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Chapter Five

Crafting Business Strategy

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OBJECTIVES

Define generic strategies and show how they relate to a firm’s strategic position

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Describe the drivers of low-cost, differentiation, and focus strategic positions

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Identify and explain the risks associated with each generic strategy position

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Show how different positions fit with various stages of the industry life cycle

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Evaluate the quality of the firm’s strategy5

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JUDO STRATEGY

“At its heart, judo strategy is about developing a deep understanding of your competition and the moves that will turn your competitors’ strength to your advantage.”

– David Yoffie and Mary Kwak

From Judo Strategy

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TOWS MATRIX

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STRATEGIC POSITIONING SHOULD IMPROVE PROFITABILITY

Where managers of a company situate that company relative to its rivals along important competitive dimensions

Definition

Purpose

To reduce the effects of rivalry and thereby improve profitability

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No advantage overrivals

Advantage over rivals

Low-cost

Differentiation

Description

Produce an essentially equivalent product at a lower cost

Produce a differentiated product and charge suffici-ently higher prices to more than offset the added costs of differentiation

A FIRM CAN GAIN ADVANTAGE OVER RIVALS IN TWO WAYS

7Adapted from poster, M.1980. Competitive strategy, 1980.

Low-cost Differentiation

Strategic advantage

Strategictarget

Narrow(i.e., particular segment only)

Broad(i.e., industry wide)

Broaddifferentiation

Focused costleadership

Focuseddifferentiation

Broad low-costleadership

THE STRATEGIC POSITIONING MODEL

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LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET SHARE AND/OR PROFITS

Examples

Benefits

Low-cost leadership Differentiation

• Pacific Cycle

• Gallo Wines

• Wal-Mart

• Southwest Airlines

• Home Depot

• Trek Bicycles

• Coca-Cola and Pepsi

• Mercedez Benz

• Honda, Yamaha, and Suzuki motorcycles

• Stouffers (frozen foods)

• Capture market share by offering lower-price or

• Earn higher by maintaining price parity

• Capture market share by

offering higher quality at same price or

• Earn higher margins by raising prices over competitors

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Low-cost Differentiation

Strategic advantage

Strategictarget

Narrow

Broad• Trek Bicycles

• Coca-cola

• Jet Blue

• Ikea

• Godiva

• Montague

• Wal-Mart

• Gallo Wines

STRATEGIC POSITIONING EXAMPLES

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KEY DRIVERS OF COST ADVANTAGE

• Economies of scale

• Learning

• Product technology

• Product design

• Location advantages for sourcing inputs

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ECONOMIES OF SCALE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

• Economies of scale exist during a period of time if the average total cost for a unit of production is lower at higher levels of output

• You must review cost to assess whether economies of scale exist:

–Fixed costs remain the same for different levels of production

–Variable costs are the costs of variable inputs (such as raw materials and labor) and vary directly with output

–Marginal cost is the cost of the last unit of production

–Total cost is the sum of all production costs and always increases as output goes up

–Average cost is the mean cost of total production during a given period (say, a year)

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DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Some sourcesof economies

• R&D spend

• Advertising spend

• Specialization of specific production processes

• Superior inventory management

• Purchasing power

Some sourcesof diseconomies

• Bureaucracy

• High labor costs

• Inefficient operations

• Technology

Economiesof scale

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LEARNING CURVE AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Costs decrease …

as the scale of operation increases during any given period of time

Economiesof scale

with the cumulative level of production since the production of the first unit

Learning curve

How Learning Differs from Scale

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Learning/Experience Curve Effects

Exhibit 5.4 Comparing Experience Curve Effects

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ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

If a firm produces two or more products and can share resources among two or more of these (e.g., share manufacturing machines) – thereby lowering the costs of each product – it benefits from economies of scope (Coca Cola/Snapple example)

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PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Often, a new entrant who wants to compete against industry incumbents with significant scale and experience advantages, tries to match or beat incumbents’ costs by introducing a production technology that is subject to different economics (e.g., Jet Blue, Nucor Steel)

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PRODUCTION DESIGN AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Product design can sometimes be altered to lower a firm’s production costs (e.g., Canon vs. Xerox)

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LOCATION AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Sometimes firms try to attain lower production costs by locating their operations in cheaper labor markets (e.g., Pacific Cycle manufactures in China and Taiwan to achieve lower costs than Trek who manufactures in the US)

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KEY DRIVERS OF DIFFERENTIATION ADVANTAGES

• Premium brand image

• Customization

• Unique styling

• Speed

• More convenient access

• Unusually high-quality

To drive up customer’s willingness to pay and generate demand sufficient to

(1) Recoup added costs and

(2) Generate enough profits to make strategy worthwhile

Key Drivers Purpose

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DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE

Low-cost

Differentiation

• Economies of scale

• Learning

• Economies of scope

• Superior technology

• Product design

• Location

Drivers Threats

• New technology

• Too low-quality

• Social, political, and economic risks of outsourcing

• Premium brand image

• Customization

• Unique styling

• Speed

• Convenient access

• Unusually high-quality

• Failure to increase buyer’s willingness to pay higher prices

• Under estimating cost of differentiation

• Over fulfillment of buyer’s needs

• Lower cost imitation

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STRATEGIES FOR DIFFERENT PHASES OF THE INDUSTRY LIFE CYCLE

Decline

Mature

Embryonic

Growth

Phases of in-dustry life cycle

Arenas Vehicles Differentiators Staging Economic LogicLocal Internal

developmentAlliances to secure missing inputs or distribution access

Target basic needs, minimal differentiation

Tactics to gain early footholds

Prices tend to be high. Costs are also high Focus is on securing additional capital to fund growth phase.

Penetration into adjacent markets

Alliances for cooperationAcquisitions in targeted markets

Increased efforts toward differentiationLow cost leaders emerge through gaining experience advantages and scale

Integrated positions require choice of focusing first on cost or differentiation

Margins can improve rapidly because of experience and scalePrice premiums accrue to successful differentiators

GlobalizationDiversification

Mergers and acquisitions result in consolidation

More stable positions emerge across competitors

Choosing international markets and new industry diversification; need rational sequencing

Consolidation results in fewer competitors (favoring higher margins) but declining growth demands cost containment and rationalization of operations.

Some arenas may be abandoned if decline is severeFocus on segments which provide most profitability

Acquisitions for diversifying movesDivestitures to exit for some competitors

Rationalizing cost

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TESTING THE QUALITY OF A STRATEGY

Key Evaluation Criteria Sub-questions1. Does your strategy exploit your key

resources?• With your particular mix of resources, does this strategy give you

an advantageous position relative to your competitors?• Can you pursue this strategy more economically than

competitors?• Do you have the capital and managerial talent to do all you

envision? • Are you spread too thin?

2. Does your strategy fit with current industry conditions?

• Is there healthy profit potential where you're headed? • Are you aligned with the key success factors of your industry?

3. Will your differentiators be sustainable?

• Will competitors have difficulty imitating you? • If imitation cannot be foreclosed, does your strategy include a

ceaseless regimen of innovation and opportunity creation to keep distance between you and the competition?

4. Are the elements of your strategy consistent and aligned with your strategic position?

• Have you made choices of arenas, vehicles, differentiators, and staging, and economic logic?

• Do they all fit and mutually reinforce each other?6. Can your strategy be implemented? • Will your stakeholders allow you to pursue this strategy?

• Do you have the proper complement of implementation levers in place?

• Is the management team able and willing to lead the required changes?