6 CHAPTER McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Business Strategy: Differentiation, Cost Leadership,

6CHAPTER

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Business Strategy: Differentiation, Cost Leadership, and Integration

Part 2 Strategy Formulation

LO 6-1LO 6-1 Define business-level strategy and describe how it determines a firm’s strategic position.

LO 6-2 Examine the relationship between value drivers and differentiation strategy.

LO 6-3 Examine the relationship between cost drivers and cost-leadership strategy.

LO 6-4 Assess the benefits and risks of cost-leadership and differentiation business strategies vis-à-vis the five forces that shape competition.

LO 6-5 Explain why it is difficult to succeed at an integration strategy.

LO 6-6 Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.

LO 6-7 Describe and evaluate the dynamics of competitive positioning.

Chapter Case 6 Chapter Case 6 Trimming Fat at Whole Foods Market

• Whole Foods…Business Strategy Revitalization

Started as small natural-foods store 1980 Became market leader; differentiation through

organics and quality

Competitive advantage through 2008

• CEO John Mackey: Refocused Mission, Reduced Costs

Business Strategy and Competitive Advantage

• A business-level strategy is an integrated and coordinated set of commitments and actions designed to provide value to customers and gain a competitive advantage by utilizing core competencies in specific individual product markets..

Business-Level Strategy: How to Compete for Advantage?

• Answer the “Who, What, Why, and How”

Who - which customer segments to serve?

What needs, wishes, desires will we satisfy?

Why do we want to satisfy them?

How will we satisfy customers’ needs?

• Details actions managers take in quest for competitive advantage

Single product or group of similar products

Abell’s Framework for Defining the Business

Who is beingsatisfied?

Customer Groups

What is beingsatisfied?

Customer Needs

How arecustomer needs

satisfied?Distinctive

Competencies

Definitionof Business

EXHIBIT 6.1 Industry and Firm Effects Jointly Determine Competitive Advantage


• Two fundamental questions:

How do you generate advantage? How do you sustain advantage?

• Key idea for sustainability is “barriers to imitation.”

How long will it be before the first rival imitates the first mover?

How fast does new imitation occur once it starts?

These two factors determine appropriability..


• Does market share generate competitive advantage?

The computer industry is an excellent example of the lack of correspondence between market share and profit rates. IBM was a clear market leader in terms of market share but had only mediocre economic performance relative to its rivals. High market share is no guarantee of high rates of profitability.


• Does market share generate competitive advantage?

Perhaps high market share causes high profit rates.

But it could equally well be that there is a third factor (e.g., good service capabilities at Caterpillar), unobserved by us, that causes both high profitability and high market share.

In this case, we would see a correlation between profitability and market share but no causal explanation.


• When can market share work to generate and sustain an advantage?

Scale economies combined with high exit costs may make market share a defensible advantage.

Sustainable Competitive Advantage

• Costly Duplication due to:

Historical Conditions;

Uncertainty;

Social Complexity; and

Property Rights Protection.


• An organization’s knowledge or expertise can lead to sustainable advantage if: The knowledge is tacit rather than articulable;

Tacit Knowledge: “We know more than we can tell.” Tacit Skills: Riding a bike, swimming, “learning by doing,” which is

critical for maintaining a manufacturing base

The knowledge is not observable in use; The knowledge is (socially) complex, rather than simple.

Strategic Position

• Determined by Firm’s Business-Level Strategy Two primary competitive levers:

Value (V) Cost (C)

• Economic Value Created: (V-C) The greater (V-C) = Competitive Advantage

• Strategic Position Based on: Value creation Cost

Forms of Competitive Advantage

CompetitiveAdvantage

Cost Advantage

DifferentiationAdvantage

Similar ProductAt Lower Cost

Price PremiumFrom Unique

Product

Generic Business Strategies

• Different generic strategies can lead to competitive advantage in the same industry.

• Differentiation Higher Value; Unique Features

Rolex

• Cost-Leadership Similar Value; Lower Cost

Timex

• Scope of Competition Narrow (Focused)

Rolex Broad

Timex

EXHIBIT 6.2 Strategic Position and Competitive Scope: Generic Business Strategies

LO 6-1 Define business-level strategy and describe how it determines a firm’s strategic position.

LO 6-2LO 6-2 Examine the relationship between value drivers and differentiation strategy.

LO 6-3LO 6-3 Examine the relationship between cost drivers and cost-leadership strategy.





2/28/2003 Southern Methodist University Slide # 6

Building Competitive AdvantageBuilding Competitive AdvantageResources and Capabilities

Competitive PositioningCompetitive Positioning Defending Defending

Value drivers Cost driversValue drivers Cost drivers Isolating mechanismsIsolating mechanisms

Retain customers Retain customers & Prevent imitation& Prevent imitation

Superior ContributionSuperior Contribution Sustainable PositionSustainable Position

Competitive AdvantageCompetitive Advantage

4/22/2003 Southern Methodist University Slide # 7

Competitive Positioning With Competitive Positioning With CustomersCustomers Economic contributionEconomic contribution

The value customers receives less the The value customers receives less the cost to the firmcost to the firm

Buyer’ surplus

Supplier’s profit

Economic contribution produced by supplier

Product value

Market price

Product cost

© 2005 Mara Lederman, Rotman School of Management

Types of Competitive Advantage

Buyer value generated (willingness to pay)

Costs incurred (including opportunity cost of capital)

Industry average

competitor

Successful differentiated

competitor

Successful low-cost

competitor

Competitor with dual

advantage

$

Value Created

Differentiation Advantage

• Differentiation Advantage, a concept developed by economist Joan Robinson, occurs when a firm is able to obtain from its differentiation a price premium in the market which exceeds the cost of

providing differentiation.

EXHIBIT 6.3 Value Drivers: Differentiation

• Differentiation:

Product features, customer service, customization, and complements

Competitive advantage = economic value created (V-C) > competitors Marriott line of Hotels

1–25

STRATEGY HIGHLIGHT 6.1STRATEGY HIGHLIGHT 6.1 Toyota: From “Perfect Recall” to “Recall

Nightmare”• Toyota’s strategic challenges….

Launched Lexus 1989

Luxury car segment dominated by Mercedes-Benz, BMW, Cadillac

LS400 line required recall a little over a year after launch Turned threat into opportunity to establish reputation for superior

customer service

Two years after launch Lexus ranked first on quality and customer satisfaction by J.D. Powers

2010 Toyota has largest recall in automotive history

Needed to exhibit superior customer responsiveness again

8 million vehicles recalled was much more challenging

EXHIBIT 6.4 Cost Drivers: Cost-Leadership

• Cost Leadership:

Cost of input factors, economies of scale, and learning-curve and experience-curve effects

Competitive advantage = economic value created (V-C) > competitors

Walmart vs. Kmart

Dell vs. Compaq, Gateway, & HP

1–27

STRATEGY HIGHLIGHT 6.2STRATEGY HIGHLIGHT 6.2 Ryanair: Lower Cost than the Low-Cost Leader!

• The “Southwest Airlines of Europe”

“Lowest-cost airline in the world”

No window shades on older planes, seats don’t recline, etc.

Fares as low as $8

Numerous fees and surcharges: pillows, blankets, check-in, etc.

20+% of revenues flow from ancillary services

Ryanair Sample Revenue Calculation

Ticket Price, $8

Checking Two Bags, $45

Online Check-in, $7.50

Credit Card Fee, $6

Subsidy from More Expensive Flights,

$5.50

Pillow & Blanket, $5

Priority Boarding, $4

1 Bottle of Water, $3.50 Ad Revenue, $2

Revenue $87Cost $70

Profit $17

Ticket Price, $8



Credit Card Fee, $6


$5.50



1 Bottle of Water, $3.50 Ad Revenue, $2 Ticket Price, $8



Credit Card Fee, $6


$5.50



1 Bottle of Water, $3.50 Ad Revenue, $2

Revenue $87Cost $70

Profit $17

Revenue $87Cost $70

Profit $17

Drivers of Cost AdvantageDrivers of Cost Advantage

PRODUCTION TECHNIQUES

PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

MANAGERIAL/ ORGANIZATIONALEFFICIENCY

ECONOMIES OF LEARNING

ECONOMIES OF SCALE

• Organizational slack

• Ratio of fixed to variable costs• Costs of installing and closing capacity

• Location advantages• Ownership of low-cost inputs • Bargaining power• Supplier cooperation

• Design for automation• Designs to economize on materials

• Mechanization and automation• Efficient utilization of materials• Increased precision

• Increased dexterity• Improved coordination/ organization

• Indivisibli\ties• Specialization and division of labor

EXHIBIT 6.5 Economies of Scale and Diseconomies of Scale

31

Economies of Scale: The Long-Run Cost Curve for a Plant

Economies of Scale: The Long-Run Cost Curve for a Plant

Units of outputper periodMinimum

EfficientPlant Size

Cost perunit ofoutput

Sources of scale economies:- technical input/output relationships- indivisibilities- specialization

"Big Box" Retailers' Advantage

Box 2 x 2 x 2Volume 8

Box 3 x 3 x 3Volume 27

• Cube-Square Rule: Each dimension increases 50% (2 goes to 3) BUT Each volume increases 237.5% (8 goes to 27) !!

The Learning Curve

PerUnitCost ($)

Cumulative Output (units)

0

20

40

60

80

100

120

0 50 100 150 200 250

90%

80%

70%

PerUnitCost ($)

Cumulative Output (units)

0

20

40

60

80

100

120

0 50 100 150 200 250

90%

80%

70%

Aircraft Assembly (1925-57): 80%

Calculator (1975-78): 74%

EXHIBIT 6.6 Gaining Competitive Advantage Through Learning and Experience

Curves

Limits of “Learning Curve” Advantages

Copying and reverse engineering of products;

Hiring a competitor’s employees;

Purchasing the know-how from consultants;

Obtaining the know-how from customers; and

Experience advantages are often nullified by innovations.








EXHIBIT 6.7 Competitive Positioning and the Five Forces


LO 6-2LO 6-2 Examine the relationship between value drivers and differentiation strategy.

LO 6-3LO 6-3 Examine the relationship between cost drivers and cost-leadership strategy.





EXHIBIT 6.8 Avon Pursuing an Integration Strategy

EXHIBIT 6.9 Value and Cost Drivers

Integration Strategy – Corporate Level

• Conglomerates can coordinate above the SBU level

Tata Group from India 2008 bought Jaguar & Land Rover

– Prestigious differentiated products

2009 Tata Motors creates a Nano car– Lowest-priced car in the world!– Zero to 60 mph in 30 seconds– No radio or glove box– Targets bicyclists to move to cars








The Dynamics of Competitive Positioning

• Strategic Positions need to change over time eBay withdrew from selling new goods & sold Skype

• Productivity Frontier Value-cost relationship Captures the best practices at a point in time

• Mobile Devices 2005 – Apple differentiator, Dell cost leader

2010 – Apple still differentiator, HP moving to successful integrator, Dell shifting toward integrator

EXHIBIT 6.10The Dynamics of Competitive

Positioning: Apple, HP, and Dell

Differentiation vs. Cost Leadership as a Basis for Competitive Advantage

Differentiation vs. Cost Leadership as a Basis for Competitive Advantage

Highest return on equity among top 200 US companies, 2002

(%) (%)

Colgate Palmolive 367.8 Gillette 53.8Caremark Rx 303.2 H.J. Heinz 48.5American Standard 161.4 Pfizer 45.7Yum Brands 98.1 Dell Computer 43.0Kellogg 80.5 TJX 41.3Anheuser-Busch 63.4 Oracle 36.4Nextel Communications 58.3 PepsiCo 35.6Sara Lee 58.0 3M 32.9Altria Group 57.0 Eli Lilly 32.7Wyeth 54.5 Sysco 31.9

QUESTION: Which is the primary basis for competitive advantagein the above companies: cost or differentiation?


Business-level strategy determines a firm’s strategic position in its quest for competitive advantage in a single industry or product market.

Strategic positioning requires that managers address strategic trade-offs that arise between value and cost, because higher value tends to go along with higher cost.

Differentiation and cost leadership are distinct strategic positions.

Besides selecting an appropriate strategic position, managers must also define the scope of competition—whether to pursue a specific market niche or go after the broader market.


The goal of a differentiation strategy is to increase the perceived value of goods and services so that customers will pay a higher price for additional features.

Take-Away Concepts

In a differentiation strategy, the focus of competition is on non-price attributes.

Some of the unique value drivers managers can manipulate are product features, customer service, customization, and complements.

Value drivers contribute to competitive advantage only if their increase in value creation (∆V) exceeds the increase in costs (∆C).


The goal of a cost-leadership strategy is to reduce the firm’s cost below that of its competitors.

In a cost-leadership strategy the goal is to reduce the firm’s costs below that of its competitors. The focus is on lowest-possible price with acceptable quality.

Some of the unique cost drivers that managers can manipulate are the cost of input factors, economies of scale, and learning- and experience-curve effects.

No matter how low the price, if there is no acceptable value proposition, the product or service will not sell.

Take-Away Concepts


The five forces model helps managers use generic business strategies to protect themselves against the industry forces that drive down profitability.

Differentiation and cost-leadership strategies allow firms to carve out strong strategic positions, not only to protect themselves against the five forces, but also to benefit from them in their quest for competitive advantage.

Exhibit 6.7 lists benefits and risks of each business strategy.

Take-Away Concepts


A successful integration strategy requires that trade-offs between differentiation and low cost be reconciled.

Integration strategy often is difficult because the two distinct strategic positions require internal value chain activities that are fundamentally different from one another.

When firms fail to resolve strategic trade-offs between differentiation and cost, they end up being stuck in the middle. They then succeed at neither strategy, leading to a competitive disadvantage.


To address the trade-offs between differentiation and cost leadership at the business level, managers may leverage quality, economies of scope, innovation, and the firm’s structure, culture, and routines.

The trade-offs between differentiation and low cost can either be addressed at the business level or at the corporate level.

Take-Away Concepts


Strategic positions need to change over time as the environment changes.

Best practices determine the productivity frontier at any given time.

Reaching the productivity frontier enhances the likelihood of obtaining a competitive advantage.

Not reaching the productivity frontier implies competitive disadvantage if other firms are positioned at the productivity frontier.

Take-Away Concepts

Documents

6 CHAPTER McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Business Strategy: Differentiation, Cost Leadership,