Chapter 6

STRATEGIES FOR COMPETITIVE ADVANTAGE

The Nature of Competitive Advantage

What is competitive advantage?

Competitive advantage is the reason a purchase is actually made at a profitable price and that one supplier is chosen over the other various alternatives.

Competitive advantage occurs at the intersection of two distinct sets of forces:

External: customers, industry environment, macro, etc.Internal: firm capabilities and resources

Focusing on Transactions

“Transactions represent key linking pins between goals and objectives, the competitive environment, a firm’s resources and capabilities, and a firm’s performance.”

Customer decisions reflect their own individual values and judgments, influenced by the variety of options available.

As a result, what appears to be an advantage on paper can often fail to translate into an advantage in the marketplace.

Focusing on Transactions

Determined by the Customer

A Reflection of Context

Episodic

Determined by the Customer

Customers determine value based on:Attributes that are valuable, rare, inimitable, and

difficult to substitute.

The challenge is that customer tastes vary and change; so creating value for them is like hitting a moving target.

Competitive advantage then is an ongoing pursuit of trial and error, learning, and adaptation, where customers are ultimately the arbiters of success.

A Reflection of Context

Customers reveal their judgments about value and competitive advantage through their purchasing decisions.

These purchasing decisions reflect the conditions in which they take place.Changes exogenous to buyers/sellers—

conditions changed outside of the buyer-seller relationshipTechnological change

Episodic

Competitive advantage occurs in particular instances, when particular products and services are valued and scarce, with no immediate or acceptable substitutes, in the eyes of customers.

Changes in any of the conditions have the potential to change the nature of the competitive advantage.

So, no competitive advantage is completely safe or completely insurmountable.

Focusing on TransactionsDemand Curves

Mathematical functions used to illustrate the relationship between consumption and price

Shift periodically based on:Changes in disposable incomeChanges in expectationChanges in tastes and preferencesChanges in the prices of related goods

(complementary and substitute goods)Changes in demographics (e.g. population size,

composition, etc.)

Types of Competitive Advantage

Focus

Differentiation Low Cost

In his 1980 work, Porter argued for three types of competitive advantage.

Types of Competitive Advantage

Porter’s Generic Strategies

Competitive Advantage

Cost Uniqueness

Scope of Operatio

ns

Broad Target

Low Cost Differentiation

Narrow Target

Focused Low CostFocused

Differentiation

Better represented as…

Types of Competitive Advantage

More commonly known as “Porter’s generic strategies”

Customers, acting rationally and to the best of their ability, seek the best value in relation to their own interests (BIG ASSUMPTION)

The best value offers the greatest level of consumer surplus.

Consumer surplus reflects:Use valueTransaction cost / price

Differentiation

Focuses on high use value.

High use value increases the desirability of the product or service, even when the price is high.

Differentiation leverages inelastic demand.

Consider, for example, Nordstroms or Market Street.

Low Cost

Focuses on lowering the costs to the buyer.

Lower costs increase the desirability of the product or service, even when use value is identical to or lower than other products of services.

Low cost then leverages elastic demand.

Consider, for example, Wal-Mart or Chevrolet.

Focused DifferentiationRequires offering unique features that fulfill the

demand requirements of a narrow market

Some focused differentiators focus on a particular sales channel (e.g. internet only)

Others target a limited demographic group (e.g. Sandals resorts—couples only, no kids)

Consider, for example, Natural Grocer or Land Rover

Focused Low CostRequires competing based on price to a

narrow target market

Charges lower prices relative to other firms in that target market

Consider, for example, RedBox or Papa Murphy’s Pizza

Differentiation, Low Cost, and Performance

Generic strategies are equifinal

Each of the generic strategies can lead to competitive advantage and financial success.

Because of various operational differences in these two strategies, each will produce different patterns of financial success.

Differentiation, Low Cost, and Performance

Consider the following:

Nordstrom Target

(sales) 551,339 / 7,722,860 (profit) = .071 (profit margin)

(sales) 2,408 / 51,271 (profit) = .047 (profit margin)

Store profit per square foot = $369

Store profit per square foot = $307

SGA % of sales = 27.2% SGA % of sales = 21.8%

Inventory turnaround = 4.84 Inventory turnaround = 5.98

(sq. ft) 132,039 x 187 (stores) = 2,4691,293

(sq. ft.) 127,000 x 1300 (stores) = 65,100,000

Final Thoughts & Caveats

Monopoly, Limits to Competition, and Competitive AdvantageStrategic management can be seen as a process of

cultivating small, pseudo-monopolies.

Even monopoly profits are limited by the resource constraints of the buyers but profits are certainly easier to achieve and sustain.

Strategic management can be viewed as a process where firms seek to attract customers and to limit competition, in effect creating for themselves monopoly-like conditions.

Final Thoughts & Caveats

Monopoly, Limits to Competition, and Competitive Advantage

Gain a measure of power over elastic consumers by limiting the range of options that consumers can consider. That power then yields above market prices and margins.

Gain a measure of power by making consumers less elastic, thereby limiting the options that they will consider. This monopoly power yields above market prices and margins because customers see higher use value in the particular brand of the specific providers.

Final Thoughts & Caveats

Stuck in the Middle Remember that all competition is local.

Simply because a firm is not the lowest cost provider anywhere does not mean that it cannot be the lowest cost provider for some groups of customers.

Because a firm is not the most differentiated among all providers does not mean that it is not the most differentiated for some groups of customers.

Final Thoughts & Caveats

Stuck in the Middle It can be helpful to think of these two

strategies as combinations of two basic types of effort. Such a combination is best represented by the concept of a production possibilities frontier.

Final Thoughts & Caveats

The Dynamic Capabilities PerspectiveCompetitive advantage is not static.Firms can acquire competitive advantage and

then lose it, even though industry conditions remain attractive.

Maintaining competitive advantage requires managing a dynamic process, where demand is constantly shifting and adapting, where competitors are moving into and out of the market, imitating one another and innovating themselves, and creating and refining new alternatives from which customers can choose.

Final Thoughts & Caveats

The Dynamic Capabilities Perspective

What can we learn from the example of Home Depot and Lowe’s?

What could either firm do differently?