Business-Level Strategy: Creating and Sustaining Competitive Advantages Chapter Five McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives After reading this chapter, you should have a good understanding of: LO1 The central role of competitive advantage in the study of strategic management. LO2 The three generic strategies: overall cost leadership, differentiation, and focus. LO3 How the successful attainment of generic strategies can improve a firm’s relative power vis-à-vis the five forces that determine an industry’s average profitability. LO4 The pitfalls managers must avoid in striving to attain generic strategies. 5-2

Learning Objectives (cont.) LO5 How firms can effectively combine the generic strategies of overall cost leadership and differentiation. LO6 How Internet-enabled business models are being used to improve strategic positioning. LO7 The importance of considering the industry life cycle to determine a firm’s business-level strategy and its relative emphasis on functional area strategies and value-creating activities. LO8 The need for turnaround strategies that enable a firm to reposition its competitive position in an industry. 5-3

Three Generic Strategies 5-4

Three Generic Strategies Overall cost leadership Low-cost-position relative to a firm’s peers Manage relationships throughout the entire value chain Differentiation Create products and/or services that are unique and valued Non-price attributes for which customers will pay a premium 5-5

Three Generic Strategies Focus strategy Narrow product lines, buyer segments, or targeted geographic markets Attain advantages either through differentiation or cost leadership 5-6

Example Companies pursuing an overall cost leadership strategy McDonalds Wal-Mart Companies pursuing a differentiation strategy Harley Davison Apple Companies pursuing a focus strategy Rolex Lamborghini Encourage students to evaluate these companies as you discuss these strategies further in the following slides. 5-7 7

Competitive Advantage and Business Performance 5-8

Overall Cost Leadership Tight set of interrelated tactics that includes: Tight cost and overhead control Avoidance of marginal customer accounts Cost minimization in all activities in the firm’s value chain Tight set of interrelated tactics that includes: Aggressive construction of efficient-scale facilities Vigorous pursuit of cost reductions from experience Tight cost and overhead control Avoidance of marginal customer accounts Cost minimization in all activities in the firm’s value chain 5-9

Overall Cost Leadership Experience curve refers to how business “learns” to lower costs as it gains experience with production processes with experience, unit costs of production decline as output increases in most industries 5-10

Overall Cost Leadership (Cont.) Parity on the basis of differentiation Permits a cost leader to translate cost advantages directly into higher profits than competitors Allows firm to earn above-average profits A firm must attain competitive parity on the basis of differentiation relative to competitors 5-11

Comparing Experience Curve Effects 5-12

Improving Competitive Position vis-à-vis the Five Forces An overall low-cost position Protects a firm against rivalry from competitors Protects a firm against powerful buyers Provides more flexibility to cope with demands from powerful suppliers for input cost increases Provides substantial entry barriers from economies of scale and cost advantages Puts the firm in a favorable position with respect to substitute products 5-13

Pitfalls of Overall Cost Leadership Strategies Too much focus on one or a few value-chain activities All rivals share a common input or raw material The strategy is imitated too easily A lack of parity on differentiation Erosion of cost advantages when the pricing information available to customers increases 5-14

Differentiation Prestige or brand image Technology Innovation Features Customer service Dealer network 5-15

Differentiation Firms may differentiate along several dimensions at once Successful differentiation requires integration with all parts of a firm’s value chain An important aspect of differentiation is speed or quick response Firms achieve and sustain differentiation and above-average profits when price premiums exceed extra costs of being unique 5-16

Differentiation: Improving Competitive Position Creates higher entry barriers due to customer loyalty Provides higher margins that enable the firm to deal with supplier power Establishes customer loyalty and hence less threat from substitutes Creates higher entry barriers due to customer loyalty Provides higher margins that enable the firm to deal with supplier power Reduces buyer power because buyers lack suitable alternative Reduces supplier power due to prestige associated with supplying to highly differentiated products Establishes customer loyalty and hence less threat from substitutes 5-17

Potential Pitfalls of Differentiation Strategies Uniqueness that is not valuable Too much differentiation Too high a price premium Differentiation that is easily imitated Dilution of brand identification through product-line extensions Perceptions of differentiation may vary between buyers and sellers 5-18

QUESTION High product differentiation is generally accompanied by  A. Higher market share B. Decreased emphasis on competition based on price C. Higher profit margins and lower costs D. Significant economies of scale B. Decreased emphasis on competition based on price 5-19 19

Focus Focus is based on the choice of a narrow competitive scope within an industry Firm selects a segment or group of segments (niche) and tailors its strategy to serve them Firm achieves competitive advantages by dedicating itself to these segments exclusively 5-20

Focus Cost focus Differentiation focus firm strives to create a cost advantage in its target segment Differentiation focus firm seeks to differentiate in its target market 5-21

Focus: Improving Competitive Position Creates barriers of either cost leadership or differentiation, or both Used to select niches that are least vulnerable to substitutes or where competitors are weakest 5-22

Pitfalls of Focus Strategies Erosion of cost advantages within the narrow segment Focused products and services still subject to competition from new entrants and from imitation Focusers can become too focused to satisfy buyer needs 5-23

Three Combination Approaches Automated and flexible manufacturing systems Exploiting the profit pool concept for competitive advantage Coordinating the “extended” value chain by way of information technology Mass customization a firm’s ability to manufacture unique products in small quantities at low cost. Primary benefit of successful integration of low-cost and differentiation strategies is difficulty it poses for competitors to duplicate or imitate strategy Goal of combination strategy is to provide unique value in an efficient manner 5-24 24

U.S. Automobile Industry’s Profit Pool 5-25

Combination Strategies: Improving Competitive Position High entry barriers Bargaining power over suppliers Reduces power of buyers (fewer competitors) Value position reduces threat from substitute products Reduces the possibility of head-to-head rivalry 5-26

Pitfalls of Combination Strategies Firms that fail to attain both strategies may end up with neither and become “stuck in the middle” Miscalculating sources of revenue and profit pools in the firm’s industry Underestimating the challenges and expenses associated with coordinating value-creating activities in the extended value chain 5-27

Internet-Enabled Low Cost Leader Strategies Online bidding and order processing are eliminating the need for sales calls and are minimizing sales force expenses. Online purchase orders are making many transactions paperless, thus reducing the costs of procurement and paper. Direct access to progress reports and the ability for customers to periodically check work in progress is minimizing rework. Collaborative design efforts using Internet technologies that link designers, materials suppliers, and manufacturers are reducing the costs and speeding the process of new product development. 5-28

Internet-Enabled Differentiation Strategies Internet-based knowledge management systems that link all parts of the organization are shortening response times and accelerating organization learning. Quick online responses to service requests and rapid feedback to customer surveys and product promotions are enhancing marketing efforts. Personalized online access provides customers with their own “site within a site” in which their prior orders, status of current orders, and requests for future orders are processed directly on the supplier’s website. Online access to real-time sales and service information is being used to empower the sales force and continually update R&D and technology development efforts. 5-29

Internet-Enabled Focus Strategies Permission marketing techniques are focusing sales efforts on specific customers who opt to receive advertising notices. Niche portals that target specific groups are providing advertisers with access to viewers with specialized interests. Virtual organizing and online “officing” are being used to minimize firm infrastructure requirements. Procurement technologies that use Internet software to match buyers and sellers are highlighting specialized buyers and drawing attention to smaller suppliers. 5-30

Industry Life-Cycle Stages: Strategic Implications refers to the stages of introduction, growth, maturity, and decline that occur over the life of an industry Emphasis on strategies, functional areas, value-creating activities, and overall objectives varies over the course of an industry life cycle 5-31 31

Stages of the Industry Life Cycle 5-32

QUESTION The most likely time to pursue a harvest strategy is in a situation of  A. High growth B. Strong competitive advantage C. Mergers and acquisitions D. Decline in the market life cycle D. Decline in the market life cycle 5-33 33

Industry Life-Cycle Strategies In the Introduction Stage: Products are unfamiliar to consumers Market segments not well defined Product features not clearly specified Competition tends to be limited 5-34

Industry Life-Cycle Strategies For the Introduction Stage: Develop product and get users to try it Generate exposure so product becomes “standard” 5-35

Industry Life-Cycle Strategies The Growth Stage is: Characterized by strong increases in sales Attractive to potential competitors 5-36

Industry Life-Cycle Strategies For the Growth Stage: Brand recognition Differentiated products Financial resources to support value-chain activities 5-37

Industry Life-Cycle Strategies In the Maturity stage: Aggregate industry demand slows Market becomes saturated, few new adopters Direct competition becomes predominant Marginal competitors begin to exit 5-38

Industry Life-Cycle Strategies For the Maturity Stage: Efficient manufacturing operations and process engineering Low costs (customers become price sensitive) 5-39

Industry Life-Cycle Strategies In the Decline Stage: Industry sales and profits begin to fall Strategic options become dependent on the actions of rivals 5-40

Strategies in the Decline Stage For the Decline Stage Maintaining Exiting the market Harvesting Consolidation 5-41

Turnaround Strategies in the Life Cycle Turnaround strategy a strategy that reverses a firm’s decline in performance and returns it to growth and profitability. Asset and cost surgery Selective product and market pruning Piecemeal productivity improvements • Asset and cost surgery. Very often, mature firms tend to have assets that do not produce any returns. These include real estate, buildings, etc. Outright sales or sale and leaseback free up considerable cash and improve returns. Investment in new plants and equipment can be deferred. Firms in turnaround situations try to aggressively cut administrative expenses and inventories and speed up collection of receivables. Costs also can be reduced by outsourcing production of various inputs for which market prices may be cheaper than in-house production costs. • Selective product and market pruning. Most mature or declining firms have many product lines that are losing money or are only marginally profitable. One strategy is to discontinue such product lines and focus all resources on a few core profitable areas. For example, in the early 1980s, faced with possible bankruptcy, Chrysler Corporation sold off all its nonautomotive businesses as well as all its production facilities abroad. Focus on the North American market and identification of a profitable niche—namely, minivans—were keys to their eventual successful turnaround. • Piecemeal productivity improvements. There are many ways in which a firm can eliminate costs and improve productivity. Although individually these are small gains, they cumulate over a period of time to substantial gains. Improving business processes by reengineering them, benchmarking specific activities against industry leaders, encouraging employee input to identify excess costs, increasing capacity utilization, and improving employee productivity lead to a significant overall gain. 5-42 42