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Chapter 6 Business-Level Strategy

Learning Objectives After reading this chapter, you should have a good understanding of:   The central role of competitive advantage in the study of strategic management.   The three generic strategies: overall cost leadership, differentiation, and focus.   How the successful attainment of generic strategies can improve a firm’s relative power vis-à-vis the five forces that determine an industry’s average profitability.   The pitfalls managers must avoid in striving to attain generic strategies.   How firms can effectively combine the generic strategies of overall cost leadership and differentiation. 6-3

Question Which of the following is not one of the three generic strategies, according to Michael Porter, to overcome the five forces and achieve competitive advantage? a)Overall cost leadership b)Differentiation c)Focus d)Integration 6-4

Types of Competitive Advantage and Sustainability   Three generic strategies 1. 1.Overall cost leadership Low-cost-position relative to a firm’s peers Manage relationships throughout the entire value chain 6-5

Types of Competitive Advantage and Sustainability 2. 2.Differentiation Create products and/or services that are unique and valued Non-price attributes for which customers will pay a premium 3. 3.Focus strategy Narrow product lines, buyer segments, or targeted geographic markets Attain advantages either through differentiation or cost leadership 6-6

Three Generic Strategies 6-7

Example 1. 1.Companies pursuing an overall cost leadership strategy   McDonalds   Wal-Mart 2. 2.Companies pursuing a differentiation strategy   Harley Davison   Apple 3. 3.Companies pursuing a focus strategy   Rolex   Lamborghini 6-8

Overall Cost Leadership   Integrated tactics   Aggressive construction of efficient-scale facilities   Vigorous pursuit of cost reductions from experience   Tight cost and overhead control   Avoidance of marginal customer accounts   Cost minimization in all activities in the firm’s value chain, such as R&D, service, sales force, and advertising 6-9

Overall Cost Leadership   Experience Curve   How business “learns” to lower costs as it gains experience with production processes   With experience, unit costs of production decline as output increases in most industries 6-10

6-11 Experience Curve Effects Exhibit 5.4 Comparing Experience Curve Effects

6-12 Learning Organizations Defined: An organization skilled at creating, acquiring, and transferring knowledge and at modifying its behavior to reflect new knowledge and insights.

Overall Cost Leadership   A firm following an overall cost leadership position:   Must attain competitive parity on the basis of differentiation relative to competitors   Competitive parity on the basis of differentiation Permits a cost leader to translate cost advantages directly into higher profits than competitors Allows firm to earn above-average profits 6-13

Overall Cost Leadership: Improving Competitive Position vis-à-vis the Five Forces   An overall low-cost position   Protects a firm against rivalry from competitors   Protects a firm against powerful buyers   Provides more flexibility to cope with demands from powerful suppliers for input cost increases   Provides substantial entry barriers from economies of scale and cost advantages   Puts the firm in a favorable position with respect to substitute products 6-14

Pitfalls of Overall Cost Leadership Strategies   Too much focus on one or a few value-chain activities   Too often managers make big cuts in operating expenses, but don’t question year-to-year spending on capital projects   Should explore all value-chain activities as candidates for cost reductions   All rivals share a common input or raw material   Vulnerable to price increases 6-15

  Strategy is imitated too easily   A lack of parity on differentiation   To attain advantage, must obtain level of differentiation   Can be achieved by reputation, quality, through signaling mechanisms   Erosion of cost advantages when the pricing information available to customers increases Pitfalls of Overall Cost Leadership Strategies 6-16

Question Explain how Wal-Mart and McDonald’s follow the overall cost leadership strategy. 6-17

Differentiation   Differentiation can take many forms   Prestige or brand image   Technology   Innovation   Features   Customer service   Dealer network 6-18

Differentiation   Firms may differentiate along several dimensions at once   Firms achieve and sustain differentiation and above-average profits when price premiums exceed extra costs of being unique   Requires integration with all parts of a firm’s value chain   Important aspect is speed or quick response 6-19

Differentiation: Improving Competitive Position vis-à-vis the Five Forces   Differentiation   Avoids need for low-cost position by increasing a firm’s margins   Creates higher entry barriers due to customer loyalty and uniqueness in its products or services   Provides higher margins that enable the firm to deal with supplier power 6-20

Differentiation: Improving Competitive Position vis-à-vis the Five Forces   Differentiation   Reduces buyer power because buyers lack suitable alternative   Reduces supplier power due to prestige associated with supplying to highly differentiated products   Establishes customer loyalty and hence less threat from substitutes 6-21

Question There are potential pitfalls of all strategies. Which of the following is not a potential pitfall of a differentiation strategy? a)Too high a price premium b)Differentiation that is easily irritated c)Too little differentiation d)Dilution of brand identification through product-line extensions 6-22

Potential Pitfalls of Differentiation Strategies   Uniqueness that is not valuable   Must be unique and possess high customer value   Too much differentiation   Firms may strive for too much quality   Too high a price premium   Customers may desire product, but repelled by price 6-23

Potential Pitfalls of Differentiation Strategies   Differentiation that is easily imitated   Dilution of brand identification through product- line extensions   Increase short-term revenues, detrimental in long run   Perceptions of differentiation may vary between buyers and sellers   “Beauty is in the eye of the beholder” 6-24

Example: Differentiate Or Die   In one-year period, 1,600 headlines that used the word "differentiate" or "differentiation."   In the construction world: "Tile Roofs Add Value, Differentiate Builders“, "Differentiate to Stand Out from your Competition"   In automobiles: "Dodge Nitro SUV: Company Figures Out How to Differentiate Its Model in a Crowded Field“   In Internet businesses: "Differentiation Can Be Brutal in the Web Search Business"

Focus   Focus is based on the choice of a narrow competitive scope within an industry   Firm selects a segment or group of segments (niche) and tailors its strategy to serve them   Firm achieves competitive advantages by dedicating itself to these segments exclusively 6-26

Focus   Two variants   Cost focus Strives to create a cost advantage in its target segment   Differentiation focus Seeks differentiate in target market   Both rely on providing better service than broad-based competitors who are trying to serve the focuser’s target segment 6-27

Focus: Improving Competitive Position vis-à-vis the Five Forces   Focus   Creates barriers of either cost leadership or differentiation, or both   Used to select niches that are least vulnerable to substitutes or where competitors are weakest 6-28

Pitfalls of Focus Strategies   Erosion of cost advantages within the narrow segment   Focused products and services still subject to competition from new entrants and from imitation   Focusers can become too focused to satisfy buyer needs 6-29

Example: Expensive Golf Gear   "For as long as golf has been played, golfers have been trying to buy a better game," says Steve Pike   Designer business with highest-end equipment from manufacturers such as Callaway, TaylorMade, and Titleist   Showing up with top-notch gear is like bringing a platinum-covered bazooka to a knife fight   Consumers think the higher the price, the better the equipment

Question The goal of a combination strategy is to: a) Provide unique value b) Duplicate competitors products c) Lower costs by using a substitute d) Develop a new product line 6-31

Combination Strategies: Integrating Overall Low Cost and Differentiation   Primary benefit of successful integration of low- cost and differentiation strategies is difficulty it poses for competitors to duplicate or imitate strategy   Goal of combination strategy is to provide unique value in an efficient manner 6-32

Combination Strategies: Integrating Overall Low Cost and Differentiation   Two types of value to customers   Differentiated attributes High quality Brand identification Reputation   Lower prices 6-33

Three Combination Approaches   Automated and flexible manufacturing systems   Firms are able to manufacture unique products, in small quantities, with lower prices Known as “Mass Customization” Technology advances in CAD/CAM 6-34

Three Combination Approaches   Exploiting the profit pool concept for competitive advantage   Profit pool is the total profits in an industry at all points along the industry’s value-chain   Structure can be complex   Pattern of profit is different from pattern of revenue generation 6-35

The U.S. Automobile Industry’s Profit Pool 6-36

Three Combination Approaches   Coordinating the “extended” value chain by way of information technology   Integrate activities throughout the “extended value chain”   Enables a firm to add value for its own value- creating activities and its customers and suppliers 6-37

Combination Strategies: Improving Competitive Position vis-à-vis the Five Forces   Obtain advantages of competition from both approaches   High entry barriers   Bargaining power over suppliers   Reduces power of buyers (fewer competitors)   Value position reduces threat from substitute products   Reduces the possibility of head-to-head rivalry 6-38

Pitfalls of Combination Strategies   Firms that fail to attain both strategies may end up with neither and become “stuck in the middle”   Underestimating the challenges and expenses associated with coordinating value-creating activities in the extended value chain   Miscalculating sources of revenue and profit pools in the firm’s industry 6-39