Modern Competitive Strategy 3 rd Edition Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reservedMcGraw-Hill/Irwin

Chapter 3 Competitive Advantage 3-2

The goal of strategic thinking The focus of entrepreneurial action The motivation for top management’s vision for the firm’s future A focus on economic fundamentals and performance What is Competitive Advantage? 3-3

What Determines Sustained Competitive Advantage? A strong offense to attain market superiority Create a higher economic contribution than competitors Contribution = Value - Cost A strong defense of the market position against rivals Customer retention Defending against imitation Both are necessary and neither is sufficient 3-4

Value-Cost Framework Value Willingness to pay: The highest price a customer would be willing to pay for a product in absence of a competing product and in context of other purchasing opportunities Cost Marginal cost to produce a unit of the product at a given level of value Effective competitive positioning Offering more value per unit cost than competitors, consistently over time 3-5

Economic Contribution Distributed between Buyer and Supplier Figure

Differentiator Invests in higher value (raising costs) Cost leader Invests in lower costs (reducing value) Generic Strategies 3-7

Value and Cost: Substitutes or Complements Figure

Firms in the Middle Two assumptions behind the belief that SIM (Stuck in the Middle) firms perform poorly SIM firm cannot compete on value with the Differentiator or on cost with the Cost Leader SIM firm’s customer base is too small to allow it to improve its competitive position Counter example: Target Corporation Gross margin over revenues is close to that of higher value firms - JCPenney Operating costs per revenue dollar is closer to low cost firm – Wal-Mart 3-9

Competitors’ Value-Cost Profile Target: The More Profitable Firm in Middle Target’s Added Productivity Cost Value Wal-Mart Target JC Penney Value 3-10

Unprofitable Firms in Middle: US Domestic Airline Industry Figure

Value versus Cost Advantage Pursue value investments when: Marginal customers are value-sensitive Returns to increasing value are higher than returns on reducing costs Pursue cost reductions when: Marginal customers are price-sensitive Value improvements are costly, difficult, or easily duplicated by competitors 3-12

Value and Cost Drivers 3-13

Examples of Value Drivers Technology Functionality, features Quality Durability, reliability, aesthetics Delivery Just-in-time production systems Breadth of line Potential benefits: one- stop shopping, interchangeable parts, interface compatibility and cross-selling Service Responsiveness, problem solving 3-14

Customization Customer-based product design Geography Location, scope Risk assumption Warranties Brand/ Reputation Signals of price or quality Network externalities Increase in product value with each new customer – e.g., communication standard Environmental policies Sustainable practices Complements DVD players and disks Examples of Value Drivers (cont’d) 3-15

Examples of Cost Drivers Scale or volume economies Average cost declines as volume increases based on high recurring fixed costs or sunk costs Scope economies Cost of producing two products together is lower than the cost of producing them separately Learning curve Cost declines with cumulative volume as learning takes place and practices improve 3-16

Examples of Cost Drivers (cont’d) Low input costs Firms with lower cost inputs are better positioned to take advantage of industry opportunities and absorb changes Vertical integration For tasks that are specialized to the firm, coordination costs are lower within the firm than with a market supplier Organizational practices Firms develop process innovations to lower costs or improve value in specific activities 3-17

Isolating mechanisms Mechanisms that prevent industry forces from eating up the firm’s profits Increase customer retention Reduce imitation by competitors 3-18

Increasing Customer Retention Increase switching costs Search costs High for products whose value is apparent only after experiencing the product – experience goods Transition costs Costs associated with shifting from old equipment or practices to new Learning costs Costs incurred in learning a new process 3-19

Barriers to Imitation Property rights Patents, trademarks Dedicated assets Exclusive distribution channels, suppliers or location Sunk Costs One time, non-repeated investments in technology, brand, network scope and other assets whose economic benefits are reaped continuously afterward Casual ambiguity Difficulty in copying a capability because it cannot be modeled effectively 3-20

Building Competitive Advantage Figure 2.7 Value Drivers Cost Drivers Resources Capabilities Retaining Customers Preventing Imitation Superior Market Position Defendable Market Position Sustainable Competitive Advantage Market PositionIsolating Mechanisms 3-21