FOUNDATIONS OF STRATEGY
Chapter 4: The Nature & Sources of Competitive Advantage
COMPETITIVE ADVANTAGE
•
Competitive advantage- when 2 or more firms compete within the same market,
one firms posses a competitive advantage over its rival when it earns or has the
potential to earn a persistently higher rate of profit
•
However, competitive advantage doesn’t always mean superior profit; so firms
forgo current profit in favor of investment in market share, technology, customer
loyalty or other endeavors
•
In the long run, competition eliminates differences in profitability between
competing firms but external and internal changes can create short-term
opportunities for creating an advantage
TOP CARBONATED SOFT DRINK BRANDS BY MARKET SHARE (2011)
1)Coke
4)Mountain Dew
• 17%
• Coca-Cola
• 6.7%
• PepsiCo
2)Diet Coke
5)Dr. Pepper
• 9.6%
• Coca-Cola
• 6.4%
• Dr. Pepper Snapple
3)Pepsi Cola
6)Sprite
• 9.2%
• PepsiCo
• 5.7%
• Coca-Cola
EXTERNAL SOURCES OF CHANGE
•
For an external change to create competitive advantage the change must have
differential effects on companies because of their different resources and
capabilities or strategic positioning
•
The extent to which external changes create competitive advantage and
disadvantage depends on the magnitude of the change and the extent of firms’
strategic differences
How does
competitive
advantage emerge?
External sources of change:
-changing customer demand
-Changing prices
-Technological change
Resources heterogeneity
among firms means
differential impact
Some firms faster and
more effective in
exploiting change
Internal
sources of
change
Some firms have greater
creative and innovative
capability
RESPONSIVENESS TO CHANGE
•
2 Key Capabilities of Responsiveness:
• Ability to anticipate changes
• Speed at which you adjust to those changes (time-based competition)
• Information
• Rely on customers, suppliers and even competitors for that
information
• Short Cycle Times
• Allow information on emerging markets to be acted on quickly
• Important in the fashion industry (who puts out trending designs
out first)
INTERNAL CHANGES THROUGH INNOVATION
•
•
Innovation can create competitive advantage but also provide a basis for
overturning the competitive advantage of other firms
Strategic Innovation (new game strategy) - new approaches to doing business
including business models
• Creating new value for customers from novel products, experiences or modes of
product delivery:
• Toys-R-Us: big-box store with a variety of toys
• Nordstrom: augmented customer service
• Sephora: atypical approaches to display and store layout
• Redesigned processes and novel organizational designs
• Apple combining an MP3 player with its iTunes store
• SWA no frills service, single plane type and non-union employees
SHAPING INNOVATIVE STRATEGIES
•
New Industries
• Launching products that creates a whole new industry
• Purest form of blue ocean strategy
• Xerox created plain-paper copier industry
•
New Customer Segments
• Creating new customer segments for existing product concepts
• Apple didn’t invent the personal computer but launched the
market for computers in the home
•
New Sources of Competitive Advantage
• Introducing novel approaches to creating customer value
• Coca-Cola introduced the freestyle fountain dispenser which
provides a selection of 125 varieties of Coca-Cola products in a
self-serve format
SUSTAINING COMPETITIVE ADVANTAGE
•
Competitors undermine another firms competitive advantage by either innovation
or imitation
•
Imitation is the most direct form of competition therefore barriers are needed to
guard against it
•
Isolating mechanisms- barriers that protects a firms profits from being driven
down by the competitive process
•
For successful imitation a firm must meet these four conditions:
• Identification- identify that a rival possesses a competitive advantage
• Incentive- believe that investing in imitation can earn superior returns
• Diagnosis- be able to diagnosis the features of its rival’s strategy that gives it
competitive advantage
• Resource Acquisition- acquire through transfer or replication the resources and
capabilities needed for imitation
4 CONDITIONS & THEIR ISOLATING MECHANISMS
IDENTIFICATION
•
Obscure the firm’s superior profitability
• Much easier for private as opposed to public firms
•
Pedigree Petfoods (Mars Inc.) was able to accomplish this until the UK
Monopolies Commission revealed that Pedigree earned a return on capital of 47%
INCENTIVE
•
Firms may be able to undermine the incentive for other firms to imitate
through deterrence and preemption
•
Deterrence- signaling aggressive intentions to imitators
• NutraSweet’s aggressive price war against the Holland Sweetener
Company may have deterred other potential entrants
•
Preemption- exploiting all available investment opportunities
• Proliferation of product varieties
• Large investments in production capacity ahead of the growth of market
demand
• Patent proliferation
DIAGNOSIS
•
•
In order to imitate, a firm must understand the basis of its rivals success
The problem lies in the identification of the link from superior performance to the
decisions that generate that performance
• Causal ambiguity- the more complex a firm’s competitive advantage and the
more it is based on complex bundles of capabilities, the more difficult it is to
diagnose the reasons behind its success
• Uncertain imitability- with ambiguity associated with the causes of success,
attempts at imitation are subject to uncertain success
•
Recent research suggests that the complex combinations of resources and
capabilities may make imitation nearly impossible
•
Another issue is the idea that some practices may be generically beneficial for a
firm to put into place while other practices are only successful when combined
with other practices
RESOURCE ACQUISITION
•
Now firms face the challenge of assembling the resources and
capabilities of the advantaged firm
•
To guard against imitators, firms can base its competitive advantage
around resources and capabilities that are immobile and difficult to
replicate
•
On the other hand competitive advantage not requiring complex, firmspecific resources are often imitated quickly
•
This all depends on the extent to which first-mover advantage plays a
role in the market
• First-mover advantage- the idea that the first firm to occupy a strategic
position gains access to resources and capabilities that cannot be
matched
TYPES OF COMPETITIVE ADVANTAGE
•
Firms can achieve or potentially achieve a higher rate of profit over a
rival in one of two ways:
• Cost Advantage- supply an identical product or service at a lower cost
• Differentiation Advantage- supply a product or service that is unique in
such a way that customers are willing to pay a price premium
•
These two sources of competitive advantage are radically different in
terms of company strategy – opposite ends of the spectrum
Cost
Differentiation
COST VS. DIFFERENTIATION ADVANTAGE
EXAMPLES OF COST VS. DIFFERENTIATION
Cost:
Differentiation
•
Walmart
•
Apple
•
McDonalds
•
Mercedes and BMW
•
Ikea
•
Bose
•
Southwest Airlines
•
Nike
COST ADVANTAGE
•
There are seven determinants of a firms unit cost or cost per unit of output (cost
drivers)
•
These determinants vary across industries, firms, and across different activities
within a firm
•
By analyzing these different cost drivers, firms can:
• Analyze its cost position in relation to it competitors and diagnose the sources of
inefficiency
• Make recommendations on how to improve its cost efficiency
COST DRIVERS
Economies of Scale
-Technical input-output relationships
-Indivisibility
-Specializations
Economies of Learning
-Increased individual skills
-Improved organizational routines
Production Techniques
-Process innovation
-Re-engineering of business processes
Product Design
Input Costs
-Standardization of designs & components
-Design for manufacture
-Location advantages
-Ownership of low-cost inputs
-Nonunion labor
-Bargaining power
Capacity Utilization
-Ratio of fixed to variable costs
-Fast and flexible capacity adjustment
Residual Efficiency
-Organizational slack/X-inefficiency
-Motivation and organizational culture
-Managerial effectiveness
VALUE CHAIN ANALYSIS
•
A value chain analysis is an effective way to conduct this examination because it
requires identifying:
• Relative importance to total cost
• Cost drivers for each activity
• Efficiency of each activity
• Comparison of costs to each other
• Whether to outsource or not
•
A value chain analysis involves 6 steps in which a firm:
• Breaks itself down into separate activities
• Establishes the importance of each activity in the total cost of the product
• Compares costs by activity
• Identifies cost drivers for each activity
• Identifies linkages between activities
• Identifies opportunities for reducing costs
STAGES OF VALUE CHAIN ANALYSIS FOR COST ADVANTAGE
1. Break down the firm into separate activities- this requires the knowledge of the
chain of processes involved in the transformation of inputs to outputs and can
usually be guided by a firms divisional and departmental structure
2. Establish the relative importance of different activities in the total cost of the
product- to identify which activities are major sources of cost so we can ultimately
assign costs and assets to each activity
3. Compare costs by activity- to establish which activities are performed with relative
efficiency and those do not, then benchmark those costs against those of
competitors
STAGES OF VALUE CHAIN ANALYSIS FOR COST ADVANTAGE
4. Identify cost drivers for each activity- taking into consideration if the activity is
capital intensive (machine depreciation and maintenance, output of machine) or
labor intensive (wage rates, speed of work, defect rates)
5. Identify linkages between activities- because the costs of some activities may be
effected by the performance of other activities
6. Identify opportunities for reducing costs- after performing the first 5 steps,
opportunities for cost reduction become more evident
 Is outsourcing possible for inefficient activities?
 Can wages be reduced directly or from relocation of services? (Input costs)
 Would better training create a more efficient and effective worker? (Economies
of learning)
DIFFERENTIATION ADVANTAGE
•
Occurs when a firm is able to obtain from its differentiation a price premium in
the market that exceeds the cost of providing the differentiation
•
Opportunities differ from market to market and product to product
•
Products that lack physical differentiation (commodities) can still create
customer value where others have not
•
Critical issue of differentiation advantage: the firm must make sure its
differentiation creates value for customers and that the value exceeds the cost of
the differentiation
•
We can also use the value chain analysis to discover opportunities for
differentiation advantage
STAGES OF VALUE CHAIN ANALYSIS FOR DIFFERENTIATION ADVANTAGE
1. Construct a value chain for the firm and the customer- values chains for the firm,
immediate customers and firms or customer further down the value chain can be
useful. Also create separate value chains for the main categories of customers
because they may have different needs.
2. Identify the drivers of uniqueness in each activity- analyze each separate activity
to discover its individual variables and actions that can be taken to achieve
uniqueness.
DIFFERENTIATION ADVANTAGE
STAGES OF VALUE CHAIN ANALYSIS FOR DIFFERENTIATION ADVANTAGE
3. Select the most promising differentiation variables for the firm- on the supply
side there are 3 important considerations
 Analyze strengths and capabilities to establish the greatest potential for
differentiating or lower cost differentiating than rivals
 Identify linkages among activities because if those interactions aren’t flowing
well, product reliability can be compromised
 Considering the ease of sustaining uniqueness or differentiation- the more
specific the resources are to the firm or complex coordination of the
differentiation, the more difficult imitation will be for competitors
4. Locate linkages between the value chain of the firm and that of the buyer- to
create value for its customers, firms must locate the linkages between
differentiation of it own activities and cost reduction and differentiation within the
customers
PORTER’S GENERIC STRATEGIES
• Porter believes that cost leadership and differentiation are mutually
exclusive and a firm that tries to focus on both is almost guaranteed low
profitability
• Ultimately, a firm needs to decide on pursuing either cost or differentiation
advantage and then decide on its market scope, industry wide (broad
market) or single segment (narrow market)
Source of Competitive Advantage
Competitive
Scope
Industry-wide
Single Segment
Low Cost
Differentiation
Cost Leadership
Differentiation
Focus