Chapter 5: Business-Level Strategy: Creating and Sustaining Competitive Advantages

Cost Leadership requires learning to lower costs through experience, ________________, as well as, ____________________.

The Experience Curve, Competitive Parity

Business Level Strategies

A strategy designed for firm or a division of the firm that competes within a single business. Business level strategies typically require a choice: How to overcome the five forces and achieve competitive advantage? SUGGESTION: Use Porter's THREE generic strategies: 1) Overall cost leadership 2) Differentiation 3) Focus

As markets mature,

A) costs continue to increase. B) applications for patents increase C) differentiation opportunities increase. D) there is increasing emphasis on efficiency ANSWER: D

_______________ focus exploits differences in cost behavior in some segments, while ______________________ focus exploits the special needs of buyers in other segments.

Cost, Differentiation

Firms can also underestimate the challenges & expenses associated with coordinating value-creating activities in the extended ___________________.

Value Chain

THREE Generic Strategies

1) Overall cost leadership is based on: Creating a low-cost position relative to a firm's peers Managing relationships throughout the entire value chain to lower costs 2) Differentiation implies: Products and/or services that are unique & valued Emphasis on non- price attributes for which customers will gladly pay a premium 3) A focus strategy requires: Narrow product lines, buyer segments, or targeted geographic markets Advantages obtained either through differentiation or cost leadership.

Three Generic Strategies

The overall cost leadership and differentiation strategies strive to attain advantages industry-wide, while focusers have a narrow target market in mind. Generic strategies are plotted on TWO dimensions: competitive advantage and market served.

Pitfalls of Differentiation

1) Uniqueness that is not valuable. 2) Too much differentiation. 3) Too high a price premium. 4) Differentiation that is easily imitated. 5) Dilution of brand identification through product line extensions. 6) Perceptions of differentiation may vary between buyers and sellers. It's not enough just to be different. A differentiation strategy must provide unique bundles of products and/or services that customers value highly. Firms may also strive for quality of service that is higher than customers desire, thus they become vulnerable to competitors who provide an appropriate level of quality at a lower price. In addition customers may desire the product but are repelled by the price premium. Differentiation advantages can be eroded through imitation. Firms may also erode their quality brand image by adding products or services with lower prices and less quality, thus confusing the customer.

Reverse Positioning

A break in industry tendency to continuously augment products, characteristics of the product life cycle, by offering products with fewer product attributes and lower prices. **Decrease the features of your product and offer it at a lower price.

Breakaway Positioning

A break in industry tendency to incrementally improve products along specific dimensions, characteristic of the product life cycle, by offering products that are still in the industry but that are perceived by customers as being different. **Position your product ENTIRELY different from other rivals to cater to the existing segments and attract new demand and sales.

Competitive Parity

A firm's achievement of similarity or being "on par" with competitors with respect to low-cost, differentiation, or other strategic product characteristics. Competitive parity on the basis of differentiation permits the cost leader to translate cost advantages directly into higher profits than competitors. Thus, the cost leader earns above-average returns. A business that strives for a low-cost advantage must attain an absolute cost advantage relative to its rivals. This is typically accomplished by offering a no-frills product or service to a broad target market using standardization to derive the greatest benefits from economies of scale and experience. However such a strategy may fail if the firm is unable to attain parity on important dimensions of differentiation such as quick responses to customer requests for services or design changes.

Focus

A firm's generic strategy based on appeal to a narrow market segment within an industry. A firm following this strategy selects a segment or group of segments and tailors its strategy to serve them. The essence of focus is the exploitation of a particular market niche. A focus strategy has TWO variants: 1) Cost focus: - Creates a cost advantage in its target segment. - Exploits differences in cost behavior. 2) Differentiation focus: - Differentiates itself in its target market. - Exploits the special needs of buyers. FOCUS requires that a firm either have a low cost position with its strategic target, high differentiation, or both. These positions provide defenses against each competitive force because of higher margins or more specialized products or services. Focus is also used to select niches that are least vulnerable to substitutes or where competitors are weakest. ADVANTAGES: Creates HIGHER entry barriers due to both cost leadership & differentiation. Can provide higher margins that enable the firm to deal with supplier power Reduces buyer power because the firm provides specialized products or services. Focused niches are less vulnerable to substitutes.

Differentiation Strategy

A firm's generic strategy based on creating differences in the firm's product or service offering by creating something that is perceived industry-wide as unique and valued by customers. Firms may differentiate themselves in both PRIMARY and SUPPORT activities. Can take many forms: - Prestige or brand image - Quality - Technology - Innovation - Features - Customer service - Dealer network REQUIRES: 1) A level of COST PARITY relative to competitors. The cost of making your product should be the same as other competitors. Produce at a low cost and sell at a premium. 2) Integration of multiple points along the value chain: - Superior material handling operations to minimize damage. - Low defect rates to improve quality. - Accurate and responsive order processing. - Personal relationships with key customers. - Rapid response to customer service requests. 3) Differentiation along several different dimensions at once. Differentiation provides protection against rivalry since brand loyalty lowers customer sensitivity to price and raises customer switching costs. Higher entry barriers result because of customer loyalty and the firm's ability to provide uniqueness in its products or services. By increasing the firm's margins, differentiation also avoids the need for a low-cost position, and enables the firm to deal with supplier power. Suppliers would also probably desire to be associated with prestige brands, thus lessening their incentives to drive up prices. Differentiation reduces buyer power, because buyers lack comparable alternatives and are therefore less price sensitive. Differentiation enhances customer loyalty, thus reducing the threat from substitutes.

Combination Strategies: Integrating Low Cost & Differentiation

A firms' integrations of various strategies to provide multiple types of value to customers. A COMBINATION low-cost and differentiation strategy enables a firm to provide TWO types of value to customers: a) differentiated abilities ( e.g., high quality, brand identification, reputation) and, b) lower prices (because of the firm's lower costs in value creating activities). For example, superior quality can lead to lower costs because of less need for rework in manufacturing, fewer warranty claims, a reduced need for customer service personnel to resolve customer complaints, and so forth. Integration of low-cost and differentiation strategies makes it difficult for competitors to duplicate or imitate strategy. The goal of a combination strategy is to provide unique value in an efficient manner.

Pitfalls of Combination Strategies

A key issue in strategic management is the creation of competitive advantages that enable the firm to enjoy above average returns. Some firms may become "stuck in the middle" if they try to attain both cost and differentiation advantages. While integrating activities across a firm's value chain, firms must consider the expenses linked to technology and investment, managerial time and commitment, and the involvement and investment required by the firm's customers and suppliers. The firm must be confident that it can generate a sufficient scale of operations and revenues to justify all associated expenses. Finally, firms may fail to accurately assess sources of revenue and profits in their value chain. **Firms can miscalculate sources of revenue and profit pools in the firm's industry.

Turnaround Strategy

A turnaround strategy involves reversing performance decline & reinvigorating growth toward profitability through: 1) Asset & cost surgery 2) Selected market & product pruning 3) Piecemeal productivity improvements Example = Ford Motor Company Example = Jamba Juice The need for turnaround may occur at any stage in the life cycle but is more likely to occur during maturity or decline. Most turnarounds require a firm to carefully analyze the external and internal environments. The external analysis leads to identification of market segments and customer groups that may still find the product attractive. Internal analysis results in actions aimed at reduced costs and higher efficiency.

Which statement regarding competitive advantages is true?

A) If several competitors pursue similar differentiation tactics, they may all be perceived as equals in the mind of the consumer. B) With an overall cost leadership strategy, firms need not be concerned with parity on differentiation. C) In the long run, a business with one or more competitive advantages is probably destined to earn normal profits. D) Attaining multiple types of competitive advantage is a recipe for failure. ANSWER: A

Improving Competitive Position: An Overall Low Cost Position

An overall low cost position enables the firm to achieve above average returns despite strong competition. It protects a firm against rivalry from competitors, because lower costs allow a firm to earn returns even if its competitors eroded their profits through intense rivalry. Buyers can exert power to drive down prices only to the level of the next most efficient producer, because there are relatively few competitors that can provide a comparable cost/value proposition. Because the cost advantage can be applied across all operations, a low-cost position puts the firm in a favorable position with respect to substitute products introduced by new and existing competitors.

Generic Strategies

Basic types of business level strategies based on breadth of target market (industry-wide versus narrow market segment) and type of competitive advantage (low-cost versus uniqueness).

Three Generic Strategies: EXAMPLES

Companies pursuing an overall cost leadership strategy include McDonalds and Walmart. Companies pursuing a differentiation strategy include Apple and Target. Companies pursuing a focus strategy include Ikea and Costco.

Pitfalls of Focus

Erosion of cost advantages within the narrow segment. Highly focused products and services are still subject to competition from new entrants & from imitation. Focusers can become too focused to satisfy buyer needs.

Cost Leadership

Involves: 1) Aggressive construction of efficient scale facilities. 2) Vigorous pursuit of cost reductions from experience. 3) Tight cost & overhead control . 4) Avoidance of marginal customer accounts. 5) Cost minimization in all activities in the firm's value chain, such as R&D, service, sales force, & advertising. **A a firm's generic strategy based on appeal to the industry-wide market using a competitive advantage based on low-cost. Cost leadership requires a tight set of interrelated tactics, including close scrutiny of the value chain.

Combination Strategies

MASS CUSTOMIZATION: A firm's ability to manufacture unique products in small quantities at low cost. This is facilitated by advances in manufacturing technologies such as CAD/CAM. Andersen Windows is given as an example. Analysis of data on customer characteristics, purchasing patterns, employee productivity and physical asset utilization allows firms to better serve customers while more efficiently using company resources. PROFIT POOL: The the total profits in an industry at all points along the industry's value chain. The structure of the profit pool can be complex. The potential pool of profits will be deeper in some segments of the value chain than others, and the depths will vary within an individual segment. Segment profitability may vary widely by customer group, product category, geographic market, or distribution channel. Additionally, the pattern of profit concentration in an industry is often very different from the pattern of revenue generation. Many firms have also achieved success by integrating activities throughout the extended value chain by using information technology to link their own value change with the value chains of their customers and suppliers. ADVANTAGES: Creates HIGHER entry barriers due to both cost leadership & differentiation. Can provide higher margins that enable the firm to deal with supplier power. Reduces buyer power because of fewer competitors. An overall value proposition reduces threat from substitutes.

Experience Curve

The decline in unit costs of production as cumulative output increases. A business can learn to lower costs as it gains experience with production processes. Among the most common factors producing the experience curve are workers getting better at what they do, product designs being simplified as the product matures, and production processes being automated and streamlined. However, experience curve gains will only be the foundation for a cost advantage if the firm knows the source of the cost reduction and can keep those gains proprietary.

Decline Stage

The decline stage is when: - Industry sales and profits begin to fall - Price competition increases - Industry consolidation occurs STRATEGIES include: MAINTAINING the product position, HARVESTING profits & reducing costs, Exiting the market, and CONSOLIDATING or acquiring surviving firms. In the decline stage, a firm's strategic options become dependent on the actions of rivals. If many competitors leave the market, sales and profit opportunities increase. On the other hand, prospects are limited if all competitors remain. Maintaining refers to keeping a product going without significantly reducing marketing support, technological development, or other investments, in the hope that competitors will eventually exit the market. HARVESTING STRATEGY: A strategy of bringing as much profit as possible out of the business in the short to medium term by reducing costs. Exiting the market involves dropping the product from the firm's portfolio. CONSOLIDATION STRATEGY: A firm's acquiring or merging with other firms in an industry in order to enhance market power and gain valuable assets. Firms can also resurrect old technologies by retreating to more defensible ground, using the new to improve the old, or improving the price-performance trade-off.

Growth Stage

The growth stage is: - Characterized by strong increases in sales - Attractive to potential competitors - When firms can build brand recognition STRATEGIES include: Creating branded differentiated products, stimulating selective demand, and providing financial resources to support value-chain activities. In the growth stage, the PRIMARY KEY to success is to build consumer preferences for specific brands. This requires strong brand recognition, differentiated products, and the financial resources to support a variety of value chain activities such as marketing and sales, and research and development. Efforts in the growth stage are directed towards stimulating selective demand in which a firm's products offerings are chosen instead of a rival's. Revenues can increase at an accelerating rate because new consumers are trying the product and a growing proportion of satisfied consumers are making repeat purchases.

Introduction Stage

The introduction stage is when: - Products are unfamiliar to consumers - Market segments are not well-defined - Product features are not clearly specified - Competition tends to be limited STRATEGIES INCLUDE: Developing a product and get users to try it, and generate exposure so the product becomes "standard." Since there are few players and not much growth, competition tends to be limited. Success requires an emphasis on research and development and marketing activities to enhance awareness. The challenge becomes one of developing the product and finding a way to get users to try it, and generating enough exposure so the product emerges as the "standard" by which all other rivals' products are evaluated. There's an advantage to being the "first mover" in a market.

Maturity Stage

The maturity stage is when: - Aggregate industry demand slows - Market becomes saturated, few new adopters - Direct competition becomes predominant - Marginal competitors begin to exit STRATEGIES include creating efficient manufacturing operations, lowering costs as customers become price-sensitive, and adopting reverse or breakaway positioning. Rivalry among existing rivals intensifies because of fierce price competition at the same time that expenses associated with attracting new buyers are rising. ADVANTAGES based on efficient manufacturing operations and process engineering become more important for keeping costs low as customers become more price sensitive. It also becomes more difficult for firms to differentiate their offerings, because users have a greater understanding of products and services. Firms can affect consumers' mental shifts through REVERSE POSITIONING or BREAKAWAY POSITIONING.

Industry Life Cycle Stages

The stages of introduction, growth, maturity, and decline that typically occur over the life of an industry. Managers must become even more aware of their firm's strengths and weaknesses in many areas to attain competitive advantages. Factors such as generic strategies, market growth rate, intensity of competition, and overall objectives can change over the course of an industry life cycle. Managers must strive to emphasize the key functional areas during each of the FOUR stages and to attain a level of parity in all functional areas and value-creating activities. **Products and services go through many cycles of innovation and renewal. Typically, only fad products have a single lifecycle. MATURITY STAGES of an industry can be transformed or followed by the stage of rapid growth if consumer tastes change, technological innovations take place, or new developments occur. The industry life cycle: 1) Introduction 2) Growth 3) Maturity 4) Decline Generic strategies, functional areas, value-creating activities, & overall objectives all vary over the course of an industry life cycle.

Pitfalls of Cost Leadership

Too much focus on one or a few value chain activities. Increase in the cost of the inputs (Raw Materials) on which the advantage is based. The strategy is imitated too easily. A lack of parity on differentiation - if you are NOT able to match your competitors on the level of differentiation, you will not be able to sustain. REDUCED FLEXIBILITY - you have to be prepared for shifts in demand, technology, etc....you need to keep up with competition. Because changing from one type of technology (Plant and machinery) to another is not easily done or afforded. Obsolescence of the basis of a cost advantage - if a new product hits, the low cost price may not be a large enough incentive to keep marketshare. Customers may purchase the most new and innovated product regardless of price. Firms need to pay attention to all activities in the value chain. Managers should explore all value chain activities, including relationships among them, as candidates for cost reductions. Firms can also be vulnerable to price increases in the factors of production. A firm's strategy may consist of value-creating activities that are easy to imitate. Firms striving to attain cost leadership advantages must obtain a level of parity on differentiation. Building a low-cost advantage often requires significant investments in plant and equipment, distribution systems, and large, economically scaled operations. As result, firms often find that these investments limit their flexibility. As a result they have difficulty responding to changes in the environment. Ultimately, the foundation of the firm's cost advantage may become obsolete. In these circumstances, other firms develop new ways of cutting costs, leaving the old cost-leaders at a significant disadvantage.