Strategic Management Chapter #6

Minimum Efficient Scale

(MES) 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

Managers can adjust a number of different levers to improve a firm's strategic position. These levers either increase perceived value or decrease costs. The most salient value drivers that managers have at their disposal are:

-Product features -Customer service -Complements

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

Broad Competitive Scope & Strategic Position on Cost:

Cost Leadership

Process Innovation

A new method or technology to produce an existing product -Initiates a new and steeper curve

Strategic Position

A strategic profile based on value creation and cost that's in a specific product market -A firm attempts to stake out a valuable and unique position that meets customer needs while simultaneously creating as large a gap as possible between the value the firm's product creates and the cost required to produce it

Learning Curves

First documented in aircraft manufacturing as the US ramped up production in the 1930s, prior to its entry into WWII -Go down as it takes less and less time to produce the same output -By moving further down a given learning curve than competitors, a firm can gain competitive advantage

Narrow Competitive Scope & Strategic Position on Cost:

Focused Cost Leadership

Narrow Competitive Scope & Strategic Position on Differentiation:

Focused Differentiation

Differentiation Strategy

Generic business strategy that seeks to create high value for customers than the value that competitors create -Goal is to 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 -A firm following this strategy aims to achieve in the minds of consumers a level of value creation that its competitors cannot easily match -Company using this strategy can achieve a competitive advantage as long as its economic value created (V-C) is greater than that of its competitors

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

Learning by doing allows a firm to...

lower its per-unit costs by moving down a given learning curve

Learning effects differ from economies of scale as shown:

-Differences in timing: learning effects occur over time as output accumulates, while economies of scale are captured at one point in time when output increases. Although learning can decline or flatten, there are no diseconomies to learning. -Differences in complexity: In some production processes, effects from economies of scale can be quite significant, while learning effects are minimal. In contrast, in some professions, learning effects can be substantial, while economies of scale are minimal ---Managers need to understand such differences to calibrate their business-level strategy. If a firm's cost advantage is due to economies of scale, a manager should worry less about employee turnover and more about drops in product runs.

A Blue Ocean Strategy can be quite difficult to translate into reality:

-Differentiation and cost leadership are distinct strategic positions that require important trade-offs -Difficult to implement because it requires the reconciliation of fundamentally different strategic positions- differentiation and low cost- which in turn require distinct internal value chain activities so the firm can increase value and lower cost at the same time -Consequence of a strategy gone bad- the firm ends up being stuck in the middle, meaning the firm has neither a clear differentiation nor a clear cost-leadership profile. Being stuck in the middle leads to inferior performance and a resulting competitive disadvantage

To initiate a strategic move that allows a firm to open a new and uncontested market space through value innovation, managers must answer the four key questions when formulating a Blue Ocean Business Strategy:

-Eliminate. Which of the factors that the industry takes for granted should be eliminated? -Reduce. Which of the factors should be reduced well below the industry's standard? -Raise. Which of the factors should be raised well above the industry's standard? -Create. Which factors should be created that the industry has never offered.

The success of each different business-level strategy (cost-leadership, differentiation, and focused variations thereof) depends on context and relies on two factors:

-How well the strategy leverages the firm's internal strengths while mitigating its weaknesses -How well it helps the firm exploit external opportunities while avoided external threats

Although a Cost-Leadership Strategy provides some protection against the 5 Forces, it also carries some 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 -The risk of replacement is particularly pertinent if a potent substitute emerges due to an innovation -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 -Over time, competitors can beat the low-cost leader by implementing the same business strategy, but more effectively

Cost Leader

-Protected from other competitors because of having the lowest cost -They are fairly well isolated from threats of powerful suppliers to increase input prices, because they're more able to absorb price increases through accepting lower profit margins -Can absorb price reductions more easily when demanded by powerful buyers

When a Blue Ocean Strategy is successfully implemented it allows two pricing strategies:

-The firm can charge a higher price than the cost leader, reflecting its higher value creation and thus generating greater profit margins -The firm can lower its price below that of the differentiator because of it's 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

A successful differentiation strategy is likely to be based on:

-Unique or specialized features of the product -An effective marketing campaign -Intangible resources such as a reputation for innovation, quality, and customer service

To formulate an appropriate Business-Level Strategy, managers must answer the who, what, why, and how questions of competition:

-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 our customers' needs?

Complements

Add value to a product or service when they are consumed in tandem

Blue Ocean Strategy

Business-level strategy that successfully combines differentiation and cost-leadership activities using value innovation to reconcile the inherent trade-offs -Blue oceans represents untapped market space, the creation of additional demand, and the resulting opportunities for highly profitable growth -Red oceans are the known market space for existing industries. In red oceans the rivalry among existing firms is cut-throat because the market space is crowded and competition is a zero-sum game -Allows a firm to offer a differentiated product or service at low costs

Product Features

By adjusting this, managers can increase the perceived value of the product or service offering -Adding unique product attributes allows firms to turn commodity products into differentiated products commanding a premium price

Strategic Trade-Offs

Choices between a cost or value position. -Such choices are necessary because higher value creation tends to generate higher cost -Managers must address the tension between value creation and the pressure to keep cost in check as to not erode the firm's economic value creation and profit margin

A business strategy is more likely to lead to a competitive advantage if: a firm has a... it allows firms to...

Clear strategic profile -Either as a differentiator or a low-cost leader Either perform similar activities differently or perform different activities than their rivals that result in creating more value or offering similar products or services at lower cost

Economies of Scale

Decreases in cost per unit as output increases -Allows firms to: --Spread their fixed costs over a larger output --Employ specialized systems and equipment --Take advantage of certain physical properties

Broad Competitive Scope & Strategic Position on Differentiation:

Differentiation

Cost-Leadership Strategy

Generic business strategy that seeks to create the same or similar value for customers at a lower cost -Goal is to reduce the firm's cost below that of its competitors while offering adequate value -The Cost Leader, as the name implies, 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 -A cost leader can achieve a competitive advantage as long as its economic value created (V-C) is greater than that of its competitors

Strategy Canvas

Graphical depiction of a company's relative performance vis-a-vis its competitors across the industry's key success factors

Value Curve

Horizontal connection of the points of each value on the strategy canvas that helps strategists diagnose and determine courses of action -Strong curve has focus and divergence, and it can even provide a kind of tagline as to what strategy is being undertaken or should be undertaken -Curve that zigzags across the strategy canvas indicates a lack of effectiveness in its strategic profile

Diseconomies of Scale

Increases in cost per unit when output increases -As firms get too big, the complexity of managing and coordinating raises the cost, negating any benefits to scale -Large firms tend to become overly bureaucratic, with too many layers of hierarchy, they grow inflexible and slow in decision making

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

Industry; Firm -Industry Effects: 5 Forces Model, Complements, Strategic Groups -Firm Effects: Value position and cost position relative to competitors, business strategies: Cost leadership, differentiation, blue ocean

Focused Cost-Leadership Strategy

Same as the cost-leadership strategy except with a narrow focus on a niche market

Focused Differentiation Strategy

Same as the differentiation strategy except with a narrow focus on a niche market

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.

_____ _____ are critical to driving down a firm's cost and strengthening a cost-leadership position

Scale Economies -Although managers need to increase output to operate at a minimum efficient scale, they also need to be watchful not to drive scale beyond Q2, where they would encounter diseconomies -Monitoring the firm's cost structure closely over different output ranges allows managers to fine-tune operations and benefit from economies of scale

A firm's business-level strategy determines its _____ _____

Strategic Position

Business-Level Strategy

The goal-directed actions managers take in their quest for competitive advantage when competing in a single product market -May involve a single product or a group of similar products that use the same distribution channel -Concerns the question: "How should we compete?"

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 -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 -Requires that a firm's strategic moves lower its costs and at the same time increase the perceived value for buyers. Lowering a firm's cost is primarily achieved by eliminating and reducing the taken-for-granted factors that the firm's rivals in their industry compete on. -Perceived buyer value is increased by raising existing key success factors and by creating new elements that the industry has not offered previously.

Scope of Competition

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

Experience Curve

The underlying technology changes while holding cumulative output constant

When attempting to increase the perceived value of the firm's product or service offerings, managers must remember that the different value drivers contribute to competitive advantage only if...

Their increase in value creation exceeds the increase in costs

Differentiation Strategy and Cost-Leadership Strategy are called generic strategies because...

They can be used by any organization- manufacturing or service, large or small, for-profit or nonprofit, public or private, domestic or foreign- in the quest for competitive advantage, independent of industry context

Although a differentiation strategy is generally associated with premium pricing, managers have an important second pricing option:

When a firm is able to offer a differentiated product or service and can control its cost at the same time, it is able to gain market share from other firms in the industry by charging a similar price but offering more perceived value.

Experience-curve effects based on process innovation allow a firm to...

leapfrog to a steeper learning curve, thereby driving down its per-unit costs