Business-Level Strategy: Creating and Sustaining Competitive Advantages Chapter Five McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.

Learning Objectives After reading this chapter, you should have a good understanding of: LO5.1 The central role of competitive advantage in the study of strategic management and the three generic strategies: overall cost leadership, differentiation, and focus. LO5.2 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. LO5.3 The pitfalls managers must avoid in striving to attain generic strategies. LO5.4 How firms can effectively combine the generic strategies of overall cost leadership and differentiation.

Learning Objectives (cont.) LO5.5 What factors determine the sustainability of a firm’s competitive advantage. LO5.6 How Internet-enabled business models are being used to improve strategic positioning. LO5.7 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. LO5.8 The need for turnaround strategies that enable a firm to reposition its competitive position in an industry.

Three Generic Strategies Exhibit 5.1

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

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

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. 7

Competitive Advantage and Business Performance Exhibit 5.2

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

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

Overall Cost Leadership Competitive parity a firm’s achievement of similarity, or being “on par,” with competitors with respect to low cost, differentiation, or other strategic product characteristic. A firm must attain competitive parity on the basis of differentiation relative to competitors

Comparing Experience Curve Effects Exhibit 5.4

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

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

Differentiation Differentiation strategy a firm’s generic strategy based on creating differences in the firm’s product or service offering by creating something that is perceived industry-wide as unique and valued by customers. Firms achieve and sustain differentiation and above-average profits when price premiums exceed extra costs of being unique

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

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

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

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

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

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

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

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 24

U.S. Automobile Industry’s Profit Pool Exhibit 5.8

Pitfalls of Combination Strategies Firms that fail to attain both strategies may end up with neither and become “stuck in the middle” Underestimating the challenges and expenses associated with coordinating value creating activities in the extended value chain 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

Internet-Enabled Low Cost Leader Strategies 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. Exhibit 5.9

Internet-Enabled Differentiation Strategies 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. Exhibit 5.10

Internet-Enabled Focus Strategies 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. Exhibit 5.11

Industry Life-Cycle Stages: Strategic Implications refers to the stages of introduction, growth, maturity, and decline that typically 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 30

Stages of the Industry Life Cycle Exhibit 5.12

QUESTION The most likely time to pursue a harvest strategy is in a situation of  High growth Strong competitive advantage Mergers and acquisitions Decline in the market life cycle D. Decline in the market life cycle 32

Strategies in the Introduction Stage the first stage of the industry life cycle, characterized by (1) new products that are not known to customers, (2) poorly defined market segments, (3) unspecified product features, (4) low sales growth, (5) rapid technological change, (6) operating losses, and (7) a need for financial support.

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

Industry Life-Cycle Strategies Growth stage The second stage of the product life cycle, characterized by (1) strong increases in sales; (2) growing competition; (3) developing brand recognition; and (4) a need for financing complementary value-chain activities such as marketing, sales, customer service, and research and development.

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

Industry Life-Cycle Strategies Maturity stage The third stage of the product life cycle, characterized by (1) slowing demand growth, (2) saturated markets, (3) direct competition, (4) price competition, and (5) strategic emphasis on efficient operations. Reverse positioning, breakaway positioning

Industry Life-Cycle Strategies Decline stage The fourth stage of the product life cycle, characterized by (1) falling sales and profits, (2) increasing price competition, and (3) industry consolidation.

Strategies in the Decline Stage For the Decline Stage Maintaining Harvesting Exiting the market Consolidation

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. 40