1. PowerPoint slides by: R. Dennis Middlemist Colorado State University Copyright © 2004 South-Western All rights reserved. Chapter 4 Business-Level Strategy

2. Copyright © 2004 South-Western. All rights reserved.4–2 Knowledge Objectives Studying this chapter should provide you with the strategic management knowledge needed to:  Define business-level strategy.  Discuss the relationship between customers and business- level strategies in terms of who, what, and how.  Explain the differences among business-level strategies.  Use the five forces of competition model to explain how above-average returns can be earned through each business-level strategy.  Describe the risks of using each of the business-level strategies.

3. Copyright © 2004 South-Western. All rights reserved.4–3 Figure 1.1 Copyright © 2004 South-Western. All rights reserved. The Strategic Management Process

4. Copyright © 2004 South-Western. All rights reserved.4–4 Business-Level Strategy (Defined) An integrated and coordinated set of commitments and actions the firm uses to gain a competitive advantage by exploiting core competencies in specific product markets

5. Copyright © 2004 South-Western. All rights reserved.4–5 Key Issues Business-Level Strategy Business-levelStrategy Which good or service to provide How to manufacture it How to distribute it

6. Copyright © 2004 South-Western. All rights reserved.4–6 Core Competencies and Strategy Resources and superior capabilities that are sources of competitive advantage over a firm’s rivals Providing value to customers and gaining competitive advantage by exploiting core competencies in individual product markets Core Competencies Strategy Business-level Strategy An integrated and coordinated set of actions taken to exploit core competencies and gain competitive advantage

7. Copyright © 2004 South-Western. All rights reserved.4–7 Customers: Business-Level Strategic Issues Customers are the foundation of successful business-level strategy  Who will be served by the strategy?  What needs those target customers have that the strategy will satisfy?  How those needs will be satisfied by the strategy?

8. Copyright © 2004 South-Western. All rights reserved.4–8 Customers: Who, What, Where Firms must manage all aspects of their relationship with customers  Reach: firm’s success and connection to customers  Richness: depth and detail of two-way flow of information between the firm and the customer  Affiliation: facilitation of useful interactions with customers

9. Copyright © 2004 South-Western. All rights reserved.4–9 Customer Needs—Who? Determining the Customers to Serve Customers IndustrialMarkets ConsumerMarkets Market Segmentation

10. Copyright © 2004 South-Western. All rights reserved.4–10 Basis for Customer Segmentation Consumer Markets 1.Demographic factors (age, income, sex, etc.) 2.Socioeconomic factors (social class, stage in the family life cycle) 3.Geographic factors (cultural, regional, and national differences) 4.Psychological factors (lifestyle, personality traits) 5.Consumption patterns (heavy, moderate, and light users) 6.Perceptual factors (benefit segmentation, perceptual mapping) SOURCE: Adapted from S. C. Jain, 2000, Marketing Planning and Strategy, Cincinnati: South-Western College Publishing, 120. Table 4.1

11. Copyright © 2004 South-Western. All rights reserved.4–11 Basis for Customer Segmentation (cont’d) Industrial Markets 1.End-use segments (identified by SIC code) 2.Product segments (based on technological differences or production economics) 3.Geographic segments (defined by boundaries between countries or by regional differences within them) 4.Common buying factor segments (cut across product market and geographic segments) 5.Customer size segments SOURCE: Adapted from S. C. Jain, 2000, Marketing Planning and Strategy, Cincinnati: South-Western College Publishing, 120. Table 4.1

12. Copyright © 2004 South-Western. All rights reserved.4–12 Market Segmentation: Consumer Markets Demographic factors Socioeconomic factors Geographic factors Psychological factors Consumption patterns Perceptual factors Consumer Markets Demographic Socioeconomic Geographic Psychological Consumption Perceptual

13. Copyright © 2004 South-Western. All rights reserved.4–13 Industrial Markets End-use Product Geographic Common buying factor Customer size Market Segmentation: Industrial Markets End-use segments Product segments Geographic segments Common buying factor segments Customer size segments

14. Copyright © 2004 South-Western. All rights reserved.4–14 Customer Needs—What? Customer Needs to Satisfy  Customer needs are related to a product’s benefits and features  Customer needs are neither right nor wrong, good nor bad  Customer needs represent desires in terms of features and performance capabilities

15. Copyright © 2004 South-Western. All rights reserved.4–15 Customer Needs—How? Determining the Core Competencies Necessary to Satisfy Customer Needs  Firms use core competencies to implement value creating strategies that satisfy customers’ needs  Only firms with capacity to continuously improve, innovate and upgrade their competencies can expect to meet and/or exceed customer expectations across time

16. Copyright © 2004 South-Western. All rights reserved.4–16 Types of Business-Level Strategy Business-Level Strategies  Are intended to create differences between the firm’s position relative to those of its rivals To position itself, the firm must decide whether it intends to:  Perform activities differently or  Perform different activities as compared to its rivals

17. Copyright © 2004 South-Western. All rights reserved.4–17 Types of Potential Competitive Advantage Achieving lower overall costs than rivals  Performing activities differently (cheaper process) Possessing the capability to differentiate the firm’s product or service and command a premium price  Performing different (valuable) activities

18. Copyright © 2004 South-Western. All rights reserved.4–18 Two Targets of Competitive Scope Broad Scope  The firm competes in many customer segments Narrow Scope  The firm selects a segment or group of segments in the industry and tailors its strategy to serving them at the exclusion of others

19. Copyright © 2004 South-Western. All rights reserved.4–19 Southwest Airlines’ Activity System

20. Copyright © 2004 South-Western. All rights reserved.4–20 Five Business- Level Strategies Figure 4.1 SOURCE: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 12. Copyright © 1985, 1998 by Michael E. Porter.

21. Copyright © 2004 South-Western. All rights reserved.4–21 Cost Leadership Strategy An integrated set of actions taken to produce goods or services with features that are acceptable to customers at the lowest cost, relative to that of competitors with features that are acceptable to customers  Relatively standardized products  Features acceptable to many customers  Lowest competitive price

22. Copyright © 2004 South-Western. All rights reserved.4–22 Cost Leadership Strategy Cost saving actions required by this strategy:  Tightly controlling production costs and overhead  Minimizing costs of sales, R&D and service  Building efficient manufacturing facilities  Monitoring costs of activities provided by outsiders  Simplifying production processes

23. Copyright © 2004 South-Western. All rights reserved.4–23 How to Obtain a Cost Advantage Cost Drivers Value Chain Determine and control Reconfigure, if needed  Alter production process  Change in automation  New distribution channel  New advertising media  Direct sales in place of indirect sales  New raw material  Forward integration  Backward integration  Change location relative to suppliers or buyers

24. Copyright © 2004 South-Western. All rights reserved.4–24 Examples of Value- Creating Activities Associated with the Cost Leadership Strategy SOURCE: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 47. Copyright © 1985, 1998 by Michael E. Porter. Figure 4.2

25. Copyright © 2004 South-Western. All rights reserved.4–25 Value-Creating Activities for Cost Leadership Cost-effective MIS Few management layers Simplified planning Consistent policies Effecting training Easy-to-use manufacturing technologies Investments in technologies Finding low cost raw materials Monitor suppliers’ performances Link suppliers’ products to production processes Economies of scale Efficient-scale facilities Effective delivery schedules Low-cost transportation Highly trained sales force Proper pricing

26. Copyright © 2004 South-Western. All rights reserved.4–26 Cost Leadership Strategy: New Entrants Can frighten off new entrants due to:  Their need to enter on a large scale in order to be cost competitive  The time it takes to move down the learning curve The Threat of Potential Entrants

27. Copyright © 2004 South-Western. All rights reserved.4–27 Cost Leadership Strategy: Suppliers Can mitigate suppliers’ power by:  Being able to absorb cost increases due to low cost position  Being able to make very large purchases, reducing chance of supplier using power Bargaining Power of Suppliers

28. Copyright © 2004 South-Western. All rights reserved.4–28 Cost Leadership Strategy: Buyers Can mitigate buyers’ power by:  Driving prices far below competitors, causing them to exit, thus shifting power with buyers back to the firm Bargaining Power of Buyers

29. Copyright © 2004 South-Western. All rights reserved.4–29 Cost Leadership Strategy: Substitutes Cost leader is well positioned to:  Make investments to be first to create substitutes  Buy patents developed by potential substitutes  Lower prices in order to maintain value position Product Substitutes

30. Copyright © 2004 South-Western. All rights reserved.4–30 Cost Leadership Strategy: Competitors Due to cost leader’s advantageous position:  Rivals hesitate to compete on basis of price  Lack of price competition leads to greater profits Rivalry with Existing Competitors

31. Copyright © 2004 South-Western. All rights reserved.4–31 Cost Leadership Strategy (cont’d) Competitive Risks  Processes used to produce and distribute good or service may become obsolete due to competitors’ innovations  Focus on cost reductions may occur at expense of customers’ perceptions of differentiation  Competitors, using their own core competencies, may successfully imitate the cost leader’s strategy

32. Copyright © 2004 South-Western. All rights reserved.4–32 Differentiation Strategy An integrated set of actions taken to produce goods or services (at an acceptable cost) that customers perceive as being different in ways that are important to them  Nonstandardized products  Customers value differentiated features more than they value low cost

33. Copyright © 2004 South-Western. All rights reserved.4–33 Elasticities of demand By offering a differentiated product the producer seeks to make the elasticity of demand for the product ’sticky’ or what we call inelastic. If the demand for a product is inelastic it is not very sensitive to changes in price neither in changes in price of the product itself or the changes in price of subsitude products.

34. Copyright © 2004 South-Western. All rights reserved.4–34 Segmentation Underlying differentiation is the concept of market segmentation – the identification of special groups of buyers who will pay more for a differentiated product that is targeted at them. A strong brand can even be a source of differentiation (Hilton), as well as levels of service (Ritz), better performance (Porsche) or design (Apple).

35. Copyright © 2004 South-Western. All rights reserved.4–35 The source of differentiation is important First we must establish where the firm has potential for differentiation or can do so at a lower cost than rivals. The differentiation must be based upon the firm’s internal strengths in terms of resources and capabilities. The more differentiation is based upon resources and capabilities which are specific to the firm or involve the complex coordination of large numbers of individuals, the more difficult it will be for competitors to imitate. Offering more leg room or wider seats can easily be imitated by another airline, high level of punctuality cannot.

36. Copyright © 2004 South-Western. All rights reserved.4–36 How to Obtain a Differentiation Advantage Cost Drivers Value Chain Control if needed Reconfigure to maximize  Lower buyers’ costs  Raise performance of product or service  Create sustainability through:  Customer perceptions of uniqueness  Customer reluctance to switch to non- unique product or service

37. Copyright © 2004 South-Western. All rights reserved.4–37 Value-Creating Activities and Differentiation Highly developed MIS Emphasis on quality Worker compensation for creativity /productivity Use of subjective performance measures Basic research capability Technology High quality raw materials Delivery of products High quality replacement parts Superior handling of incoming raw materials Attractive products Rapid response to customer specifications Order-processing procedures Customer credit Personal relationships

38. Copyright © 2004 South-Western. All rights reserved.4–38 Examples of Value- Creating Activities Associated with the Differentiation Strategy SOURCE: Adapted with the permission of The Free Press, an imprint of Simon & Schuster Adult Publishing Group, from Competitive Advantage: Creating and Sustaining Superior Performance, by Michael E. Porter, 47. Copyright © 1985, 1998 by Michael E. Porter. Figure 4.3

39. Copyright © 2004 South-Western. All rights reserved.4–39 Differentiation Strategy: New Entrants Can defend against new entrants because:  New products must surpass existing products  New products must be at least equal to performance of proven products The Threat of Potential Entrants

40. Copyright © 2004 South-Western. All rights reserved.4–40 Differentiation Strategy: Suppliers Can mitigate suppliers’ power by:  Absorbing price increases due to higher margins  Passing along higher supplier prices because buyers are loyal to differentiated brand Bargaining Power of Suppliers

41. Copyright © 2004 South-Western. All rights reserved.4–41 Differentiation Strategy: Buyers Can mitigate buyers’ power because well differentiated products reduce customer sensitivity to price increases Bargaining Power of Buyers

42. Copyright © 2004 South-Western. All rights reserved.4–42 Differentiation Strategy: Substitutes Well positioned relative to substitutes because  Brand loyalty to a differentiated product tends to reduce customers’ testing of new products or switching brands Product Substitutes

43. Copyright © 2004 South-Western. All rights reserved.4–43 Differentiation Strategy: Competitors Defends against competitors because brand loyalty to differentiated product offsets price competition Rivalry with Existing Competitors

44. Copyright © 2004 South-Western. All rights reserved.4–44 Competitive Risks of Differentiation The price differential between the differentiator’s product and the cost leader’s product becomes too large Differentiation ceases to provide value for which customers are willing to pay Experience narrows customers’ perceptions of the value of differentiated features Counterfeit goods replicate differentiated features of the firm’s products

45. Copyright © 2004 South-Western. All rights reserved.4–45 Criticism of the concept Differentiation: Some forms of differentiation are not based on price: the option is therefore over- simplistic The form of differentiation may not lend itself to higher prices. The firm may have as an objective to increase its market share, and it may use differentiation and low price for this purpose.

46. Copyright © 2004 South-Western. All rights reserved.4–46 Hard difference... Identifying the need for differentiation solves nothing: it is the precise form, i.e. what will be attractive to the buyer is what matters, and is not easy to determine. So the real problem remains: how to make the product attractive to the customer. It is easy to say: offer a product which is somehow different from the products which your competitors are offering, but finding a way to do that and succeeding in making the buyers appreciate the difference is hard.

47. Copyright © 2004 South-Western. All rights reserved.4–47 Focus Strategies An integrated set of actions taken to produce goods or services that serve the needs of a particular competitive segment  Particular buyer group (e.g. youths or senior citizens  Different segment of a product line (e.g. professional craftsmen versus do-it-yourselfers  Different geographic markets (e.g. East coast versus West coast)

48. Copyright © 2004 South-Western. All rights reserved.4–48 Focus Strategies (cont’d) Types of focused strategies  Focused cost leadership strategy  Focused differentiation strategy To implement a focus strategy, firms must be able to:  Complete various primary and support activities in a competitively superior manner, in order to develop and sustain a competitive advantage and earn above-average returns

49. Copyright © 2004 South-Western. All rights reserved.4–49 Factors That Drive Focused Strategies Large firms may overlook small niches. A firm may lack the resources needed to compete in the broader market A firm is able to serve a narrow market segment more effectively than can its larger industry-wide competitors Focusing allows the firm to direct its resources to certain value chain activities to build competitive advantage

50. Copyright © 2004 South-Western. All rights reserved.4–50 Competitive Risks of Focus Strategies A focusing firm may be “ outfocused ” by its competitors A large competitor may set its sights on a firm’s niche market Customer preferences in niche market may change to more closely resemble those of the broader market

51. Copyright © 2004 South-Western. All rights reserved.4–51 Integrated Cost Leadership/ Differentiation Strategy A firm that successfully uses an integrated cost leadership/differentiation strategy should be in a better position to:  Adapt quickly to environmental changes  Learn new skills and technologies more quickly  Effectively leverage its core competencies while competing against its rivals

52. Copyright © 2004 South-Western. All rights reserved.4–52 Integrated Cost Leadership/ Differentiation Strategy (cont’d) Commitment to strategic flexibility is necessary for implementation of integrated cost leadership/differentiation strategy  Flexible manufacturing systems  Information networks  Total quality management (TQM) systems

53. Copyright © 2004 South-Western. All rights reserved.4–53 Flexible Manufacturing Systems Computer-controlled processes used to produce a variety of products in moderate, flexible quantities with a minimum of manual intervention  Goal is to eliminate the “low-cost-versus-wide product-variety” tradeoff  Allows firms to produce large variety of products at relatively low costs

54. Copyright © 2004 South-Western. All rights reserved.4–54 Information Networks Link companies electronically with their suppliers, distributors, and customers  Facilitate efforts to satisfy customer expectations in terms of product quality and delivery speed  Improve flow of work among employees in the firm and their counterparts at suppliers and distributors

55. Copyright © 2004 South-Western. All rights reserved.4–55 Total Quality Management (TQM) Systems Emphasize total commitment to the customer through continuous improvement using:  Data-driven, problem-solving approaches  Empowerment of employee groups and teams Benefits  Increases customer satisfaction  Cuts costs  Reduces time-to-market for innovative products

56. Copyright © 2004 South-Western. All rights reserved.4–56 Risks of the Integrated Cost Leadership/ Differentiation Strategy Often involves compromises  Becoming neither the lowest cost nor the most differentiated firm Becoming “stuck in the middle”  Lacking the strong commitment and expertise that accompanies firms following either a cost leadership or a differentiated strategy