0 Chapter Five Crafting Business Strategy

1 OBJECTIVES Define generic strategies and show how they relate to a firm’s strategic position 1 Describe the drivers of low-cost, differentiation, and focus strategic positions 2 Identify and explain the risks associated with each generic strategy position 3 Show how different positions fit with various stages of the industry life cycle 4 Evaluate the quality of the firm’s strategy 5

2 THE RACE TO THE FUTURE IS ON Companies can be classified as: Drivers Passengers Road Kill Which will get to the future first?

3 STRATEGIC POSITIONING SHOULD IMPROVE PROFITABILITY Where managers of a company situate that company relative to it’s rivals along important competitive dimensions Definition Purpose To reduce the effects of rivalry and thereby improve profitability

4 No advantage over rivals Advantage over rivals Low-cost Differentiation Description Produce an essentially equivalent product at a lower cost Produce a differentiated product and charge suffici- ently higher prices to more than off-set the added costs of differentiation A FIRM CAN GAIN ADVANTAGE OVER RIVALS IN TWO WAYS

5 Adapted from Porter, M Competitive strategy, Low-costDifferentiation Strategic advantage Strategic target Narrow (i.e., particular segment only) Broad (i.e., industry wide) Broad differentiation Focused cost leadership Focused differentiation Broad low-cost leadership THE STRATEGIC POSITIONING MODEL

6 LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET SHARE AND/OR PROFITS Examples Benefits Low-cost leadershipDifferentiation Pacific Cycle Gallo Wines Wal-Mart Southwest Airlines Home Depot Trek Bicycles Coca-Cola and Pepsi Mercedez Benz Honda, Yamaha, and Suzuki motorcycles Stouffers (frozen foods) Capture market share by offering lower-price or Earn higher by maintaining price parity Capture market share by offering higher quality at same price or Earn higher margins by raising prices over competitors

7 Low-costDifferentiation Strategic advantage Strategic target Narrow Broad Trek Bicycles Coca-cola Jet Blue Montague Mercedes Benz (in US) Wal-Mart Gallo Wines STRATEGIC POSITIONING EXAMPLES

8 KEY DRIVERS OF COST ADVANTAGE Economies of scale Learning Product technology Product design Location advantages for sourcing inputs

9 ECONOMIES OF SCALE Economies of scale Learning Economies of scope Production technology Product design Location Economies of scale exist during a period of time if the average total cost for a unit of production is lower at higher levels of output You must review cost to assess whether economies of scale exist: –Fixed costs remain the same for different levels of production –Variable costs are the costs of variable inputs (such as raw materials and labor) and vary directly with output –Marginal cost is the cost of the last unit of production –Total cost is the sum of all production costs and always increases as output goes up –Average cost is the mean cost of total production during a given period (say, a year)

10 DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE Learning Economies of scope Production technology Product design Location Some sources of economies R&D spend Advertising spend Specialization of specific production processes Superior inventory management Purchasing power Some sources of diseconomies Bureaucracy High labor costs Inefficient operations Economies of scale

11 LEARNING CURVE AS A SOURCE OF COST ADVANTAGE Economies of scale Learning Economies of scope Production technology Product design Location Costs decrease … as the scale of operation increases during any given period of time Economies of scale with the cumulative level of production since the production of the first unit Learning curve How Learning Differs from Scale

12 ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE Economies of scale Learning Economies of scope Production technology Product design Location If a firm produces two or more products and can share resources among two or more of these (e.g., share manufacturing machines) – thereby lowering the costs of each product – it benefits from economies of scope

13 PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE Economies of scale Learning Economies of scope Production technology Product design Location Often, a new entrant who wants to compete against industry incumbents with significant scale and experience advantages, tries to match or beat incumbents’ costs by introducing a production technology that is subject to different economics (e.g., Jet Blue, Nucor Steel)

14 PRODUCTION DESIGN AS A SOURCE OF COST ADVANTAGE Economies of scale Learning Economies of scope Production technology Product design Location Product design can sometimes be altered to lower a firm’s production costs (e.g., Canon vs. Xerox)

15 LOCATION AS A SOURCE OF COST ADVANTAGE Economies of scale Learning Economies of scope Production technology Product design Location Sometimes firms try to attain lower production costs by locating their operations in cheaper labor markets (e.g., Pacific Cycle manufactures in China and Taiwan to achieve lower costs than Trek who manufactures in the US)

16 KEY DRIVERS OF DIFFERENTIATION ADVANTAGES Premium brand image Customization Unique styling Speed More convenient access Unusually high-quality To drive up customer’s willingness to pay and generate demand sufficient to (1)Recoup added costs and (2)Generate enough profits to make strategy worthwhile Key DriversPurpose

17 DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE Low-cost Differentiation Economies of scale Learning Economies of scope Superior technology Product design Location DriversThreats New technology Too low-quality Social, political, and economic risks of outsourcing Premium brand image Customization Unique styling Speed Convenient access Unusually high-quality Failure to increase buyer’s willingness to pay higher prices Under estimating cost of differentiation Over fulfillment of buyer’s needs Lower cost imitation

18 COUNTERFEITING AS A THREAT TO DIFFERENTIATION $250 billion annually lost to American businesses 750,000 jobs lost annually $600 billion in counterfeited goods

19 STRATEGIES FOR DIFFERENT PHASES OF THE INDUSTRY LIFE CYCLE Decline Mature Embryonic Growth Phases of in- dustry life cycle ArenasVehiclesDifferentiatorsStagingEconomic Logic LocalInternal development Alliances to secure missing inputs or distribution access Target basic needs, minimal differentiation Tactics to gain early footholds Prices tend to be high. Costs are also high Focus is on securing additional capital to fund growth phase. Penetration into adjacent markets Alliances for cooperation Acquisitions in targeted markets Increased efforts toward differentiation Low cost leaders emerge through gaining experience advantages and scale Integrated positions require choice of focusing first on cost or differentiation Margins can improve rapidly because of experience and scale Price premiums accrue to successful differentiators Globalization Diversification Mergers and acquisitions result in consolidation More stable positions emerge across competitors Choosing international markets and new industry diversification; need rational sequencing Consolidation results in fewer competitors (favoring higher margins) but declining growth demands cost containment and rationalization of operations. Some arenas may be abandoned if decline is severe Focus on segments which provide most profitability Acquisitions for diversifying moves Divestitures to exit for some competitors Rationalizing cost

20 TESTING THE QUALITY OF A STRATEGY Key Evaluation CriteriaSub-questions 1. Does your strategy exploit your key resources? With your particular mix of resources, does this strategy give you an advantageous position relative to your competitors? Can you pursue this strategy more economically than competitors? Do you have the capital and managerial talent to do all you envision? Are you spread too thin? 2. Does your strategy fit with current industry conditions? Is there healthy profit potential where you're headed? Are you aligned with the key success factors of your industry? 3. Will your differentiators be sustainable? Will competitors have difficulty imitating you? If imitation cannot be foreclosed, does your strategy include a ceaseless regimen of innovation and opportunity creation to keep distance between you and the competition? 4. Are the elements of your strategy consistent and aligned with your strategic position? Have you made choices of arenas, vehicles, differentiators, and staging, and economic logic? Do they all fit and mutually reinforce each other? 6. Can your strategy be implemented?Will your stakeholders allow you to pursue this strategy? Do you have the proper complement of implementation levers in place? Is the management team able and willing to lead the required changes?