Strategic Management Ch 6 Business Strategy: Differentiation, Cost Leadership, and Blue Oceans

spread fixed costs over a larger output

Larger output allows firms to spread their fixed costs over more units. That is why gains in market share are often critical to drive down per-unit cost. This relationship is even more pronounced in many high-tech industries because most of the cost occurs before a single product or service is sold

A cost leader can achieve a competitive advantage

as long as its economic value created (V-C) is greater than its competitors

The most important cost drivers that managers can manipulate to keep their costs low are:

cost of input factors economies of scale learning curve effects experience curve effects

differentiation parity

creates the same value as another firm

economies of scope

savings that come from producing two (or more) outputs at less cost than producing each output individually, despite using the same resources and technology

even if a firm fails to achieve cost parity

(which is often the case because higher value creation tends to go along with higher costs in terms of higher-quality raw materials, research and development, employee training to provide superior customer service, and so on) it can still gain a competitive advantage if its economic value creation exceeds that of its competitors

learning curve effects

-Learning drives down costs -It takes less time to produce the same output. - We learn how to be more efficient. -People learn from cumulative experience: -Writing computer code -Developing new medicines -Building submarines -First noted during WWII: -When production doubled, per-unit cost dropped 20%. The steeper the learning curve, the more learning has occurred. As cumulative output increases, firms move down the learning curve, reaching lower per-unit costs

product features

Adding unique product attributes allows firms to turn commodity products into differentiated products commanding a premium price. Strong R&D capabilities are often needed to create superior product features.

How do managers formulate appropriate business level strategy

Answering Who - which customer segments will we serve, What - customer needs, wishes, and desires will we satisfy, Why - do we want to satisfy them, How will we satisfy customer needs

Blue Ocean Strategy

Business-level strategy that successfully combines differentiation and cost-leadership activities using value innovation to reconcile the inherent trade-offs.

strategic trade-offs

Choices between a cost or value position. Such choices are necessary because higher value creation tends to generate higher cost.

complements

Complements add value to a product or service when they are consumed in tandem. Finding complements, therefore, is an important task for managers in their quest to enhance the value of their offerings. A prime example of complements is smartphones and cellular services. A smartphone without a service plan is much less useful than one with a data plan.

economic value created

Difference between value (V) and cost (C), or (V - C).

A successfully implemented blue ocean strategy allows firms two pricing options

First, the firm can charge a higher price than the cost leader, reflecting its higher value creation and thus generating greater profit margins. Second, the firm can lower its price below that of the differentiator because of its lower-cost structure. If the firm offers lower prices than the differentiator, it can gain market share and make up the loss in margin through increased sales.

To formulate an effective business strategy, managers need to keep in mind that competitive advantage is determined jointly by

Industry and Firm effects

employ specialized systems and equipment

Larger output also allows firms to invest in more specialized systems and equipment, such as enterprise resource planning (ERP) software or manufacturing robots. Tesla's strong demand for its new Model 3 sedan allows it to employ cutting-edge robotics in its Fremont, California, manufacturing plant to produce cars of the highest quality at large scale, and thus driving down costs.

cost of input factors

One of the most basic advantages a firm can have over its rivals is access to lower-cost input factors such as raw materials, capital, labor, and IT services

Differentiation : benefits and risks

The successful differentiator stakes out a unique strategic position, where it can benefit from imperfect competition and command a premium price. A well-executed differentiation strategy reduces rivalry among competitors. The viability of a differentiation strategy is severely undermined when the focus of competition shifts to price rather than value-creating features. This can happen when differentiated products become commoditized and an acceptable standard of quality has emerged across rival firms

Managers can adjust a number of different levers to improve a firm's strategic position.

These levers either increase perceived value or decrease costs. Here, we will study the most salient value drivers that managers have at their disposal. `They are: ▪ Product features ▪ Customer service ▪ Complements

cost leader

focuses its attention and resources on reducing the cost to manufacture a product or deliver a service in order to offer lower prices to its customers. The cost leader attempts to optimize all of its value chain activities to achieve a low-cost position. Although staking out the lowest-cost position in the industry is the overriding strategic objective, a cost leader still needs to offer products and services of acceptable value.

value curve

horizontal connection of the points of each value on the strategy canvas that helps strategists diagnose and determine courses of action

minimum efficient scale

output range needed to bring down the cost per unit as much as possible, allowing a firm to stake out the lowest-cost position that is achievable through economies of scale

The goal of a cost-leadership strategy is

reduce the firm's cost below that of its competitors while offering adequate value

cost leadership strategy

seeks to create the same or similar value for customers by delivering products or services at a lower cost than competitors, enabling the firm to offer lower prices to its customers.

What causes per-unit cost to drop as output increases (up to point Q1)? Economies of scale allow firms to:

spread fixed costs over a larger output employ specialized systems and equipment take advantage of certain physical properties

business level strategy

the goal-directed actions managers take in their quest for competitive advantage when competing in a single product market

economies of scale

the greater efficiency and cost savings that result from large-scale or mass production - decrease in cost per unit as output increases

value innovation

the simultaneous pursuit of differentiation and low cost in a way that creates a leap in value for both the firm and the consumers; considered a cornerstone of blue ocean strategy Instead of attempting to out-compete your rivals by offering better features or lower costs, successful value innovation makes competition irrelevant by providing a leap in value creation, thereby opening new and uncontested market spaces.

scope of competition

the size - narrow or broad - of the market in which a firm chooses to compete

the focus on competition in a differentiation strategy tends to be on

unique product features, service, and new-product launches or on marketing and promotion rather than price

differentation strategy

seeks to create higher value for customers than the value that competitors create, by delivering products or services with unique features while keeping costs at the same or similar levels, allowing the firm to charge higher prices to its customers

diseconomies of scale

the property whereby long-run average total cost rises as the quantity of output increases

experience curve

we change the underlying technology while holding cumulative output constant. experience-curve effects based on process innovation allow a firm to leapfrog to a steeper learning curve, thereby driving down its per-unit costs.

cost parity

when one firm has the same cost as another

Cost leadership: benefits

A cost-leadership strategy is defined by obtaining the lowest-cost position in the industry while offering acceptable value. The cost leader, therefore, is protected from other competitors because of having the lowest cost. If a price war ensues, the low-cost leader will be the last firm standing; all other firms will be driven out as margins evaporate. Since reaping economies of scale is critical to reaching a low-cost position, the cost leader is likely to have a large market share, which in turn reduces the threat of entry.

Cost leadership: risks

If a new entrant with new and relevant expertise enters the market, the low-cost leader's margins may erode due to loss in market share while it attempts to learn new capabilities. For example, Walmart faces challenges to its cost leadership. Dollar General stores, and other smaller low-cost retail chains, have drawn customers who prefer a smaller format than the big box of Walmart. The risk of replacement is particularly pertinent if a potent substitute emerges due to an innovation. Leveraging ecommerce, Amazon has become a potent substitute and thus a powerful threat to many brick-and-mortar retail outlets including Barnes & Noble, Best Buy, The Home Depot, and even Walmart. Powerful suppliers and buyers may be able to reduce margins so much that the low-cost leader could have difficulty covering the cost of capital and lose the potential for a competitive advantage. The low-cost leader also needs to stay vigilant to keep its cost the lowest in the industry. Over time, competitors can beat the cost leader by implementing the same business strategy, but more effectively. Although keeping its cost the lowest in the industry is imperative, the cost leader must not forget that it needs to create an acceptable level of value. If continuously lowering costs leads to a value proposition that falls below an acceptable threshold, the low-cost leader's market share will evaporate. Finally, the low-cost leader faces significant difficulties when the focus of competition shifts from price to non-price attributes.

customer service

Managers can increase the perceived value of their firms' product or service offerings by focusing on customer service. For example, the online retailer Zappos earned a reputation for superior customer service by offering free shipping both ways: to the customer and for returns. Zappos's strategic leaders didn't view this as an additional expense but rather as part of their marketing budget. Moreover, Zappos does not outsource its customer service, and its associates do not use predetermined scripts. They are instead encouraged to build a relationship of trust with each individual customer.

take advantage of certain physical properties

One such property is known as the cube-square rule: The volume of a body such as a pipe or a tank increases disproportionately more than its surface. This same principle makes big-box retail stores such as Walmart or The Home Depot cheaper to build and run. They can also stock much more merchandise and handle inventory more efficiently. Their huge size makes it difficult for department stores or small retailers to compete on cost and selection.

The goal of a differentiation strategy

add unique features that will increase the perceived value of goods and services in the minds of consumers so they are willing to pay a higher price