difficult for a new company to gain a foothold in the market and differentiate itself.


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Four Nonprice Competitive

Strategies

Figure 6.8


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Toyota’s Product Lineup

Figure 6.9

Toyota has used market development to become a broad differentiator and has developed a vehicle for almost every main segment of the car market.


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Game Theory

Companies in an industry can be viewed as players that are all simultaneously making choices about which business models and strategies to pursue in order to maximize their profitability.

Basic principles that underlie game theory:



Look Forward and Reason Back –

Decision Trees

 Look forward, think ahead, and anticipate how rivals will respond to whatever strategic moves they make

 Reason backwards to determine which strategic moves to pursue today based on how rivals will respond to future strategic moves



Know Thy Rival – how is the rival likely to act



Find the Dominant Strategy –

Payoff Matrix

 One that makes you better off if you play that strategy

 No matter what strategy your opponent uses



Strategy Shapes the Payoff Structure of the Game

These basic principles of game theory can be used in determining which business model and strategies to pursue.


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A Decision Tree for UPS’s Pricing Strategy

Figure 6.10


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A Payoff Matrix for GM and Ford

Figure 6.11


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Altered Payoff Matrix for GM and Ford

Figure 6.12


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Declining Industries

A declining industry is one in which market demand has leveled off or is falling and the size of total market starts to shrink.

Competition tends to intensify and industry profits tend to fall.

 Reasons for and severity of the decline

• Reasons technological change, social trends, demographic shifts

• Intensity of competition is greater when:

 The decline is rapid versus slow and gradual.

 The industry has high fixed costs.

 The exit barriers are high.

 The product is perceived as a commodity.

• Not all industry segments typically decline at the same rate

 Creating pockets of demand

 Strategies

• Leadership – seeks to become dominant player in declining industry

• Niche – focuses on pockets of demand that are declining more slowly

• Harvest – optimizes cash flow

• Divestment – sells business to others


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Factors for Intensity of Competition in Declining Industries

Figure 6.13


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Strategy Selection in a Declining Industry

Figure 6.14

Choice of strategy is determined by:

• Severity of the industry decline

• Company strength relative to the remaining pockets of demand


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Chapter

Seven

Strategy in

High-

Technology

Industries

High-Technology Industries

High-tech industries are those in which the underlying scientific knowledge that companies in the industry use is advancing rapidly.

By implication, the attributes of the products and services that result from its application are also advancing rapidly .

Technology is:

• The body of scientific knowledge used in the production of goods or services

• Accounting for an even larger share of economic activity

• Revolutionizing aspects of the product or production system in industries not thought of as high-tech


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Technical Standards and Format Wars

Technical standards are a set of technical specifications that producers adhere to when making the product or a component of it.

Format wars

• Often, only one standard will come to dominate a market.

• Many battles in high-tech industries revolve around companies competing to be the one that sets the standard.

The source of product differentiation and competitive advantage is based on the technical standard.


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Technical Standards for Personal Computers

Figure 7.1


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Benefits of Standards

Standards emerge because there are economic benefits associated with them.

Standards help:



Guarantee compatibility between products and their compliments

 Reduce confusion in the minds of consumers

 Reduce production costs through massproduction

 Reduce the risks associated with supplying complementary products and help

Standards lead to both low-cost and differentiation advantages for individual companies.


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Establishments of Standards

Standards emerge in one of three ways:

1.

Companies may lobby the government to mandate an industry standard.

2.

Standards are often set by cooperation among businesses or industry forums.

 May become part of the public domain

3.

Standards are often selected competitively by market demand.

• Network effects – size of the network for complementary products determines industry demand

• Positive feedback loop – increase in demand further increases the value of owning a product

• Lockout – from the market occurs for companies promoting alternate standards when consumers are unwilling to bear the switching costs (unless benefits outweigh costs of switching)


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Positive Feedback in the Market for VCRs

Figure 7.2


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Strategies for Winning a Format War

Successful strategies revolve around finding ways to make network effects work in their favor and against their competitors :

 Ensure a supply of complements.

• In addition to the product itself

 Leverage killer applications.

• New products that are so compelling that customers adopt them in droves, killing demand for competing formats

 Aggressively price and market.

• Pricing the product low to increase the installed base, then pricing complements high to make profits

 Cooperate with competitors.

• To speed up adoption of the technology

 License the format.

• Reduce financial incentive for competitors to develop their own


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Cost Structures in

High-Technology Industries

Figure 7.3


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Managing

Intellectual Property Rights

Intellectual property rights apply to the product of any intellectual and creative efforts.



Patents, copyrights, and trademarks give individuals and companies incentives to engage in the expense and risk of creating new intellectual property.

 Digitalization and piracy rates

• Large scale problem with high piracy rates

• Legal and technological solutions are required

 Strategies for managing digital rights

• Low costs of copying and distributing digital media

» Can be used to the company’s advantage

» Drive down costs of purchasing media

• Encryption software

• Vigorous defense of intellectual property rights


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Capturing First-Mover Advantages

First-mover advantage: the first to develop and pioneer revolutionary new products that can lead to an enduring competitive advantage

If the new product satisfies unmet consumer needs and demand is high:

• First mover may be in a monopoly position to capture significant revenues and profits.

• Strong revenues and profits signal an opportunity to potential rivals.

•

Rival imitators may enter market in the absence of strong barriers to imitation resulting in lower market returns.

Being a first-mover does not guarantee success.

Success depends on the first-mover strategy that is pursued.


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The Impact of Imitation on Profits of a First Move

Figure 7.4


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First-Mover Advantages

The five main sources of first-mover advantages:

1.

Exploit network effects and positive feedback loops

Locking customers into its technology

2.

Establish significant brand loyalty

Expensive for later entrants to break down

3.

Enable economies of scale and learning effects

So first-mover has cost advantage and can respond to new entrants by cutting price to maintain market share

4.

Create switching costs for customers

Making it difficult for rivals to take customers away

5.

Accumulate valuable knowledge

Regarding customers, distribution, and technology that late entrants will find difficult or expensive to match


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First-Mover Disadvantages

1.

Pioneering costs

To develop technology and distribution channels and to educate the customers

Later entrants ‘free-ride’ on first-mover’s investments.

2.

More prone to make mistakes

Because of the uncertainties in a new market

Later entrants learn from the mistakes of first-movers.

3.

Risk of building the wrong resources and capabilities

Mass-market may differ from the needs of early adopters

Firstmovers risk ‘Plunging into the chasm’.

4.

May invest in inferior or obsolete technology

If the underlying technology is advancing rapidly

Late entrants may be able to ‘leap frog’ the technology.


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Strategies for Exploiting

First-Mover Advantages

1.

Going it alone

Develop and market the innovation itself.

2.

Strategic alliance or joint venture

Develop and market the innovation jointly with other companies.

3.

License the innovation to others

L et them develop the market.

Key questions in choosing a strategy:

• Does the company have the complementary assets to exploit its innovation?

• How difficult is it for imitators to copy the company’s innovation ( height of barriers to imitation )?

• Are there capable competitors who could rapidly imitate the innovation?


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Strategies for Profiting from Innovation

Table 7.1


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Technological Paradigm Shifts

Occur when new technologies emerge that:

• Revolutionize the structure of the industry

• Dramatically alter the nature of the competition

• Requires companies to adopt new strategies to survive

Paradigm shifts are more likely to occur with:

• Natural limits to technology

The established technology in the industry is mature and approaching its natural limit.

• New disruptive technology

Has entered the marketplace and is taking root in niches that are poorly served by incumbent companies using established technology.


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The Technology S-Curve

Figure 7.5


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Established and Successor

Technologies

Figure 7.6


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Swarm of Successor

Technologies

Figure 7.7


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Disruptive Technology

Disruptive technology is a new technology that gets its start away from the mainstream of a market and invades the main market as its functionality improves over time.

 Revolutionizes the industry structure and competition

 Causes a technological paradigm shift

Disruptive technology often causes the decline of established companies – because they listen to customers who say they do not want it.


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Strategic Implications of Paradigm

Shifts for Established Companies

 Having access to knowledge about how disruptive technologies can revolutionize markets is in itself a valuable asset.

 It is important for established enterprises to invest in newly emerging technologies that may become disruptive.

 Commercialization of disruptive technology may require a different value chain with a different cost structure.

Internal forces suppress change.

Chances of success in developing and commercializing disruptive technology will be enhanced if it is placed in its own organization.


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Strategic Implications of

Paradigm Shifts for New Entrants

New entrants, or attackers, have several advantages over established enterprises:

 Pressure to continue the out-of-date existing business model does not hamper new entrants.

 New entrants need not worry about established customer base, distribution channels, or suppliers.

But new entrants face important new issues:

 May be constrained by lack of capital

 Need to manage the organizational problems associated with rapid growth

 Find a way to take the technology from a small niche into the mass-market

 Decide whether to go it alone or partner with an established company


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Chapter

Eight

Strategy in the Global

Environment

The Global and National

Environments

International expansion represents a way of earning greater returns by transferring the skills and product offerings derived from distinctive competencies to markets where indigenous competitors lack these skills.

The trend toward globalization has many implications:

1.

Industries are becoming global in scope

Industry boundaries no longer stop at national borders.

2.

Shift from national to global markets

This has intensified competition in industry after industry.

3.

Steady decline in barriers to cross-border trade and investment

This has opened up many once protected markets to companies based outside of them.


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Increasing Profitability and Profit

Growth Through Global Expansion

 Expanding the market by leveraging products

• Taking goods or services developed at home and selling them internationally

• Utilizing the distinctive competencies that underlie the production and marketing

 Cost economies from global volume

• Economies of scale from additional sales volume

• Lower unit costs and spreading of fixed costs

 Location economies

• Economic benefits from performing a value creation activity in the optimal location

• Leveraging the skills of global subsidiaries

• Applying these skills to other operations within firm’s global network

Must also consider transportation costs, trade barriers, as well as the political and economic risks.


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Pressures for Cost Reductions and Local Responsiveness

Figure 8.2

The best strategy for a company to pursue may depend on the kinds of pressures it must cope with:

• Cost Reductions or

• Local Responsiveness


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Pressures for Cost Reductions

Pressures for cost reductions are greatest in industries producing commodity-type products where price is the main competitive weapon:

 Where differentiation on non-price factors is difficult

 Where competitors are based in low-cost location

 Where consumers are powerful and face low switching costs

 Where there is persistent excess capacity

 The liberalization of the world trade and investment environment


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Pressures for Local

Responsiveness

The greatest pressures for local responsiveness arise from:  Differences in customer tastes and preferences

 Differences in infrastructure and traditional practices

 Differences in distribution channels

 Host government demands

Dealing with these contradictory pressures is a difficult strategic challenge, primarily because being locally responsive tends to raise costs.


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Choosing a Global Strategy



Standard Globalization Strategy

•

Reaping the cost reductions that come from economies of scale and location economies

•

Business model based on pursuing a low-cost strategy on a global scale

Makes the most sense when there are strong pressures for cost reduction and the demand for local responsiveness is minimal



Localization Strategy

• Customizing the company’s goods or services so that thy provide a good match to tastes and preferences in different national markets

Most appropriate when there are substantial differences across nations with regard to consumer tastes and preferences and where cost pressures are not too intense


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Choosing a Global Strategy



Transnational Strategy

•

Difficult to pursue due to its conflicting demands

•

Business model that simultaneously:

»

Achieves low costs

»

Differentiates across markets

»

Fosters a flow of skills between subsidiaries

Building an organization capable of supporting a transnational strategy is a complex and challenging task.



International Strategy

•

Multinational companies that sell products that serve universal needs (minimal need to differentiate) and do not face significant competitors (low cost pressure) .

In most international companies the head office retains tight control over marketing and product strategy.


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Basic Entry Decisions

1. Which overseas markets to enter

• Assessment of long-run profit potential

» A function of the size of the market, purchasing power of consumers, the likely future purchasing power of consumers

• Balancing the benefits, costs, and risks associate with doing business in a country

» A function of economic development and political stability

2. Timing of entry

• First-mover advantages: preempt and build share

• First-mover disadvantages: pioneering costs

3. Scale of Entry and Strategic Commitments

• Entering on a large scale is a major strategic commitment

» With long term impacts that may be difficult to reverse

• Benefits and drawbacks of small-scale entry


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The Choice of Entry Mode

When and how to enter a new national market raise the question of how to determine the best mode or vehicle for entry. The optimal one depends on the company’s strategy:

1. Exporting

Most manufacturing companies begin their global expansion as exporters and later switch to one of the other modes.

2. Licensing

A foreign licensee buys the rights to produce a company’s product for a negotiated fee; licensee puts up most of the overseas capital.

3. Franchising

Franchising is a specialized form of licensing. The franchiser not only sells intangible property, but also insists that franchisee agrees to follow strict rules as to how it does business.

4. Joint Ventures

Typically a 50/50 venture – a favored mode for entering a new market

5. Wholly-Owned Subsidiaries

Parent company owns 100% of subsidiary’s stock – setup or acquire


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Advantages and Disadvantages of Different Entry Modes

Table 8.1


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Choosing Among Entry Modes

 Distinctive Competencies and Entry Mode

To earn greater returns from differentiated products or where competitors lack comparable products, the optimal mode of entry depends on the nature of the company’s distinctive competency:

• Technological know-how

» Wholly-owned subsidiary is preferred over licensing and joint ventures to minimize risk of losing control.

• Management know-how

» Franchising, joint ventures, or subsidiaries are preferred as risk is low of losing management know-how.

 Pressures for Cost Reduction and Entry Mode

The greater the cost pressure, the more likely a company will want to pursue some combination of exporting and wholly-owned subsidiary:

• Export finished goods from wholly-owned subsidiary

• Marketing subsidiaries for overseeing distribution

» Tight control over local operations allows company to use profits generated in one market to improve position in other markets.


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Global Strategic Alliances

Global Strategic Alliances are cooperative agreements between companies from different countries that are actual or potential competitors. They range from short-term contractual cooperative arrangements to formal joint ventures with equity participation.

 Advantages

• Facilitate entry into a foreign market

• Share fixed costs and associated risks

• Bring together complementary skills and assets

• Set technological standards for its industry

 Disadvantages

• Give competitors a low-cost route to gain new technology and market access

Some alliances benefit the company.

Beware, alliances can end up giving away technology and market access with very little gained in return.


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Making Strategic Alliances Work

The failure rate for international strategic alliances is quite high. Success seems to be a function of three main factors:

1. Partner selection – A good partner:

• Helps the company achieve strategic goals

• Shares the firm’s vision for the purpose of the alliance

• Is unlikely to try to exploit the alliance to its own ends



Conduct research on potential partners

2. Alliance structure

• Risk of giving too much away is at an acceptable level

• Guard against opportunism by partner in alliance agreement

3. Manner in which alliance is managed

• Sensitivity to cultural differences

• Build relationship capital through interpersonal relationships

Successful partners view the alliance as an opportunity to learn rather than purely as a cost- or risk-sharing device.


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Structuring Alliances to Reduce Opportunism

Figure 8.5

Opportunism includes the expropriation of technology or markets


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Chapter

Nine

Corporate

Strategy:

Horizontal

Integration,

Vertical

Integration, and Strategic

Outsourcing

Corporate-Level Strategy

Corporate-Level Strategy should allow a company, or its business units, to perform the value-creation functions at lower cost or in a way that allows for differentiation and premium price.

Corporate strategy is used to identify:

1.

Businesses or industries that the company should compete in

2.

Value creation activities that the company should perform in those businesses

3.

Method to enter or leave businesses or industries in order to maximize its long-run profitability

Companies must adopt a long-term perspective

Consider how changes in the industry and its products, technology, customers, and competitors will affect its current business model and future strategies.


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Corporate-Level Strategy:

The Multi-Business Model

A company’s corporate-level strategies should be chosen to promote the success of a company’s business model – and to allow it to achieve a sustainable competitive advantage at the business level.

A multi-business company must construct its business model at two levels:

1.

Business models and strategies for each business unit or division in every industry in which it competes

2.

Higher-level multi-business model that justifies its entry into different businesses and industries


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Repositioning and Redefining

A Company’s Business Model

Corporate-level strategies are primarily directed toward improving a company’s competitive advantage and profitability in its present business or product line:

 Horizontal Integration

• The process of acquiring or merging with industry competitors

 Vertical Integration

• Expanding operations backward into an industry that produces inputs for the company or forward into an industry that distributes the company’s products

 Strategic Outsourcing

• Letting some value creation activities within a business be performed by an independent entity


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Horizontal Integration

Single-Industry Strategy

Horizontal Integration is the process of acquiring or merging with industry competitors in an effort to achieve the competitive advantages that come with large scale and scope.

Staying inside a single industry allows a company to:

 Focus resources

Its total managerial, technological, financial and functional resources and capabilities are devoted to competing successfully in one area.

 ‘Stick to its knitting’

Company stays focused on what it does best, rather than entering new industries where its existing resources and capabilities add little value.


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Benefits of


Profits and profitability increase when horizontal integration:

1.

Lowers the cost structure

• Creates increasing economies of scale

• Reduces the duplication of resources between two companies

2.

Increases product differentiation

• Product bundling – broader range at single combined price

• Total solution – saving customers time and money

• Cross-selling – leveraging established customer relationships

3.

Replicates the business model

• In new market segments within same industry

4.

Reduces industry rivalry

• Eliminate excess capacity in an industry

• Easier to implement tacit price coordination among rivals

5.

Increases bargaining power

• Increased market power over suppliers and buyers

• Gain greater control


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Problems with


A wealth of data suggests that the majority of mergers and acquisitions DO NOT create value and that many may actually DESTROY value.

 Implementing a horizontal integration is not an easy task.

• Problems associated with merging very different company cultures

• High management turnover in the acquired company when the acquisition is a hostile one

• Tendency of managers to overestimate the benefits to be had in the merger

• Tendency of managers to underestimate the problems involved in merging their operations

 The merger may be blocked if merger is perceived to:

• Create a dominant competitor

• Create too much industry consolidation

• Have the potential for future abuse of market power


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Vertical Integration

Entering New Industries

A company may expands its operations backward into industries that produces inputs to its products or forward into industries that utilize, distribute or sell it products.









Backward Vertical Integration

• Company expands its operations into an industry that produces inputs to the company’s products.

Forward Vertical Integration

•

Company expands into an industry that uses, distributes, or sells the company’s products.

Full Integration

• Company produces all of a particular input from its own operations.

• Disposes of all of its completed products through its own outlets.

Taper Integration

• In addition to company-owned suppliers, the company will also use other suppliers for inputs or independent outlets in addition to company-owned outlets.


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Stages in the Raw Material to Consumer Value Chain

Figure 9.1


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Raw Material to Consumer Value Chain in the Personal Computer Industry

Figure 9.2


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Full and Taper Integration

Figure 9.3


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Increasing Profitability Through


A company pursues vertical integration to strengthen the business model of its original or core business or to improve its competitive position:

1.

Facilitates investments in efficiency-enhancing specialized assets

• Allows company to lower the cost structure or

• Better differentiate its products

2.

Enhances or protects product quality

• To strengthen its differentiation advantage through either forward or backward integration

3.

Results in improved scheduling

• Makes it easier and more cost-effective to plan, coordinate, and schedule the transfer of product within the value-added chain

• Enables a company to respond better to changes in demand


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Problems with


Companies may disintegrate or exit industries adjacent to the industry value chain when encountering disadvantages from the vertical integration:

 Cost structure is increasing.

• Company-owned suppliers develop a higher cost structure than those of the independent suppliers

• Bureaucratic costs of solving transaction difficulties

 The technology is changing fast.

• Vertical integration may lock into old or inefficient technology

• Prevent company from changing to a new technology that could strengthen the business model

 Demand is unpredictable.

 Creates risk in vertical integration investments.

Vertical integration can weaken business model when:

• Company-owned suppliers lack incentive to reduce costs

• Changing demand or technology reduces ability to be competitive


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Alternatives to Vertical Integration:

Cooperative Relationships

Strategic Alliances are long-term agreement between two or more companies to jointly develop new products or processes that benefit all companies concerned.

 Short-term contracts and competitive bidding

• May signal a company’s lack of commitment to its supplier

 Strategic alliances and long-term contracting

• Enables creation of a stable long-term relationship

• Becomes a substitute for vertical integration

• Avoids the problems of having to manage a company located in an adjacent industry

 Building long-term cooperative relationships

• Hostage taking – creating a mutual dependency

• Credible commitments – a believable promise or pledge

• Maintaining market discipline – power to discipline supplier

•

Periodic contract renegotiation  Parallel sourcing policy


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Strategic Outsourcing

Strategic Outsourcing allows one or more of a company’s value-chain activities or functions to be performed by independent specialized companies that focus all their skills and knowledge on just one kind of activity.

 Company is choosing to focus on a fewer number of value-creation activities



In order to strengthen its business model

 Company’s typically focus on noncore or nonstrategic activities



In order to determine if they can be performed more effectively and efficiently by independent specialized companies

 Virtual Corporation



Describes companies that have pursued extensive strategic outsourcing


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Strategic Outsourcing of Primary

Value Creation Functions

Figure 9.4


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Benefits of Outsourcing

1.

Reducing the cost structure

• The specialist company cost is less than what it would cost to perform the activity internally.

2.

Enhanced differentiation

• The quality of the activity performed by the specialist is greater than if the activity were performed by the company.

3.

Focus on the core business

• Distractions are removed.

• The company can focus attention and resources on activities important for value creation and competitive advantage.

Strategic outsourcing may be detrimental when:

• Holdup – company becomes too dependent on specialist provider

• Loss of information – company loses important customer contact or competitive information


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Chapter

Ten

Corporate-Level

Strategy:

Formulating and

Implementing

Related and

Unrelated

Diversification


Corporate-Level Strategy should allow a company, or one of its business units, to perform the value-creation functions at lower cost or in a way that allows for differentiation and premium price.

Corporate strategy is used to identify:

1.

Businesses or industries that the company should compete in

2.

Value creation activities which the company should perform in those businesses

3.

Method to enter or leave businesses or industries in order to maximize its long-run profitability

Companies must adopt a long-term perspective

Consider how changes in the industry and its products, technology, customers, and competitors will affect its current business model and future strategies.


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Corporate-Level Strategy of Diversification

Diversification Strategy is the company’s decision to enter one or more new industries (that are distinct from its established operations) to take advantage of its existing distinctive competencies and business model.

Types of diversification:

 Related diversification

 Unrelated diversification

Methods to implement a diversification strategy:

 Internal new ventures

 Acquisitions

 Joint ventures


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Expanding

Beyond a Single Industry

Staying inside a single industry allows a company to:

•

Focus its resources  ‘Stick to its knitting’

BUT a company’s fortunes are tied closely to the profitability of its original industry:

 Can be dangerous if the industry matures and goes into decline

 May be missing the opportunity to leverage their distinctive competencies in new industries

 Tendency to rest on their laurels and not engage in constant learning

To stay agile, companies must leverage – find new ways to take advantage of their distinctive competencies and core business model in new markets and industries.


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A Company as a Portfolio of

Distinctive Competencies

Reconceptualize the company as a portfolio of distinctive

competencies . . . rather than a

 portfolio of products: might be leveraged to create opportunities in new industries

 Existing competencies versus new competencies that would need to be developed

 Existing industries in which a company competes versus new industries


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Establishing a

Competency Agenda

Figure 10.1

Source: Reprinted by permission of Harvard Business School Press. From Competing for the Future: Breakthrough Strategies for

Seizing Control of Your Industry and Creating the Markets of Tomorrow by Gary Hamel and C. K. Prahalad, Boston, MA. Copyright ©

1994 by Gary Hamel and C. K. Prahalad. All rights reserved.


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Increasing Profitability

Through Diversification

A diversified company can create value by:



Transferring competencies among existing businesses



Leveraging competencies to create new businesses



Sharing resources to realize economies of scope



Using product bundling



Managing rivalry by using diversification as a means in one or more industries



Exploiting general organizational competencies that enhance performance within all business units

Managers often consider diversification when their company is generating free cash flow – with resources in excess of those needed to maintain competitive advantage.


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

Transferring Competencies

Transferring competencies across industries: taking a distinctive competency developed in one industry and implanting it in an EXISTING business unit in another industry

• The competencies transferred must involve activities that are important for establishing competitive advantage

• Tend to acquire businesses related to their existing activities because of the commonality between one or more value-chain functions

For such a strategy to work, the distinctive competency being transferred must have real strategic value.


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Transfer of Competencies at Philip Morris

Figure 10.2


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

Leveraging Competencies

Leveraging competencies: taking a distinctive competency developed by a business in one industry and using it to create a NEW business unit in a different industry

• The difference between leveraging and transferring competencies is that an entirely

NEW business is created

• Different managerial processes are involved

• Tend to use R&D competencies to create new business opportunities in diverse areas


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

Sharing Resources

Sharing resources and capabilities across two or more business units in different industries to realize economies of scope.

Economies of scope arise when business units are able to effectively able to pool, share, and utilize expensive resources or capabilities:

1.

Companies that can share resources have to invest proportionately less than companies that cannot share.

2.

Resource sharing can result in economies of scale.

Economies of scope are possible only when there are significant commonalities between one or more value-chain functions.


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Sharing Resources at Procter & Gamble

Figure 10.3


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

Using Product Bundling

Use product bundling to differentiate products and expand products lines in order to satisfy customers’ needs for a package of related products.

• Allows customers to reduce their number of suppliers for convenience and cost savings.

• Increased value of orders gives customers increased commitment and bargaining power with suppliers.


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

Managing Rivalry

Manage rivalry by holding a competitor in check that has either entered its industry or has the potential to do so.

• Multipoint competition is when companies compete with each other in different industries.

• Companies can manage rivalry by signaling that competitive attacks in one industry will be met by retaliatory attacks in the aggressor’s home industry.

• Mutual forbearance from signaling may result in less intense rivalry and higher industry profits.


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

Exploiting General

Organizational Competencies

General organizational competencies are skills of a company’s top managers and functional experts that transcend individual functions or business units.

These capabilities help each business unit perform at a higher level than if it operated as an individual company:

1. Entrepreneurial capabilities – encourage risk taking while managing & limiting the amount of risk undertaken

2. Organizational design – create structure, culture, and control systems that motivate and coordinate employees

3. Superstrategic capabilities – effectively manage the managers of the business units and helping them think through strategic problems

These managerial skills are often not present, as they are rare and difficult to develop and put into action.


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Types of Diversification

 Related diversification

Entry into a new business activity in a different industry that:

• Is related to a company’s existing business activity or activities and

• Has commonalities between one or more components of each activity’s value chain

Based on transferring and leveraging competencies, sharing resources, and bundling products

 Unrelated diversification

Entry into industries that have no obvious connection to any of a company’s value-chain activities in its present industry or industries

Based on using only general organizational competencies to increase profitability of each business unit


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Commonalities Between Value

Chains of Three Business Units

Figure 10.4


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Disadvantages and

Limits of Diversification

Conditions that can make diversification disadvantageous:

1.

Changing Industry and Firm-Specific Conditions

• Future success of this strategy is hard to predict.

• Over time, changing situations may require businesses to be divested.

2.

Diversification for the Wrong Reasons

• Must have clear vision as to how value will be created.

• Extensive diversification tends to reduce rather than improve profitability.

3.

Bureaucratic Costs of Diversification

• Costs are a function of the number of business units in a company’s portfolio, and the

• Extent to which coordination is required to gain the benefits.


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Coordination Among

Related Business Units

Figure 10.5


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Choosing a Strategy

The choice of strategy depends on a comparison of the benefits of each strategy versus the cost of pursuing it:







Related diversification

• When company’s competencies can be applied across a greater number of industries and

• Company has superior capabilities to keep bureaucratic costs under control

Unrelated diversification

• When functional competencies have few useful applications across industries and

• Company has good organizational design skills to build distinctive competencies

Web of corporate level strategy

• May pursue both related and unrelated diversification

• As well as other strategies that improve long-term profitability


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Sony’s Web of


Figure 10.6


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Diversification That

Dissipates Value

 Diversifying to pool risks

• Stockholders can diversify their own portfolios at lower costs than the company can.

• This represents an unproductive use of resources as profits can be returned to shareholders as dividends.

• Research suggests that corporate diversification is not an effective way to pool risks.

 Diversifying to achieve greater growth

• Growth on its own does not create value.

• Business cycles of different industries are inherently difficult to predict.

Based on a large number of academic studies:

Extensive diversification tends to reduce, rather than improve, company profitability.


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Entry Strategies to

Implement Multibusiness Model

Various entry strategies may be employed based on the company’s competencies and capabilities:



Internal New Ventures

•

Company has a set of valuable competencies in its existing businesses.

•

Competences leveraged or recombined to enter new business areas.



Acquisitions

•

Company lacks important competencies to compete in an area.

•

Company can purchase an incumbent company that has those competencies at a reasonable price.



Joint Ventures

•

Company can increase the probability of success by teaming up with another company with complementary skills.

•

Joint ventures are preferred when risks and costs of setting up a new business unit are more than company can assume.


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

Pitfalls of New Ventures

 Scale of entry

• Large-scale entry is initially more expensive than smallscale entry, but it brings higher returns in the long run.

 Commercialization

• Technological possibilities should not overshadow market needs and opportunities.

 Poor implementation

• Demands on cash flow

• Need clear strategic objectives

• Anticipate time and costs


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Scale of Entry and Profitability

Figure 10.7


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

Guidelines for Successful

Internal New Venturing

Structured approach to managing internal new venturing:

 Research aimed at advancing basic science and technology

 Development research aimed at finding and refining commercial applications for the technology

 Foster close links between R&D and marketing; between R&D and manufacturing

 Selection process for choosing ventures

 Monitor progress


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

The Attractions of Acquisition

Acquisitions are the principle strategy used to implement horizontal integration:

 Used to achieve diversification when the company lacks important competencies

 Enable a company to move quickly

 Perceived as less risky than internal new ventures

 An attractive way to enter a new industry that is protected by high barriers to entry


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

Acquisition Pitfalls

There is ample evidence that many acquisitions fail to create value or to realize their anticipated benefits:

 Integrating the acquired company

• Difficulty in integrating value-chain and management activities

• High management and employee turnover in acquired company



Overestimating the economic benefits

• Overestimate the competitive advantages and value-added that can be derived from the acquisition

• Pay too much for the target company

 The expense of acquisitions

• Premium paid for publicly traded companies

• Premium cancels out the prospective value-creating gains

 Inadequate preacquisition screening

• Weaknesses of acquisitions’ business model are not clear


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

Guidelines for

Successful Acquisition

 Target identification and preacquisition screening for:

1.

Financial position

2.

Distinctive competencies and competitive advantage

3.

Changing industry boundaries

4.

Management capabilities

5.

Corporate culture

 Bidding strategy

• Avoid hostile takeovers and speculative bidding.

• Encourage friendly takeover with amicable merger.

 Integration

• Eliminate duplication of facilities and functions.

• Divest unwanted business units included in acquisition.

 Learning from experience

• Conduct post-acquisition audits.


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

Joint Ventures

Attractions:

 Helps avoid the risks and costs of building a new operation from the ground floor

 Teaming with another company that has complementary skills and assets may increase the probability of success

Pitfalls:

 Requires the sharing of profits if the new business succeeds

 Venture partners must share control – conflicts on how to run the joint venture can cause failure

 Run the risk of giving critical know-how away to joint venture partner


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Restructuring

Restructuring is the process of divesting businesses and exiting industries to focus on core distinctive competencies in order to increase company profitability.

Why restructure?

• Diversification discount: investors see highly diversified companies as less attractive

» Complexity and lack of transparency in financial statements

» Too much diversification

» Diversification for the wrong reasons

• Response to failed acquisitions

• Innovations in strategic management have diminished the advantages of vertical integration or diversification


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Chapter

Eleven

Corporate

Performance,

Governance, and Business

Ethics

Stakeholders and Corporate Performance

Stakeholders are individuals or groups with an interest, claim, or stake in the company, what it does, and how well it performs.

Stakeholders are in an exchange relationship with the company

• Contributions: they supply the organization with important resources

• Inducements: in exchange they expect their interests to by satisfied

Companies should pursue strategies that maximize long-run shareholder value and must also behave in an ethical and socially responsible manner.


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Stakeholders and the Enterprise

Figure 11.1


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Stakeholder Impact Analysis

 Identify stakeholders most critical to survival:

• Identify which stakeholders

• The stakeholders’ interests and concerns

• Claims stakeholders are likely to make on the organization

• Stakeholders who are most important to the organization’s perspective

• Identify the resulting strategic challenges

 Usually the most important:

•

Customers • Employees • Stockholders

Companies must identify the most important stakeholders and give highest priority to pursuing strategies that satisfy their needs.


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The Unique Role of Stockholders

Stockholders are a company’s legal owners and the provider of risk capital, a major source of capital to operate a business.

Risk capital –

No guarantee to the stockholders that:

• They will recoup their investment

• Or earn a decent return

ESOPs –

Employee Stock Option Plans

Employees may also be shareholders

Maximizing long-run profitability & profit growth is the route to maximizing returns to shareholders, as well as satisfying the claims of most other stakeholder groups.


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Profitability, Profit Growth and

Stakeholder Claims

To grow profits, companies must be doing one or more of the following:

1.

Participating in a market that is growing

2.

Taking market share away from competitors

3.

Consolidating the industry via horizontal integration

4.

Developing new markets through:

• Diversification • Vertical Integration • International Expansion

Stockholders receive their returns as:

 Dividend payments

 Capital appreciation in market value of shares

ROIC is an excellent measure of profitability.

A company generating positive ROIC is adding to shareholders’ equity and increasing shareholder value.


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Agency Theory

Agency relationships arise whenever one party delegates decision-making authority or control over resources to another .

Principal-agent relationships

• Principal: person delegating authority

• Agent: person to whom authority is delegated

The agency problem:

• Agents and principals may have different goals.

• Agents may pursue goals that are not in the best interests of their principals.

• Agents may take advantage of information asymmetries to maximize their interests at the expense of principals.

• It is difficult for principals to measure performance.

•

Trust

•

On-the-job consumption

•

Empire building


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The Tradeoff Between Profitability and Revenue Growth Rates

Need to maximize long-run shareholder returns by seeking the right balance between company growth . . . and profitability and profit growth.

Figure 11.2


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The Challenge for Principals

Confronted with agency problems, the challenge for principals is to:

1.

Shape the behavior of agents so that they act in accordance with goals set by principals

2.

Reduce information asymmetry between agents and principals

3.

Develop mechanisms for removing agents who do not act in accordance with goals and principals

Principals try to deal with these challenges through a series of governance mechanisms.


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Governance Mechanisms

Governance mechanisms serve to limit the agency problem by aligning incentives between agents and principals and by monitoring and controlling agents.

 The Board of Directors

• Elected by stockholders

• Legally accountable

• Monitors corporate strategy decisions

• Authority to hire, fire, and compensate

• Ensures accuracy of audited financial statements

• Inside directors

• Outside directors

 Stock-Based Compensation

• Pay-for-performance

• Stock options:

The right to buy company shares at a predetermined price at some point in the future

 Financial Statements

•

Auditors • SEC • GAAP

 The Takeover Constraint

• Limits strategies that ignore shareholder interests

• Corporate raiders


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How Options Skew the Bottom Line

Table 11.1

Source: D. Henry and M. Conlin, “Too Much of a Good Incentive?” Business Week ,

March 4, 2002, pp. 38 –39.


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Governance Mechanisms

Inside a Company

Important agency relationships also exist between levels of management within a company. Internal agency problems can be reduced by:

 Strategic control systems

• To establish standards against which performance can be measured

• To create systems for measuring and monitoring performance

• To compare actual performance against targets

• To evaluate results and take corrective actions



Balanced Scorecard model approach is used to drive future performance

 Employee incentives

• Employee stock options and stock ownership plans

• Compensation tied to attainment of superior efficiency, quality, innovation, and responsiveness to customers


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A Balanced Scorecard Approach

Figure 11.3


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Ethics and Strategy

Business ethics are the accepted principles of right or wrong governing the conduct of businesspeople.

 Ethical dilemmas occur when:

• There is no agreement over what the accepted principles are

• None of the available alternatives seem ethically acceptable

 Many accepted principles are codified into laws:

• Tort laws – governing product liability

• Contract law – contracts and breaches of contracts

• Intellectual property law – protection of intellectual property

• Antitrust law – governing competitive behavior

• Securities law issuing and selling securities

 Behaving ethically goes beyond staying within the law

An ethical strategy is one that does not violate the accepted principles.


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Ethical Issues in Strategy

Ethical issues are due to a potential conflict between the goals of the enterprise, or the goals of the individual managers, and the rights of important stakeholders:

 Self-dealing

Managers feather their nest with corporate monies

 Information manipulation

Distort or hide information to enhance competitive or personal situation

 Anticompetitive behavior

Actions aimed at harming actual or potential competitors

 Opportunistic exploitation

Of other players in the value chain in which the firm is embedded

 Substandard working conditions

Underinvest in working conditions or pay below market wages

 Environmental degradation

Directly or indirectly take actions that result in environmental harm

 Corruption

Companies pay bribes to gain access to lucrative business contracts.


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The Roots of Unethical Behavior

Why do some managers behave unethically?

No simple answers, but some generalizations:

1.

Personal ethics code: will have a profound influence on behavior as a businessperson

2.

Do not realize they are behaving unethically: by failing to ask the right questions

3.

Organization’s culture: de-emphasizes ethics and considers primarily economic consequences

4.

Unrealistic performance goals: encouraging and legitimizing unethical behavior

5.

Unethical leadership: that encourages and tolerates behavior that is ethically suspect


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Philosophical Approaches to Ethics

Philosophical underpinnings of business ethics that can provide managers with a moral compass to help navigate through difficult ethical issues:

 The Friedman Doctrine

Milton Friedman’s basic position is that the only social responsibility of business is to increase profits, as long as the company stays within the law and the rules of the game without deception or fraud.

 Utilitarian and Kantian Ethics

The moral worth of actions is determined by its consequences – leading to the best possible balance of good versus bad consequences.

Committed to the maximization of good and the minimization of harm.

 Rights Theories

Recognizes that human beings have fundamental rights and privileges.

Rights establish a minimum level of morally acceptable behavior.

 Justice Theories

Focus on the attainment of a just distribution of economic goods and services that is considered to be fair and equitable.


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Behaving Ethically

To make sure that ethical issues are considered in business decisions, managers should:

1.

Favor hiring and promoting people with a well-grounded sense of personal ethics.

2.

Build an organizational culture that places a high value on ethical behavior.

3.

Make sure that leaders not only articulate but also act in an ethical manner.

4.

Put decision-making processes in place that require people to consider the ethical dimension of business decisions.

5.

Use ethics officers.

6.

Put strong corporate governance processes in place.

7.

Act with moral courage and encourage others to do the same.


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Chapter

Twelve

Implementing

Strategy in

Companies

That Compete in a Single

Industry

Implementing Strategy

Through Organizational Design

Organizational Design is the process of selecting the right combination of organizational structure, control systems, and culture to pursue a business model successfully.

 Organizational Structure

Assigns employees to specific value creation tasks and roles



To coordinate and integrate the efforts of all employees

 Strategic Control Systems

A set of incentives to motivate employees



To provides feedback on performance so corrective action can be taken

 Organizational Culture

The collection of values, norms, beliefs, and attitudes shared within an organizations



To control interactions within and outside the organization


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Implementing Strategy

Through Organizational Design

Figure 12.1

Organizational structure, control, and culture shape people’s behaviors, values, and attitudes – and determine how they will implement an organization’s business model and strategies.


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Building Blocks of

Organizational Structure

An organization structure assigns people to tasks and connects the activities of different people and functions:



Grouping tasks, functions, and divisions

How best to group tasks into functions – and functions into business units or divisions to create distinctive competencies and pursue a particular strategy



Allocating authority and responsibility

How to allocate authority and responsibility to these functions and divisions



Integration and integrating mechanisms

How to increase the level of coordination or integration between functions and divisions as a structure evolves and becomes more complex


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

Group Tasks, Functions and Divisions

Choice of structure is made on its ability to implement company’s business model and strategies successfully:

• Organizational structure – follows the range and variety of tasks that an organization pursues.

• Companies group people and tasks into functions and then functions into divisions.

» A function is a collection of people who work together and perform similar tasks or hold similar positions.

» A division is a way of grouping functions to allow an organization to better serve its customers.

»

Handoffs are the work exchanges between people, functions, and subunits.



Bureaucratic costs result from the inefficiencies surrounding these handoffs.


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

Allocating Authority and Responsibility

To economize on bureaucratic costs and effectively coordinate the activities, company must develop a clear and unambiguous hierarchy of authority :

 Organizational Structure

• Span of control (number of subordinates)

• Tall versus flat organizations

 Flexibility  Communication problems  Response time

 Expense  Distortion of commands

 Decision Making: Centralized versus Decentralized

• Delegating and empowering employees

 Requires fewer managers  Reduces information overload

 Increases motivation and accountability

• Centralized decisions

 Easier coordination of activities

 Decisions fit broad organizational objectives

Principle of the Minimum Chain of Command:

Choose hierarchy with the fewest levels of authority necessary to use organizational resources efficiently and effectively.


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Tall and Flat Structures

Figure 12.2


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

Integration and

Integrating Mechanisms

Integration and integrating mechanisms: are used to increase communication and coordination among functions and divisions

 Direct contact

• Creates a context within which managers across functions or divisions can work together

 Liaison roles

• Increases coordination

• Gives one manager in each function or division the responsibility for coordinating with the other

 Teams

• Use when multiple functions share mutual problems

The greater the complexity of an organization’s structure, the greater the need for formal coordination among people, functions, and divisions.


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Strategic Control Systems

The formal target-setting, measurement, and feedback systems to evaluate whether a company is implementing its strategy successfully

Characteristics of an effective control system:

• Flexible – to allow managers to respond as necessary to unexpected events

• Accurate information – giving a true picture of organizational performance

• Timely – presentation of information for timely decision making

Measures should be tied to the goals of developing distinctive competencies in efficiency, quality, innovativeness, and responsiveness to customers.


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Steps in Designing an Effective Control System

Figure 12.3


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Levels of Organizational Control

Controls at each level should provide the basis on which managers at lower levels design their controls systems.

Figure 12.4


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





Types of

Strategic Control Systems

Personal Control

Shape and influence the behavior of a person in a face-to-face interaction in the pursuit of a company’s goals.



Managers question and probe to better understand subordinates.



The result is more possibilities for learning to occur and competencies to develop.

Output Control

Forecast appropriate performance goals for each division, department, and employee – then measure actual performance relative to these goals .

 The achievement of these goals is a sign that the company’s strategy is working.

Behavior Control

Establish a system of rules and procedures to direct the actions or behavior of divisions, functions, or individuals.



The result is standardization, predictability, and accuracy.


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Using Information Technology

 Behavior control

• IT standardizes behavior through the use of a consistent, cross-functional software platform.

 Output control

• IT allows all employees or functions to use the same software platform to provide information on their activities.

 Integrating mechanism

• IT provides people at all levels and across all functions with more information.


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Organizational Culture

Organizational Culture is the specific collection of values and norms shared by people in the organization.

• Organizational socialization – how people learn the culture so that they become organization ‘members’.

• Strategic leadership – style established by the founder and transmitted to the company’s managers.

 The culture becomes more distinct as the organization’s members become more similar.

• Strong and adaptive cultures – are innovative, encourage and reward initiative, and have common values:

 Bias for action – autonomy, entrepreneurship, and risk-taking

 Organization’s mission – ‘sticks to its knitting’ and business model

 How to operate the organization – motivate employees to do ..

their best


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Building Distinctive Competencies at the Functional Level







Most companies group people and tasks around a functional structure on the basis of their common expertise or because they use the same resources.

Functional Structure – advantages:

• People doing similar functions can learn from one another.

• People can monitor each other and improve work processes.

• Managers have greater control over organizational activities.

• Managing is easier with separately managed specialized groups.

Role of Strategic Control

• Managers and employees can monitor and improve operating procedures.

• Easier to apply output control.

Developing Culture

• Managers must implement functional strategy and develop incentive systems to allow each function to succeed.


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Functional Structure

Figure 12.5


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Functional Structure and Bureaucratic Costs

Whenever different functions work together, bureaucratic costs arise because of communication and measurement problems arising from the hand-offs across the functions.

 Communications problems

• Stem from differences in goal orientations and outlooks

 Measurement problems

• Difficulties measuring contribution as product range widens

 Customer problems

• Satisfying customer needs and coordinating value-chain functions

 Location problems

• Functional structure not the best way to handle regional diversity when selling or producing in multiple locations

 Strategic problems

• These problems mean a company has outgrown its structure.



Consider a more complex structure or outsourcing options.


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Implementing Strategy in a Single Industry

Implementation begins at the functional level; however, managers must coordinate and integrate across functions and business units.

Effective s trat egy implementation and organization design at the business level:

• Increases differentiation, adds value for customers, allows for a premium price

•

Reduces bureaucratic costs associated with measurement and communications problems

Effective organization design often means moving to a more complex structure that:

• Economizes on bureaucratic costs

• Increase revenue from product differentiation

• Lowers overall cost structure by obtaining economies of scope or scale


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Implementing Cost Leadership and Differentiation

 Pursuing a cost leadership approach

• The aim is to become the lowest cost producer in the industry

• Reducing costs across all functions

• Lowering cost structure while preserving its ability to attract customers

• Continuously monitoring for effective operation



In practice, the functional structure is the most suitable for cost leadership.

 Implementing a differentiation approach



Design organization structure around the source of distinctive competency, differentiated products, and customer groups.


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How Organizational Design

Increases Profitability

Figure 12.6


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Product Structure:

Implementing a Wide Product Line

Product structure is used to solve the control problems that result from producing may different kinds of products for many different market segments.

Implementing a broad product structure:

• Group the overall product line into product groups.

• Centralize support value chain functions to lower costs.

• Divide support functions into product-oriented teams who focus on the needs of one specific product group.

• Measure the performance of each product group separately from the others.

• Closely link rewards to performance of product group.


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Nokia’s Product Structure

Figure 12.7


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Market Structure: Increasing

Responsiveness to Customer Groups

Market structure focuses on the ability to met the needs of distinct and important sets of customers or different customer groups.

Increasing responsiveness to customer groups:

• Identify the needs of each customer group.

• Group people and functions by customer or market segments.

• Make different managers responsible for developing products for each group of customers.

• Establish market structure brings managers and employees closer to specific groups of customers.


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Market Structure

Figure 12.8


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Geographic Structure:

Expanding Nationally

Geographic regions may become the basis for grouping organizational activities when companies expand nationally through internal expansion, horizontal integration, or mergers.

Expanding nationally – geographic structure

• More responsive to needs of regional customers

• Can achieve a lower cost structure and economies of scale

• Provides more coordination and control than a functional structure through the regional hierarchies


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Geographic Structure

Figure 12.9


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Matrix Structure and

Product-Team Structures

In fast-changing, high-tech environments, competitive success depends on fast mobilization of company skills and resources to ensure that product development and implementation meet customer needs.

 Matrix structure

• Value chain activities are grouped by function and by product or project

• Flat and decentralized

• Promotes innovation and speed

• Norms and values based on innovation and product excellence

 Product-team structure

• Tasks divided along product or project lines

• Functional specialists are part of permanent cross-functional teams


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Matrix Structure

Figure 12.10


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Product-Team Structure

Figure 12.11


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Focusing on a

Narrow Product Line

A focused company concentrates on developing a narrow range of products aimed at one or two market segments as defined by type of customer or location.

Focusing on a narrow product line:

• Focusers tend to have higher production costs

» Output is lower

» Reduced opportunity for economies of scale

• Has to develop some form of distinctive competency

• Structure and controls systems need to be:

» Inexpensive to operate

» Flexible enough to allow distinctive competency



Focuser normally adopts a functional structure.


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Restructuring and Reengineering

To improve performance, a single business company often employs restructuring and reengineering:

 Restructuring

• Streamlining hierarchy of and reducing number of levels

• Downsizing the workforce to lower operating costs

• Reasons to restructure and downsize

» Change in the business environment

» Excess capacity

» Bureaucratic costs: organization grew too tall and inflexible

» To improve competitive advantage and stay on top

 Reengineering

• Fundamental rethinking and radical redesign of business processes to achieve dramatic improvements

• Focuses on processes (which cut across functions), not on functions


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