FOUNDATIONS OF STRATEGY

T E A M 5

A N D R E A BR A N D T

V A N E S S A GO M E Z

R A C H E L E RE A G A N

A L L I SO N S

C H M I DT

Chapter 4: The Nature & Sources of Competitive Advantage

COMPETITIVE ADVANTAGE• Competitive advantage- when 2 or more firms compete within the

same market, one firms posses a competitive advantage over its rival when it earns or has the potential to earn a persistently higher rate of profit

• However, competitive advantage doesn’t always mean superior profit; so firms forgo current profit in favor of investment in market share, technology, customer loyalty or other endeavors

• In the long run, competition eliminates differences in profitability between competing firms but external and internal changes can create short-term opportunities for creating an advantage

TOP CARBONATED SOFT DRINK BRANDS BY MARKET SHARE (2011)

1)Coke• 17%• Coca-Cola

2)Diet Coke• 9.6%• Coca-Cola

3)Pepsi Cola• 9.2%• PepsiCo

4)Mountain Dew• 6.7%• PepsiCo

5)Dr. Pepper• 6.4%• Dr. Pepper Snapple

6)Sprite• 5.7%• Coca-Cola

EXTERNAL SOURCES OF CHANGE• For an external change to create competitive advantage the change

must have differential effects on companies because of their different resources and capabilities or strategic positioning

• The extent to which external changes create competitive advantage and disadvantage depends on the magnitude of the change and the extent of firms’ strategic differences

How does competitive advantage emerge?

External sources of change:-changing customer demand-Changing prices-Technological change

Resources heterogeneity among firms means differential impact

Some firms faster and more effective

in exploiting change

Internal sources of

change

Some firms have greater creative and innovative

capability

RESPONSIVENESS TO CHANGE• 2 Key Capabilities of Responsiveness:• Ability to anticipate changes• Speed at which you adjust to those changes (time-based

competition)• Information• Rely on customers, suppliers and even competitors for

that information• Short Cycle Times• Allow information on emerging markets to be acted on

quickly• Important in the fashion industry (who puts out trending

designs out first)

INTERNAL CHANGES THROUGH INNOVATION

• Innovation can create competitive advantage but also provide a basis for overturning the competitive advantage of other firms

• Strategic Innovation (new game strategy) - new approaches to doing business including business models• Creating new value for customers from novel products, experiences

or modes of product delivery: • Toys-R-Us: big-box store with a variety of toys• Nordstrom: augmented customer service• Sephora: atypical approaches to display and store layout

• Redesigned processes and novel organizational designs• Apple combining an MP3 player with its iTunes store• SWA no frills service, single plane type and non-union employees

SHAPING INNOVATIVE STRATEGIES• New Industries• Launching products that creates a whole new industry• Purest form of blue ocean strategy• Xerox created plain-paper copier industry

• New Customer Segments• Creating new customer segments for existing product

concepts• Apple didn’t invent the personal computer but launched

the market for computers in the home• New Sources of Competitive Advantage• Introducing novel approaches to creating customer

value• Coca-Cola introduced the freestyle fountain dispenser

which provides a selection of 125 varieties of Coca-Cola products in a self-serve format

SUSTAINING COMPETITIVE ADVANTAGE• Competitors undermine another firms competitive advantage by either

innovation or imitation• Imitation is the most direct form of competition therefore barriers are

needed to guard against it• Isolating mechanisms- barriers that protects a firms profits from being

driven down by the competitive process• For successful imitation a firm must meet these four conditions:• Identification- identify that a rival possesses a competitive advantage• Incentive- believe that investing in imitation can earn superior returns• Diagnosis- be able to diagnosis the features of its rival’s strategy that

gives it competitive advantage• Resource Acquisition- acquire through transfer or replication the

resources and capabilities needed for imitation

4 CONDITIONS & THEIR ISOLATING MECHANISMS

IDENTIFICATION• Obscure the firm’s superior profitability

• Much easier for private as opposed to public firms• Pedigree Petfoods (Mars Inc.) was able to accomplish this until the

UK Monopolies Commission revealed that Pedigree earned a return on capital of 47%

INCENTIVE• Firms may be able to undermine the incentive for other firms

to imitate through deterrence and preemption• Deterrence- signaling aggressive intentions to imitators• NutraSweet’s aggressive price war against the Holland

Sweetener Company may have deterred other potential entrants

• Preemption- exploiting all available investment opportunities• Proliferation of product varieties• Large investments in production capacity ahead of the

growth of market demand• Patent proliferation

DIAGNOSIS• In order to imitate, a firm must understand the basis of its rivals

success• The problem lies in the identification of the link from superior

performance to the decisions that generate that performance• Causal ambiguity- the more complex a firm’s competitive advantage

and the more it is based on complex bundles of capabilities, the more difficult it is to diagnose the reasons behind its success

• Uncertain imitability- with ambiguity associated with the causes of success, attempts at imitation are subject to uncertain success

• Recent research suggests that the complex combinations of resources and capabilities may make imitation nearly impossible

• Another issue is the idea that some practices may be generically beneficial for a firm to put into place while other practices are only successful when combined with other practices

RESOURCE ACQUISITION• Now firms face the challenge of assembling the resources

and capabilities of the advantaged firm• To guard against imitators, firms can base its competitive

advantage around resources and capabilities that are immobile and difficult to replicate

• On the other hand competitive advantage not requiring complex, firm-specific resources are often imitated quickly

• This all depends on the extent to which first-mover advantage plays a role in the market• First-mover advantage- the idea that the first firm to

occupy a strategic position gains access to resources and capabilities that cannot be matched

TYPES OF COMPETITIVE ADVANTAGE• Firms can achieve or potentially achieve a higher rate of

profit over a rival in one of two ways:• Cost Advantage- supply an identical product or service at a

lower cost• Differentiation Advantage- supply a product or service that

is unique in such a way that customers are willing to pay a price premium

• These two sources of competitive advantage are radically different in terms of company strategy – opposite ends of the spectrum

Cost Differentiation

COST VS. DIFFERENTIATION ADVANTAGE

EXAMPLES OF COST VS. DIFFERENTIATION

Cost:• Walmart• McDonalds• Ikea• Southwest Airlines

Differentiation• Apple• Mercedes and BMW• Bose• Nike

COST ADVANTAGE• There are seven determinants of a firms unit cost or cost per unit of

output (cost drivers)• These determinants vary across industries, firms, and across

different activities within a firm• By analyzing these different cost drivers, firms can:• Analyze its cost position in relation to it competitors and diagnose

the sources of inefficiency• Make recommendations on how to improve its cost efficiency

COST DRIVERSEconomies of Scale

Economies of Learning

Production Techniques

Product Design

Input Costs

Capacity Utilization

Residual Efficiency

-Technical input-output relationships-Indivisibility-Specializations

-Increased individual skills-Improved organizational routines-Process innovation-Re-engineering of business processes-Standardization of designs & components-Design for manufacture-Location advantages-Ownership of low-cost inputs-Nonunion labor-Bargaining power

-Ratio of fixed to variable costs-Fast and flexible capacity adjustment-Organizational slack/X-inefficiency-Motivation and organizational culture-Managerial effectiveness

VALUE CHAIN ANALYSIS• A value chain analysis is an effective way to conduct this

examination because it requires identifying:• Relative importance to total cost• Cost drivers for each activity• Efficiency of each activity• Comparison of costs to each other• Whether to outsource or not

• A value chain analysis involves 6 steps in which a firm:• Breaks itself down into separate activities• Establishes the importance of each activity in the total cost of the

product• Compares costs by activity• Identifies cost drivers for each activity• Identifies linkages between activities• Identifies opportunities for reducing costs

STAGES OF VALUE CHAIN ANALYSIS FOR COST ADVANTAGE1. Break down the firm into separate activities- this requires the

knowledge of the chain of processes involved in the transformation of inputs to outputs and can usually be guided by a firms divisional and departmental structure

2. Establish the relative importance of different activities in the total cost of the product- to identify which activities are major sources of cost so we can ultimately assign costs and assets to each activity

3. Compare costs by activity- to establish which activities are performed with relative efficiency and those do not, then benchmark those costs against those of competitors

STAGES OF VALUE CHAIN ANALYSIS FOR COST ADVANTAGE4. Identify cost drivers for each activity- taking into consideration

if the activity is capital intensive (machine depreciation and maintenance, output of machine) or labor intensive (wage rates, speed of work, defect rates)

5. Identify linkages between activities- because the costs of some activities may be effected by the performance of other activities

6. Identify opportunities for reducing costs- after performing the first 5 steps, opportunities for cost reduction become more evident

Is outsourcing possible for inefficient activities? Can wages be reduced directly or from relocation of services?

(Input costs) Would better training create a more efficient and effective worker?

(Economies of learning)

DIFFERENTIATION ADVANTAGE• Occurs when a firm is able to obtain from its differentiation a price

premium in the market that exceeds the cost of providing the differentiation

• Opportunities differ from market to market and product to product• Products that lack physical differentiation (commodities) can still

create customer value where others have not• Critical issue of differentiation advantage: the firm must make sure

its differentiation creates value for customers and that the value exceeds the cost of the differentiation

• We can also use the value chain analysis to discover opportunities for differentiation advantage

STAGES OF VALUE CHAIN ANALYSIS FOR DIFFERENTIATION ADVANTAGE

1. Construct a value chain for the firm and the customer- values chains for the firm, immediate customers and firms or customer further down the value chain can be useful. Also create separate value chains for the main categories of customers because they may have different needs.

2. Identify the drivers of uniqueness in each activity- analyze each separate activity to discover its individual variables and actions that can be taken to achieve uniqueness.

DIFFERENTIATION ADVANTAGE

Support Acti

vities

Primary

Activit

ies

3. Select the most promising differentiation variables for the firm- on the supply side there are 3 important considerations Analyze strengths and capabilities to establish the greatest

potential for differentiating or lower cost differentiating than rivals

Identify linkages among activities because if those interactions aren’t flowing well, product reliability can be compromised

Considering the ease of sustaining uniqueness or differentiation- the more specific the resources are to the firm or complex coordination of the differentiation, the more difficult imitation will be for competitors

4. Locate linkages between the value chain of the firm and that of the buyer- to create value for its customers, firms must locate the linkages between differentiation of it own activities and cost reduction and differentiation within the customers

STAGES OF VALUE CHAIN ANALYSIS FOR DIFFERENTIATION ADVANTAGE

PORTER’S GENERIC STRATEGIES

Differentiation

Cost Leadership

FocusSingle Segment

Industry-wide

Low Cost Differentiation

Competitive Scope

Source of Competitive Advantage

• Porter believes that cost leadership and differentiation are mutually exclusive and a firm that tries to focus on both is almost guaranteed low profitability

• Ultimately, a firm needs to decide on pursuing either cost or differentiation advantage and then decide on its market scope, industry wide (broad market) or single segment (narrow market)