1. Foundations of strategy
Chapter 4: The Nature & Sources of Competitive Advantage
Andrea Brandt
Vanessa Gomez
Rachele Reagan
Team 5
Allison Schmidt - - - - - - -

2. Competitive advantage
Competitive advantage- when 2 or more firms compete within the same market, one firms posses a competitive advantage over its rival when it earns or has the potential to earn a persistently higher rate of profit
However, competitive advantage doesn’t always mean superior profit; so firms forgo current profit in favor of investment in market share, technology, customer loyalty or other endeavors
In the long run, competition eliminates differences in profitability between competing firms but external and internal changes can create short-term opportunities for creating an advantage
-The book defines competitive advantage as such: read definition. But its more than that. Having more profit is too simple a way to describe it.
-Firms may forgo current profit in favor of investment in market share, technology, customer loyalty among other things.
-For example, The Coca-Cola company accrued the most social media impressions, 1.4 billion, in July An impression, in terms of online advertising, is when an ad is displayed whether it is clicked on or not. It costs for each impression that occurs online so The Coca-Cola Company is forgoing some profits in favor of advertising and expanding their potential customer base

3. Top Carbonated Soft Drink Brands by market share (2011)
1)Coke
17%
Coca-Cola
2)Diet Coke
9.6%
3)Pepsi Cola
9.2%
PepsiCo
4)Mountain Dew
6.7%
PepsiCo
5)Dr. Pepper
6.4%
Dr. Pepper Snapple
6)Sprite
5.7%
Coca-Cola -
-Based on Beverage Digest’s U.S. Beverage Results, Coke has a competitive advantage in market share over other brands like PepsiCo and Dr. Pepper Snapple Group. -
-According to the Carbonated Soft Drinks: Global Industry Guide, the Coca-Cola Company is the leading player in the global carbonated soft drinks market, generating a 47.6% share of the market’s volume.

4. External sources of change
For an external change to create competitive advantage the change must have differential effects on companies because of their different resources and capabilities or strategic positioning
The extent to which external changes create competitive advantage and disadvantage depends on the magnitude of the change and the extent of firms’ strategic differences
How does competitive advantage emerge?
External sources of change:
-changing customer demand
-Changing prices
-Technological change
Resources heterogeneity among firms means differential impact
Some firms faster and more effective in exploiting change
Internal sources of change
Some firms have greater creative and innovative capability
The more turbulent an industry’s environment, the greater the number of sources of change, and the greater the differences in the firms resources and capabilities, the greater the dispersion of profitability within the industry.

5. Responsiveness to change
2 Key Capabilities of Responsiveness:
Ability to anticipate changes
Speed at which you adjust to those changes (time-based competition)
Information
Rely on customers, suppliers and even competitors for that information
Short Cycle Times
Allow information on emerging markets to be acted on quickly
Important in the fashion industry (who puts out trending designs out first)
-The competitive advantage that arises from external change also depends on a firms ability to respond to change. These external changes create opportunities for profit.
-Ability to anticipate changes in the external environment is a key capability to a companies responsiveness.
-As markets become more turbulent and unpredictable, speed of response through greater flexibility has become increasingly important.
-Companies have come to rely on “early warning system” through direct relationships with customers, suppliers, and even competitors.
-Short cycle times: allow info on emerging market developments to be acted upon quickly

6. Internal Changes Through Innovation
Innovation can create competitive advantage but also provide a basis for overturning the competitive advantage of other firms
Strategic Innovation (new game strategy) - new approaches to doing business including business models
Creating new value for customers from novel products, experiences or modes of product delivery:
Toys-R-Us: big-box store with a variety of toys
Nordstrom: augmented customer service
Sephora: atypical approaches to display and store layout
Redesigned processes and novel organizational designs
Apple combining an MP3 player with its iTunes store
SWA no frills service, single plane type and non-union employees
Innovation doesn’t refer to just refer to technological advances but also strategic innovation.

7. Shaping innovative strategies
New Industries
Launching products that creates a whole new industry
Purest form of blue ocean strategy
Xerox created plain-paper copier industry
New Customer Segments
Creating new customer segments for existing product concepts
Apple didn’t invent the personal computer but launched the market for computers in the home
New Sources of Competitive Advantage
Introducing novel approaches to creating customer value
Coca-Cola introduced the freestyle fountain dispenser which provides a selection of 125 varieties of Coca-Cola products in a self-serve format
-Strategic innovations tend to involve pioneering along one or more dimensions of strategy: new industries, new customer segments, and new sources of competitive advantage. -

8. Sustaining Competitive Advantage
Competitors undermine another firms competitive advantage by either innovation or imitation
Imitation is the most direct form of competition therefore barriers are needed to guard against it
Isolating mechanisms- barriers that protects a firms profits from being driven down by the competitive process
For successful imitation a firm must meet these four conditions:
Identification- identify that a rival possesses a competitive advantage
Incentive- believe that investing in imitation can earn superior returns
Diagnosis- be able to diagnosis the features of its rival’s strategy that gives it competitive advantage
Resource Acquisition- acquire through transfer or replication the resources and capabilities needed for imitation
-Once acquired, competitive advantage is still subject to deterioration. This depends on the ability of competitors to challenge a firm by either imitation or innovation.
-Imitation is the most direct from of competition; thus for competitive advantage to be sustained over time, barriers to imitation must exist.
-The more effective these isolating mechanisms, the longer competitive advantage can be sustained.
-In most industries the erosion of the competitive advantage of industry leaders is a slow process, often taking a decade or more.

9. 4 conditions & Their Isolating Mechanisms
Isolating Mechanisms – barriers that protect a firm’s profits from being driven down by the competitive process.

10. Identification Obscure the firm’s superior profitability
Much easier for private as opposed to public firms
Pedigree Petfoods (Mars Inc.) was able to accomplish this until the UK Monopolies Commission revealed that Pedigree earned a return on capital of 47%
-To guard against another firm’s identifying a companies competitive advantage, that company can obscure it’s superior profitability so rivals fail to see the companies success until its too late.
-Here is lies to benefit of remaining a private company because you can avoid disclosing certain financials that may show the companies superior profit in a market.

11. Incentive
Firms may be able to undermine the incentive for other firms to imitate through deterrence and preemption
Deterrence- signaling aggressive intentions to imitators
NutraSweet’s aggressive price war against the Holland Sweetener Company may have deterred other potential entrants
Preemption- exploiting all available investment opportunities
Proliferation of product varieties
Large investments in production capacity ahead of the growth of market demand
Patent proliferation
-If a firm can persuade rivals that imitation will be unprofitable, it may be able to avoid competitive challenges. Reputation is critically important in making threats credible.
-Preemption: occupying existing and potential strategic niches to reduce the range of investment opportunities open to the challenger. Different forms include : proliferation, large investments in production capacity, and patent proliferation.
-Proliferation: done by a market leader can leave new entrants and small rivals with few opportunities for establishing a market niche.
-Large investments: Nutrasweets heavy investment in production plants was a clear threat to would-be producers of the same market.
- P.P. : By limiting competitors technical opportunities.
The ability to sustain competitive advantage through pre-emption depends on the presence of two flaws in the competitive process.
The market must be small relative to the minimum efficient scale of production, such that only a very small number of competitors is viable.
There must be first-mover advantage that gives incumbent preferential access to information and other resources, putting rivals at a disadvantage.
-During our last presentation we talked about how early in Coca-Cola’s history, their were many imitators of its original drink, Coke. After securing a new and innovative bottle design, Coca-Cola patented the design so customers would have no misunderstanding as to what drink they were purchasing.

12. Diagnosis
In order to imitate, a firm must understand the basis of its rivals success
The problem lies in the identification of the link from superior performance to the decisions that generate that performance
Causal ambiguity- the more complex a firm’s competitive advantage and the more it is based on complex bundles of capabilities, the more difficult it is to diagnose the reasons behind its success
Uncertain imitability- with ambiguity associated with the causes of success, attempts at imitation are subject to uncertain success
Recent research suggests that the complex combinations of resources and capabilities may make imitation nearly impossible
Another issue is the idea that some practices may be generically beneficial for a firm to put into place while other practices are only successful when combined with other practices
-If a firm is to imitate the competitive advantage of another, it must understand the basis of its rivals success.
-In most industries, there is a serious identification problem in linking superior performance to the strategic decisions that generate the performance.
-Take Walmart for example, it is easy for competitors to get information on them all they need to do is walk into one of their stores. The difficult part is identifying which differences are the cause of their superior profitability. Is it the supply chain? Unique management? The logistics and decision making practices? Or is it the combination?
-If the companies success is the outcome of a complex configuration of strategy, structure, management systems, personal leaderships, and a host of business processes, the implication is that imitation may well be impossible.

13. Resource Acquisition
Now firms face the challenge of assembling the resources and capabilities of the advantaged firm
To guard against imitators, firms can base its competitive advantage around resources and capabilities that are immobile and difficult to replicate
On the other hand competitive advantage not requiring complex, firm- specific resources are often imitated quickly
This all depends on the extent to which first-mover advantage plays a role in the market
First-mover advantage- the idea that the first firm to occupy a strategic position gains access to resources and capabilities that cannot be matched
A firm can acquire resources and capabilities in two ways: it can buy them or it can build them. The period over which a competitive advantage can be sustained depends critically on the time it takes to acquire and mobilize the resources and capabilities needed to make a competitive challenge.
-This is either because the first-mover is able to pre-empt the best resources, or can use early entry to build superior resources and capabilities.

14. Types of Competitive Advantage
Firms can achieve or potentially achieve a higher rate of profit over a rival in one of two ways:
Cost Advantage- supply an identical product or service at a lower cost
Differentiation Advantage- supply a product or service that is unique in such a way that customers are willing to pay a price premium
These two sources of competitive advantage are radically different in terms of company strategy – opposite ends of the spectrum
Cost
Differentiation
-A firm that competes on cost with not compete on differentiation.
-Hersey’s Kisses(about $4/lb or $8.98 for this bag) vs. Chocopologie La Madeline Truffle ($2,600/lb or $250/piece) Chocopologie is the most expensive chocolate in the world. Each piece is individually made with a rare French truffle. Hersey’s mass produces its chocolate in a basic, timely manner.

15. Cost vs. Differentiation Advantage

16. Examples of Cost vs. Differentiation
Walmart
Apple
McDonalds
Mercedes and BMW
Ikea
Bose
Southwest Airlines
Nike
Walmart
- large scale and efficient supply chain
McDonalds
- Staff savings (cheap cooks, few managers)
Ikea
- Outsource to low-wage countries and basic level of service
Southwest Airlines
- No additional amenities and minimized time on tarmac
Differentiation

17. Cost Advantage
There are seven determinants of a firms unit cost or cost per unit of output (cost drivers)
These determinants vary across industries, firms, and across different activities within a firm
By analyzing these different cost drivers, firms can:
Analyze its cost position in relation to it competitors and diagnose the sources of inefficiency
Make recommendations on how to improve its cost efficiency

18. Production Techniques
Cost Drivers
-Technical input-output relationships
-Indivisibility
-Specializations
Economies of Scale
Economies of Learning
-Increased individual skills
-Improved organizational routines
Production Techniques
-Process innovation
-Re-engineering of business processes
-Standardization of designs & components
-Design for manufacture
Product Design
-Location advantages
-Ownership of low-cost inputs
-Nonunion labor
-Bargaining power
Input Costs
-Ratio of fixed to variable costs
-Fast and flexible capacity adjustment
Capacity Utilization
-Organizational slack/X-inefficiency
-Motivation and organizational culture
-Managerial effectiveness
Residual Efficiency

19. Value Chain Analysis
A value chain analysis is an effective way to conduct this examination because it requires identifying:
Relative importance to total cost
Cost drivers for each activity
Efficiency of each activity
Comparison of costs to each other
Whether to outsource or not
A value chain analysis involves 6 steps in which a firm:
Breaks itself down into separate activities
Establishes the importance of each activity in the total cost of the product
Compares costs by activity
Identifies cost drivers for each activity
Identifies linkages between activities
Identifies opportunities for reducing costs

20. Stages of Value Chain Analysis for Cost Advantage
Break down the firm into separate activities- this requires the knowledge of the chain of processes involved in the transformation of inputs to outputs and can usually be guided by a firms divisional and departmental structure
Establish the relative importance of different activities in the total cost of the product- to identify which activities are major sources of cost so we can ultimately assign costs and assets to each activity
Compare costs by activity- to establish which activities are performed with relative efficiency and those do not, then benchmark those costs against those of competitors

21. Stages of Value Chain Analysis for Cost advantage
Identify cost drivers for each activity- taking into consideration if the activity is capital intensive (machine depreciation and maintenance, output of machine) or labor intensive (wage rates, speed of work, defect rates)
Identify linkages between activities- because the costs of some activities may be effected by the performance of other activities
Identify opportunities for reducing costs- after performing the first 5 steps, opportunities for cost reduction become more evident
Is outsourcing possible for inefficient activities?
Can wages be reduced directly or from relocation of services? (Input costs)
Would better training create a more efficient and effective worker? (Economies of learning)

22. Differentiation Advantage
Occurs when a firm is able to obtain from its differentiation a price premium in the market that exceeds the cost of providing the differentiation
Opportunities differ from market to market and product to product
Products that lack physical differentiation (commodities) can still create customer value where others have not
Critical issue of differentiation advantage: the firm must make sure its differentiation creates value for customers and that the value exceeds the cost of the differentiation
We can also use the value chain analysis to discover opportunities for differentiation advantage
-Again back to Chocopologie and its La Madeline Truffle, people are willing to pay a price premium because the best ingredients are used in its products.

23. Stages of Value Chain Analysis for Differentiation Advantage
Construct a value chain for the firm and the customer- values chains for the firm, immediate customers and firms or customer further down the value chain can be useful. Also create separate value chains for the main categories of customers because they may have different needs.
Identify the drivers of uniqueness in each activity- analyze each separate activity to discover its individual variables and actions that can be taken to achieve uniqueness.

24. Differentiation Advantage
Support Activities
Primary Activities
-Supply side analysis identifies the firms potential to create uniqueness in its products or services
-This figure identifies possible sources of differentiation within Porter’s generic value chain

25. Stages of Value Chain Analysis for Differentiation Advantage
Select the most promising differentiation variables for the firm- on the supply side there are 3 important considerations
Analyze strengths and capabilities to establish the greatest potential for differentiating or lower cost differentiating than rivals
Identify linkages among activities because if those interactions aren’t flowing well, product reliability can be compromised
Considering the ease of sustaining uniqueness or differentiation- the more specific the resources are to the firm or complex coordination of the differentiation, the more difficult imitation will be for competitors
Locate linkages between the value chain of the firm and that of the buyer- to create value for its customers, firms must locate the linkages between differentiation of it own activities and cost reduction and differentiation within the customers

26. Porter’s Generic Strategies
Porter believes that cost leadership and differentiation are mutually exclusive and a firm that tries to focus on both is almost guaranteed low profitability
Ultimately, a firm needs to decide on pursuing either cost or differentiation advantage and then decide on its market scope, industry wide (broad market) or single segment (narrow market)
Source of Competitive Advantage
Low Cost
Differentiation
Differentiation
Cost Leadership
Focus
Industry-wide
Competitive Scope
Single Segment