Strategy and Competitive Advantage Chapter 5 OB/ Aug 09

Chapter Outline 5 Generic Competitive Strategies Low Cost Provider Strategies Differentiation Strategies Best-Cost Provider Strategies Focused or Market Niche Strategies

Competitive Strategy Competitive Strategy consists of all the moves and approaches a firm has taken and is taking to attract buyers, withstand competitive pressures and improve its market position

5 Generic Competitive Strategies A low cost provider strategy – appeal to a broad spectrum of customers by being the overall low cost provider of good/ service A broad differentiation strategy – seek to differentiate company’s product/ service from rivals in ways that will appeal to a broad spectrum of buyers

5 Generic Competitive Strategies (cont) A best cost strategy – give customers more value for money ( good to excellent attributes at lower costs than rivals) A focused or niche market strategy based on lower costs – concentrate on a narrow buyer segment and serve niche buyers at lower costs than rivals A focused or niche market strategy based on differentiation –concentrate on a narrow buyer segment and outcompete rivals by offering niche buyers attributes that meet their tastes and requirements better

Low Cost Strategy Powerful competitive approach where buyers are price sensitive Develop a sustainable cost advantage over competitors Use lower costs as basis for underpricing competitors and gain market share or Earn higher profits selling at the going price But must be careful not to pursue low cost so much that product is too stripped down and lose buyer appeal

Figure 5.1: The Five Generic Competitive Strategies Type of Advantage Sought Lower Cost Differentiation Overall Low-Cost Provider Strategy Broad Differentiation Strategy Broad Range of Buyers Best-Cost Provider Strategy Market Target Focused Low-Cost Strategy Focused Differentiation Strategy Narrow Buyer Segment or Niche

How to achieve Low Cost Advantage? Firm’s cumulative costs across its activity cost chain must be lower than competitors’. 2 ways to accomplish this: Improve efficiency and control costs along existing activity cost chain Revamp firm’s activity cost chain to bypass some cost producing activities Both approaches can be used simultaneously

Controlling Costs Drivers Economies or diseconomies of scale Learning curve effects Costs of key inputs Union v/s nonunion labour Bargaining power vis a vis suppliers and supply chain Location Industry value chain Sharing with other business units within the enterprise

Controlling Costs Drivers (cont) Vertical integration v/s Outsourcing First mover advantages and disadvantages Capacity utilisation Strategic choices and operating decisions Adding/ removing services provided Increasing/ decreasing distribution channels used Lengthening/ shortening delivery times to customers Raising / Lowering specifications of purchased materials Putting more / less emphasis than rivals on incentive compensation,wage increases, fringe benefits to motivate employees and boost productivity

Revamping the Value Chain Make greater use of internet technology applications Using direct to end user sales and marketing approaches Simplify the product design Stripping away the extras Shift to simpler/ less capital intensive/ more flexible technological process

Revamping the Value Chain (cont) Bypass high cost raw materials or component parts Relocate facilities Dropping the something for everyone approach

Keys to success in achieving Low Cost Leadership Scrutinise each cost creating activity and determine what drives costs Manage costs downward Restructure value chain Create cost conscious corporate culture- employee participation in cost improvement efforts and limited perks for executives Small corporate staff to keep admin costs low Benchmark costs against best in class performers Invest in resources and capacities to reduce costs

Advantages of being Low Cost Producer Provides defenses against the five competitive forces: Rivals > compete offensively on basis of price,defend against price war, win sales and market share, earn above average profits based on bigger profit margins or sales volume Buyers > partial profit margin protection from powerful customers Suppliers > protected from powerful producers if internal efficiency is source of cost advantage

Advantages of being Low Cost Producer Potential entrants > can use price cutting to make it harder for new rival to win customers, acts as a barrier to entry Substitutes > can use low price as a defense against substitutes

When to go for Low Cost Leadership Low cost price leadership should be used when: Price competition is a dominant competitive force Product is standardised,commodity type available from a variety of sellers There are few ways to achieve product differentiation Most buyers use the product in the same ways – price and not features becomes the dominant competitive force Low switching costs from one seller to another Buyers have significant power to bargain prices

The Drawbacks of Low Cost Producer Strategy Technological breakthroughs can open up cost reductions for rivals that nullify low previous low cost advantages Rival firms may find it easy or inexpensive to imitate leader’s low cost methods Too focused on driving down costs that fails to pick up on significant market changes- changing buyer preference, for added quality or service,shifts in how buyers use the product, declining buyer sensitivity to price.

Differentiation Strategy When buyer’s needs and preferences are too diverse to be satisfied by a standardised product Must study buyers’ needs and behavior carefully to learn what they consider important and valuable Competitive advantage results when buyers become strongly attached to the attributes of differentiator’s offering

Advantages of a Differentiating Strategy Successful differentiation allows a firm to: Command a premium price for its product Sell more units Gain greater buyer loyalty to its brand Provides a buffer against rival strategies as buyers become loyal to the brand and are willing to pay more for it Erects barriers to entry in the form of customer loyalty

Advantages of a Differentiating Strategy Provides defenses against the five competitive forces Mitigates bargaining power of large buyers Helps to fend off threats from substitutes The most appealing differentiation strategies are those who are least subject to quick or inexpensive imitation

Achieving Differentiation Anything a firm can do to create buyer value represents a potential basis for differentiation Differentiation can occur anywhere in the activity cost chain Approaches to a differentiating strategy: Taste Special Features Superior Service After sales service Prestige and Distinctiveness Reliability Technological leadership OB/Aug 09

Real Value,Perceived Value and Signals of Value Buyers will not pay for value they do not perceive even if extras are real Price premium must reflect value actually delivered as well as the value perceived by the buyer Actual and perceived value may differ when buyers have trouble assessing what their experience with the product will be Incomplete knowledge on the part of buyers causes them to judge value on signals such as price, packaging, ad campaigns, firm’s market share, length of time firm has been in business, professionalism of employees, seller’s list of customers

Signals of Value (cont) Such signals of value may be as important as actual value when: The nature of the differentiation is subjective or hard to quantify Buyers are making a first time purchase When repurchase is infrequent Buyers are unsophisticated

Achieving a Differentiation based Competitive Advantage Incorporate product attributes and user features that lower the buyer’s overall costs of using the company’s product Incorporate features that raise product performance Incorporate features that enhance buyer satisfaction in non-economic or intangible ways To deliver value to customers via competitive capabilities that rivals don’t have or can’t afford to match

Achieving a Differentiation based Competitive Advantage (cont) Extra price of product must outweigh the costs of achieving differentiation Buyers must value the additional features highly enough to buy the product in profitable quantities Incorporate differentiating features that are not costly but that add to customer satisfaction Sustainable differentiation usually has to be linked to core competencies, unique competitive capabilities and superior management of value chain activities that competitors cannot readily match or imitate

When a Differentiation Strategy Works Best Differentiation strategies work best where: There are many ways to differentiate the product or service and many buyers perceive these differences as having value Buyer needs and uses are diverse Few rival firms are following a similar differentiation approach Technological change is fast paced and competition revolves around rapidly evolving product features

The Risks of a Differentiating Strategy Pitfalls in pursuing differentiating strategy include: Trying to differentiate on the basis of something that does not enhance buyers’ well-being as perceived by the buyer Over-differentiate so that the product quality or service exceeds buyers’ needs Try to charge too high a price premium Tiny differences between rivals’ products offerings may not be visible or important enough to buyers A low cost strategy can defeat a differentiation strategy when buyers are satisfied with a basic product and don’t think extras are worth a higher price

Best Cost Provider Strategies Best cost provider strategies aim at giving customers more value for the money Deliver superior value to buyers by satisfying their expectations on key quality/service/features/performance attributes and beating their expectations on price Best cost strategies are hybrid strategies mid-ground between a low cost advantage and a differentiation advantage and the broad market and a narrow market niche The target market is value conscious buyers, a sizable part of the overall market

Achieving Best Cost Provider Strategies Best cost provider strategy is powerful where buyer diversity makes product differentiation the norm and where many buyers are also sensitive to price and value Can position near the middle of the market with a medium quality products at a below average price or A high quality product at an average price

Risks of a Best Cost Provider Strategy Unless a company has resources, know-how and capabilities to incorporate upscale attributes at a lower cost than rivals, this strategy is ill advised Company may be squeezed between the strategies of firms using low cost and differentiation strategies High end differentiators can steal customers with appeal of better products attributes – must achieve significantly lower costs in providing upscale features Low cost leaders may steal away customers with appeal of a lower price – must provide significantly better product attributes to justify price above low price leaders

Focused or Market Niche Strategies Concentrated attention on a narrow piece of the total market Target segment or niche can be defined by: Geographic uniqueness Specialised requirements in using the product Special product attributes that appeal to only relatively small numbers of buyers Examples: eBay : online auctions Porsche : sports cars Google: internet search engine

Focused Low-Cost Strategy Based on low cost securing a competitive advantage by serving buyers in niche target market at lower cost and lower price than rivals Strategy attractive a firm which can lower costs significantly by limited customer base to well defined buyer segment Avenues to achieving cost advantage over rivals in niche market are same as for low cost leadership Outmanage rivals in controlling factors that drive costs Reconfigure the firm’s value chain in ways that yield cost edge over rivals

Focused Low-Cost Strategy (cont) Examples: Generic items imitative of name brand merchandise e.g medicines, ink cartridge manufacturers Selling directly to retail chains wanting a basic house brand to sell to price-sensitive shoppers

A Focused Differentiation Strategy Based on differentiation aims at securing a competitive advantage by offering niche members a product they perceive as suited to their tastes and preferences Successful use of a focused differentiation strategy depends on: Existence of buyer segment that is looking for special product attributes or seller capabilities Firm’s ability to stand apart from rivals competing in the same target market niche

Achieving a Focused Differentiation Strategy Examples: Chanel, Gucci, Rolex, Rolls Royce Most markets contain a buyer segment willing to pay a price premium for the finest items available opening a window to pursue differentiation based focused strategy aimed at the very top of the pyramid

When is a Focused Low-Cost or Focused Differentiation Strategy is Attractive A focused strategy based either on low cost or differentiation becomes attractive when the following conditions are met: The target market niche is big enough to be profitable and offers good growth potential Industry leaders do not see that being present in the niche is crucial to their success It is costly or difficult to meet the specialised needs of the niche and mainstream customers at the same time The industry has many different niches and segments – less competition

When is a Focused Low-Cost or Focused Differentiation Strategy is Attractive (cont) Few if any other rivals are attempting to specialise in the same target segment – reducing the risk of segment overcrowding The focuser can compete effectively based on its capabilities and resources and goodwill to serve the targeted niche A focuser’s unique capabilities in serving a market niche can also act as an entry barrier as well as a hurdle for makers of substitute products Even if niche buyers may have substantial bargaining power, their power is reduced by having to shift to rival firms less capable of meeting their needs

The Risks of a Focused Low-Cost or Focused Differentiation Strategy Focusing also carries risks: Competitors may come up with ways to serve the niche market better than the focuser with more appealing offerings or by developing capabilities that offset the focuser’s strength There is potential for the preferences and needs of the niche members to shift over time toward the product attributes desired by the majority of buyers

The Risks of a Focused Low-Cost or Focused Differentiation Strategy (cont) Erosion of differences over buyer segments lowers the barriers to entry into the focuser’s niche and rivals in adjacent segments can start to compete for the focuser’s customers The segment can be so attractive that it is flooded with competitors, intensifying rivalry and diminishing segment profits

5 Generic Strategies: A Summary Each of the 5 generic competitive strategies positions the company differently in its market and competitive environment Each creates a central theme of how company will try to outcompete rivals Each provides boundaries and guidelines for maneuvering Each entails differences in product line,production, marketing and sustaining the strategy, affects how the business operated and manner in which value chain activities are managed

5 Generic Strategies: A Summary (cont) Deciding which generic strategy to employ is perhaps the most important strategic commitment a company makes- it tends to drive the rest of the strategic actions of the company Compromise or middle ground strategies rarely produce sustainable competitive advantage or a distinctive competitive position except for a well executed best cost producer strategy Companies with compromise strategies end up with a middle of the pack industry ranking - having a competitive edge over rivals is the most dependable contributor to above average profitability and industry leadership