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Introducing Competitive StrategyEcon 466Spring, 2010

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Concepts and vocabulary in strategyCompetition is a driving force in market economies• How do firms compete?• What determines a firm’s competitive strategy?• How is strategy related to firm performance and

success?• Use competitive strategy as a way to discuss

Financial managementFinancial intermediationMarket for financial services

Based on Besanko et.al. Chapters 6,10,11,12,13

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US Total Farm Debt Market Share by Lender1961 to 2008

Comm. Banks FCS FSA Life Ins. Cos. Ind & Others CCC Loans

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Competitive advantage• The ability of the firm to outperform its industry –

to earn a higher rate of return than the industry norm

• A competitive advantage is “sustainable” if superior performance persists despite the actions of competitors

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How does a firm create a sustainable competitive advantage?

• By creating more value than its competitors.

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Created value• The difference between the perceived or

determined value of a finished good, service or input• And the value that is sacrificed to produce it

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Framework for competitive advantage

Benefit positionrelative to competitors

Market Conditions

Cost position relativeto competitors

Value added Profitability

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Industry and business unit effects in explaining productivity

43%

24%19%

4%

32%

Effect

UnexplainedYearIndustryParentBusiness Unit

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How does the firm create value?

• Michael Porter’s value chain

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SKETCH OUT A VALUE CHAIN#2 YELLOW CORNAGRICULTURAL LENDING

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How does the firm create value?

• Michael Porter’s value chain• Firm-specific assets

Resources (Have)Capabilities (Do)

• Change the value chain (business model)• Improve the value chain

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Examples of firm-specific assets• Resources

Patents or trademarksBrand name reputationOrganizational culture

• CapabilitiesWorker’s expertise and knowhowOperational processesRecruit and reward employees

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EXAMPLES OF FIRM-SPECIFIC RESOURCES, FARMING AND LENDING

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Generic value creation strategies

Cost Advantage• maintain B and reduce C

Benefit Advantage• maintain C and increase B

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Concepts and terms we havemastered, thus far ….

• Competitive advantage• Value creation• Value chain• Firm-specific assets

ResourcesCapabilities

• Cost advantage• Benefit advantage• Value map

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Cost advantage is best if:• Economies of scale or learning exist – but rival

firms are not exploiting them• Product or service does not lend itself to benefit

enhancement• Consumers are very price sensitive• Search good

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Benefit advantage is best if:• Consumer is value conscious• Most economies of scale or learning have been

exploited• Experience good

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SKETCH OUT AN EXAMPLE OF A COST LEADERSHIP STRATEGY THAT COULD BE PURSUED BY A FARM BUSINESS

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NOW TRY A BENEFIT LEADERSHIP STRATEGY –AGAIN FOR A FARM BUSINESS

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Firm-level price elasticity of demand

• Assumes imperfect competition• Differentiated products or services• Incorporates perceived behavior of rivals• Percent change in demand resulting from a

percent change in the firm’s price

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Vertical differentiation• Attributes of a product that makes it clearly

superior to those of competitors• Examples?

AttributesProducts or services

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Horizontal differentiation• Attributes of a product or service that are valued

by some consumers and not by others• Examples?

AttributesProducts or services

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Horizontal differentiation and firm-level price elasticity of demand

Weak horizontal differentiation• High elasticity of demand

Strong horizontal differentiation• Low elasticity of demand

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LIST SOME EXAMPLES OF AGRICULTURAL PRODUCTS WITH WEAK AND STRONG HORIZONTAL DIFFERENTIATION

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Pricing strategy and horizontal differentiation

• Margin strategyWiden margin

• Share strategyIncrease market share

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Pricing strategy and horizontal differentiation

Horizontal Differentiation

Cost Advantage Benefit Advantage

Weak(High price elasticity)

ShareUnderprice competitors to gain share

ShareMaintain price parity, gain share

Strong(Low price elasticity)

MarginMaintain price parity

MarginCharge price premium

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So … who is my competitor?Substitute products or services?

Product performance characteristicsOccasions for useGeographic market

• Empirically measure cross-price elasticity of demand

∂Qy/∂Px (Px/Qy )> 0?

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HOW IMPORTANT IS GEOGRAPHY IN FINANCIAL SERVICES MARKETS?

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And how will the industry impact the competitive strategy of the firm?

• Michael Porter (again) and his Five Forces Analysis framework

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Concepts and terms we havemastered

• Competitive advantage• Value creation• Value chain• Firm-specific assets

ResourcesCapabilities

• Cost advantage• Benefit advantage• Value map

• Cost leadership• Benefit leadership• Firm-level demand elasticity• Vertical differentiation• Horizontal differentiation• Search good• Experience good• Margin strategy• Share strategy• Five-Forces analysis

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NOW LETS TRY THEM OUT!OK