Sources of Competitive Advantage The Competitive Advantage of Nations by Michael E. Porter INB410 Lecture by Ms. Adina Malik

Learning Objectives Strategy, Value Creation & Competitive Advantage The Value Chain Value Chain, Linkages and Coordination The Value Chain and Cost Advantage The Value Chain and Differentiation The Value System

Competitive Advantage Competitive advantage grows out of the way firms organize and perform discrete activities. The operations of any firm can be divided into a series of activities such as salespeople making sales calls, service technicians performing repairs, scientists in the laboratory designing products or processes, and treasurers raising capital. Firms create value for their buyers through performing these activities.

Value Creation & Competitive Advantage The ultimate value a firm creates is measured by the amount buyers a willing to pay for its product or service. A firm is profitable if this value exceeds the collective cost of performing all the required activities.

Value Creation & Competitive Advantage To gain competitive advantage over its rivals, a firm must either provide comparable buyer value but perform activities more efficiently than its competitors (lower cost), or perform activities in a unique way that creates greater buyer value and commands a premium price (differentiation).

The Value Chain Every activity employs purchased inputs, human resources, some combination of technologies, and draws on firm infrastructure such as general management and finance. Every activity employs purchased inputs, human resources, some combination of technologies, and draws on firm infrastructure such as general management and finance.

Strategy, Value Creation & Competitive Advantage Strategy guides the way a firm performs individual activities and organizes its entire value chain. Activities vary in their importance to competitive advantage in different industries.

In detergents, advertising is crucial while manufacturing is uncomplicated and after-sale service is next to nonexistent. In printing presses; technology development, assembly (part of operations), and after-sale service are essential to success.

Strategy, Value Creation & Competitive Advantage Firms gain competitive advantage from conceiving of new ways to conduct activities, employing new procedures, new technologies or different inputs. Swiss chocolate companies rose to prominence by pioneering new product formulations (among them milk chocolate) and the use of new processing methods such as continuous stirring that substantially improved product quality.

Value Chain and Linkages A firm’s value chain is an interdependent system or network of activities, connected by linkages. Linkages occur when the way in which one activity is performed affects the cost or effectiveness of other activities. Linkages often create trade-offs in performing different activities that must be optimized.

Value Chain and Linkages For example, a more costly product design, more expensive components, and more thorough inspection can reduce after-sale service costs. A company must resolve such trade-offs, in accordance with its strategy, to achieve competitive advantage.

Value Chain, Linkages and Coordination Linkages also require activities to be coordinated. On-time delivery requires that operations, outbound logistics, and service activities such as installation should function smoothly together. Good coordination allows on-time delivery without the need for costly inventory. Coordinating linked activities reduces transaction costs, allows better information for control purposes, reduces the combined time required to perform activities; increasingly important to competitive advantage.

Value Chain, Linkages and Coordination Careful management of linkages can be a decisive source of competitive advantage. Japanese firms have been particularly adept at managing linkages; they popularized such practices as overlapping the steps in the new product development process to improve ease of manufacturing and reduce development time, as well as more careful inspection to reduce after-sale service costs. Gaining competitive advantage requires that a firm’s value chain is managed as a system rather than a collection of separate parts.

The Value Chain and Cost Advantage The value chain provides a tool for understanding the sources of cost advantage. A firm’s cost position is it’s collective cost of performing all the required activities relative to competitors, and cost advantage can occur in any activity. Successful cost leaders, however, are often also low-cost product developers, low-cost marketers, and low-cost service providers. They draw cost advantage from throughout the value chain. Gaining cost advantage also usually requires optimizing the linkages among activities as well as close coordination with suppliers and channels.

The Value Chain and Differentiation The value chain also exposes the sources of differentiation. A firm creates value for its buyer (and hence meaningful differentiation) if it lowers its buyer’s cost or raises the buyer’s performance in ways the buyer cannot match by purchasing from competitors. Differentiation results, fundamentally, from the way a firm’s product, associated services, and other activities affect its buyer’s activities.

Coca-Cola System and Value Chain

The Value System A company’s value chain for competing in a particular industry is embedded in a larger stream of activities known as the ‘value system’. The value system includes suppliers, who provide inputs (raw materials, components, machinery, and purchased services) to the firm’s value chain. On its way to the ultimate buyer, a firm’s product often passes through the value chain’s of distribution channels. Ultimately, products become purchased inputs to the value chains of their buyers, who use the products to perform activities of their own.