Foundations of Strategy Chapter 4 The Nature and Sources of Competitive Advantage By: Jakeb, Cedric, David, & Cody October 5, 2014

Overview Understand ‘competitive advantage’ and identify the circumstances firms can create a competitive advantage over a rival. Distinguish two primary types of competitive advantage: Cost advantage Differentiation advantage Sustaining competitive advantage How firms utilize the value chain framework to analyze potential sources of cost and dedifferentiation

Forming an Understanding What is Competitive Advantage? Defined as: When two or more firms compete within the same market, one firm posses a competitive advantage over its rival when it earns (or has the potential to earn) a persistently higher rate of profit. Examples: Toyota’s competitive advantage in making mass produced cars Wal-Mart’s competitive advantage in discount retailing within the U.S. SAP in enterprise resource planning (ERP) software.

External vs. Internal Figure 4.1 The emergence of competitive advantage How does competitive advantage emerge? External sources of change e.g., Changing customer demand Changing prices Technological change Internal sources of change Some firms have greater creative and innovative capability Resources heterogeneity among firms means differential impact Some firms faster and more effective in exploiting change

External | Responsiveness Extent to which external change creates competitive advantage (or disadvantage) depends on magnitude of the change and extend of firms' strategic differences. More turbulent an industry = The greater the number of sources of change, The greater the differences in firms’ resources and capabilities The greater dispersion of profitability within the industry

External | Responsiveness Responsiveness to external sources involves one of two capabilities: Ability to anticipate changes in the external environment Speed Example: An unexpected rain shower creates an upsurge in the demand for umbrellas. Those street vendor who are quickest to position themselves outside a busy train station will benefit most.

External vs. Internal Figure 4.1 The emergence of competitive advantage How does competitive advantage emerge? External sources of change e.g., Changing customer demand Changing prices Technological change Internal sources of change Some firms have greater creative and innovative capability Resources heterogeneity among firms means differential impact Some firms faster and more effective in exploiting change

Internal | Innovation Competitive advantage may also be generated internally through innovation. Innovation can provide a basis for overturning the competitive advantage of other firms. Strategic innovation- new approaches to doing business including new business models; may also be based on redesigned process and novel organizational designs. Examples Southwest Airlines’ point-to-point system instead of the hub and spoke system. Apple’s resurgences during 2003-06 was a result of its reinvention of the recorded music business by combining iconic MPS player with its iTunes music download service.

Internal | Innovation Strategic Innovation tend to involve pioneering along one or more dimensions of strategy: New industries Launching products which create new markets; creating new markets can potentially be the purest form of blue ocean strategy- the creation of uncontested market space. New customer segments Creating new customer segments for existing products concepts can also open up vast new markets spaces. New sources of competitive advantage Most successful blue ocean strategies do not launch whole new industries, but rather introduce novel approaches

External vs. Internal Figure 4.1 The emergence of competitive advantage How does competitive advantage emerge? External sources of change e.g., Changing customer demand Changing prices Technological change Internal sources of change Some firms have greater creative and innovative capability Resources heterogeneity among firms means differential impact Some firms faster and more effective in exploiting change

Sustaining Competitive Advantage Once established, competitive advantage is subject to erosion by competition. The speed with which competitive advantage is undermined depends on the ability of competitors to challenge either by imitation or innovation. Imitation is the most direct from of competition thus barriers to imitation must exist for competitive advantage to be sustained. Isolating Mechanisms – Barriers that protect a firm’s profits from being driven down by the competitive process.

Competitive Imitation To identify sources of isolating mechanisms we first need to examine the process of competitive imitation. For a firm to successfully imitate the strategy of another, it must meet four conditions: Identification Incentive Diagnosis Resources acquisition

Identification A simple barrier to imitation is to obscure the firm’s superior profitability. According to George Stalk of the Boston Consulting Group, one way to throw competitors off balance is to mask high performance so rivals fail to see your success until it’s to late. Example Avoiding disclosure of a firms financial performance [much easier for a private company than a public one]

Incentive Firm may undermine the incentives for imitation by persuading rivals that imitation will be unprofitable. Reputation here is critically important. Examples NutraSweet’s aggressive price war against the Holland Sweetener Company deterred other would-be entrants. Proliferation in products; between 1950 and 1972, the six leading suppliers of breakfast cereals introduces 80 new brands into the US market Proliferation in patent;1974 Xerox dominant market position was protected by a wall of over 2000 patents. When IBM introduced its first copier in 1970, Xerox sued it for infringing 22 of these patents.

Diagnosis If a firm is to imitate the competitive advantage of another, it must understand the basis of its rival’s success. This proves difficult the more multidimensional a firm’s competitive advantage becomes. This leads to uncertain imitability – because there is ambiguity in causes of success of a competitor, any attempt to imitate the strategy is subject to uncertain success.

Resource acquisition To succeed in competitive imitation, the imitator can mount a competitive challenge only by assembling the resources and capabilities necessary for imitation: buy them or build them. Time is critical Examples In financial services, most new products are copied quickly by competitors; Collateralized debt obligations (CDO’s) developed by the firm Drexel Burnham Lambert which lead to the 2008 financial crisis.

Competitive Imitation Figure 4.2 Sustaining competitive advantage: types of isolating mechanisms Competitive Imitation Isolating Mechanism Identification Obscure performance Incentives for imitation Deterrence: signal aggressive intentions to imitators Preemption: exploit all available investment opportunities Diagnosis Casual ambiguity; rely on multiple sources of competitive advantage Resource acquisition Base competitive advantage on resources and capabilities that are immobile and difficult to replicate

Types of Competitive Advantage: Cost and Differentiation Figure 4.3 Sources of competitive advantage Cost Advantage Similar product Lower cost Competitive Advantage Price premium From unique product Differentiation Advantage

Types of Competitive Advantage: Cost and Differentiation Cost advantage Similar products, lower cost Quantitative emphasis Differentiation advantage (Chipotle) Differentiated + price premium Qualitative emphasis

Strategy and Cost Advantage How to compete in cost advantage Cost drivers All the small things Cost drivers through value chain analysis Activities Choose and rank Benchmark Links Reduce cost

Strategy and Differentiation Advantage Obtaining this requires a price premium in the market that exceeds the cost of providing the differentiation Commodities and differentiation Cemex – Cement Company Amazon – Online book selling

How do you differentiate? It’s all about identifying and understanding every possible interaction between the firm and the customers Then, learn how those interactions can be enhanced or changed to create value to the customer

Stages of Value Chain - Differentiation Construct a value chain for the firm and its customers Identify the drivers of uniqueness in each activity Select the most promising differentiation variable for the firm Locate linkages between the value chain of the firm and that of the buyer

Case Studies in Differentiation Singapore Airlines – not only reducing costs but also differentiating in various services for the customers Personalization through meals Inbound and Outbound logistics Technology Development (check-in services) Procurement (e.g. A380)

Case Studies in Differentiation Chipotle – by focusing on differentiation and not cost leadership, they have grown their profitability Quality of life for customers through organic foods Creating an atmosphere different from competitors Selling alcohol (versus that of McDonald’s and Taco Bell, encourages customers to sit and linger)

Differentiation or Low Cost? “The firm stuck in the middle is almost guaranteed low profitability.” – Porter But… there is a way to reconcile differentiation advantage with low cost strategies SIA – speedy check-in technology not only increases value for customers, but also lowers the cost of delays Chipotle – price advantage of fast customer turnover (assembly line) with the combined selection of quality ingredients

The Beginning of Starbucks March 30,1971- Starbucks Opens Jerry Baldwin Zev Siegl Gordon Bowker 1982- Howard Schulz becomes the CEO 1987- Starbucks founders sold the company to Howard Schulz, who previously owned Giornale coffee outlets

The Tenets of Starbucks Welcoming Customer Service Premium Products Slightly Exclusive

Starbuck’s Baristas vs. McDonald’s Employees Employees Morality isn’t high Low pay, benefits such as healthcare and dental are not provided to all employees working over 20 hours Employees are in process of unionizing When was the last time you went to McD’s and saw an employee excited to be at work? Master of coffee making techniques and encouraged to be knowledgeable about coffee in general Generous health care benefits and participation in equity holdings Offers scholarships to college students

Starbucks: The Victim Of Its Success Revenue went up from $160 million in 1993 to $10 billion by 2009 After Howard Schulz resigned in 2000, SB had 17000 stores in 150 countries Expansion without proper management, cause the company to compromise its principles Example: Starbucks went away from hand-pulled espresso machines to the automatic variety which sped up service but diminished the spectacle of coffee making

Growing Pains Incompetent Management McDonald and DD’s provide value, some people want to support the local companies, and there’s Starbucks struggling to get its foothold Liberals are arguing that SB isn’t as environment-friendly as it portrays itself

Four Bucks is Dumb

Unsnobbycoffee.com

Starbucks’ Response “We get a lot of questions on the competition and that everyone seems to be picking on Starbucks through their advertising and try to reposition Starbucks as expensive or snobby …We're not going to get sucked into the, 'My coffee is better than your coffee,' price point type of coffee conversation. We're going to play at a much higher level." Terry Davenport, Chief Marketing Officer of Starbucks

Breaking Point Jim Donald, CEO since 2000, is fired SB’s stock price declined 50% Operational Income greatly diminished Howard Schulz is Back

The Return of Starbucks Closed down 600 stores In 2008, 12,000 employees were layoff Temporary closed all 7,100 domestic stores for employee training (135,000 US employees) November 21, 2008: The SP was $7.83 As of October 6, 2014: The SP was $75.23

Foundations of Strategy Chapter 4 The Nature and Sources of Competitive Advantage By: Jakeb, Cedric, David, & Cody October 5, 2014