Strategy Formulation HCAD 5390

Managerial Scope of SBU vs Corporate Executives Managerial responsibilities and decision-making concerns at corporate and SBU levels At SBU level, trade-off between operational and strategic responsibilities Within SBUs, strategic role of functional areas Consolidation trend in health care means more multi-SBU corporations New freestanding ventures constantly emerging

Strategies Duties of SBU Management (I) Define strategic direction Conduct internal/external environmental assessments Negotiate strategy with corporate parent Adopt a generic strategy Formulate action strategies

Strategies Duties of SBU Management (II) Develop needed resources and competencies Negotiate with functional area managers for strategy implementation Appoint and evaluate functional area managers Monitor and control strategy implementation

Role of Corporate Center in SBU Strategy Hold SBU managers to strategic standards, goals and criteria Support SBU strategic initiatives with financial and other resources Facilitate sharing of knowledge and other resources among SBUs

Formulating Strategy in SBUs Broad strategic objectives of SBUs and independent businesses: Grow revenues and profits as rapidly as possible Build a sustainable competitive advantage

Ways to Grow Revenues and Profits Sell more units to existing customers Sell more units to new customers Sell same number of units at higher prices, leading to higher revenues and perhaps profits Sell same number of units at same price, with lower production costs, leading to higher profits

Types of SBU Growth Strategies Increase market share Enter new markets Identify new uses Create new products Acquire new businesses Collaborate with others

Building Sustainable Competitive Advantage Competition in most markets is a zero-sum game One business grows at the expense of another It does that by positioning itself more positively and distinctively to its customers When it does that, it has a competitive advantage When it does that for a long time, it has a sustainable competitive advantage

Thinking About Generic Business Strategies – á la Michael Porter Businesses gain competitive advantage by giving their customers value unavailable from their competitors. There are three variables in pursuing this goal: Cost of producing the goods/services to be sold Features of the goods/services to be sold Range of customers to whom the goods/services are marketed

Types of Business-Level Strategies Business-level strategies are intended to create differences between the firm’s position relative to those of its rivals To position itself, the firm must decide whether it intends to perform activities differently or to perform different activities as compared to its rivals

Porter’s Generic Business Strategies Combine the three variables into four generic business strategies: Full market low-cost leadership Full market differentiation Segment low-cost leadership Segment differentiation

Five Generic Strategies Competitive Advantage Cost Uniqueness Cost Leadership Differentiation Broad target Integrated Cost Leadership/ Differentiation Competitive Scope Narrow target Focused Cost Leadership Focused Differentiation

Cost Leadership Strategy An integrated set of actions designed to produce or deliver goods or services at the lowest cost, relative to competitors with features that are acceptable to customers relatively standardized products features acceptable to many customers lowest competitive price

Low-Cost Leadership Strategy Goal is to have the lowest production costs of any competitor in the market Not just “lower” costs, but “lowest” costs Does the business have the resources and competencies to create goods and services at very low costs?

Achieving Low-Cost Leadership Define and analyze the internal value chain Look for points where modifications might produce cost savings Fully utilize fixed cost resources Expand volume to achieve economies of scale Utilize new cost-saving production technologies Perform every chain activity at optimal location – insourcing vs outsourcing Take advantage of learning and experience curves

Internal Value Chain Modifications Current chain configuration is not the only one possible: Existing activities could be performed better Activity sequence could be rearranged Activities could be moved or performed simultaneously Interface between activities could be improved In-house activities could be outsourced

Exploiting Low-Cost Leadership Lower prices to reflect lower costs – leading to increased sales and revenues Leave prices at same level – earn higher profits Leave prices at same level – use greater margin to add differentiating features

Downside to Low-Cost Leadership In fixation on costs, business may ignore changing customer value preferences New preferences may require different production technologies and cost structure Competitors may be able to imitate the cost-cutting innovations If preferences do not change and innovations cannot be imitated --- sustainable competitive advantage results

Keys to Success of a Low-Cost Leadership Strategy (I) Start with sufficient working capital to survive until low-cost leadership achieved Possess the resources and competencies to carry out necessary value chain modifications Exercise tight control of all processes and personnel

Keys to Success of a Low-Cost Leadership Strategy (II) Align performance incentives with a low-cost operational strategy Leaders experienced in managing low-cost operations Corporate culture that is comfortable with a low-cost operating model

Cost Leadership Strategy and the Five Forces of Competition Rivalry Among Competing Firms Can use cost leadership strategy to advantage since: competitors avoid price wars with cost leaders, creating higher profits for the entire industry Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Bargaining Power of Buyers Can mitigate buyers’ power by: driving prices far below competitors, causing them to exit and shifting power with buyers back to the firm Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Bargaining Power of Suppliers Can mitigate suppliers’ power by: being able to absorb cost increases due to low cost position being able to make very large purchases, reducing chance of supplier using power Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Threat of New Entrants Can frighten off new entrants due to: their need to enter on a large scale in order to be cost competitive the time it takes to move down the learning curve Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Cost Leadership Strategy and the Five Forces of Competition Threat of Substitute Products Cost leader is well positioned to: make investments to be first to create substitutes buy patents developed by potential substitutes lower prices in order to maintain value position Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Differentiation Strategy An integrated set of actions designed by a firm to produce or deliver goods or services (at an acceptable cost) that customers perceive as being different in ways that are important to them price for product can exceed what the firm’s target customers are willing to pay nonstandardized products customers value differentiated features more than they value low cost

Differentiation Strategy Value provided by unique features and value characteristics Command premium price High customer service Superior quality Prestige or exclusivity Rapid innovation

Differentiation Strategy (I) Sell products with added value that customers want and competitors do not offer Added value justifies a higher price Higher price covers cost of creating the value (or the business will lose money creating it) Higher price is not more than the customer is willing to pay for the added value (or the customer will not buy it)

Differentiation Strategy (II) Create differentiation as economically as possible, while … Also keeping other costs as low as possible What kinds of differentiation should be created?

Bases for Creating Differentiation Depends on what the business is capable of creating and delivering Scrutinize the value chain to see what activities can be performed differently to add new value Differentiation opportunities can be found at almost any point in the chain

Generic Forms of Differentiation (I) More product features New, appealing product features Product features tailored to individual customer preferences Better produce performance Easier to use and operate Costs the customer less to use and operate More reliable, durable, and long-lasting

Generic Forms of Differentiation (II) More attractive in appearance More convenient purchase locations Speedier delivery Friendlier customer service at all stages More prompt after-purchase repair and maintenance service Heightened reputation and image In any way at all, the customer perceives added value

Criteria for Choosing a Differentiation Feature (I) Customer will notice it and want it more than a product without the feature Customer will pay more for a product with the feature than it cost to create it

Criteria for Choosing a Differentiation Feature (II) Business is capable of creating the product at a cost less than the price the customer willing to pay for it It is impossible for a competitor to create a product with the same feature at the same cost in the near future

Benefits of a Differentiation Strategy (I) As long as it sustains the differentiation, the business is insulated from competition in its market It effectively defines a new product in a new market segment where it is the only competitor Once hooked on the differentiating feature, many customers will accept higher prices to keep enjoying it

Benefits of a Differentiation Strategy (II) Attraction of the feature engenders customer loyalty leading to automatic repeat purchases That customer loyalty makes it harder for new competitors to enter the market

Disadvantages of a Differentiation Strategy (I) Competitor could differentiate the product even further Competitors could carve out other narrower segments of the market Customers may be confused by numerous differentiating products from many competitors Customers eventually may lose interest in the differentiating features

Disadvantages of a Differentiation Strategy (II) Differentiating features often required specialized, expensive processes and equipment that may be obsoleted by lower-cost competitive versions If enough competitors copy the differentiating features, customers may take them for granted and view the product as a commodity To stay ahead of imitative competitors, a business must continuously create new innovative differentiating features

Differentiation Strategy and the Five Forces of Competition Rivalry Among Competing Firms Can defend against competition because: brand loyalty to differentiated product offsets price competition Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Bargaining Power of Buyers Can mitigate buyer power because: well differentiated products reduce customer sensitivity to price increases Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Bargaining Power of Suppliers Can mitigate suppliers’ power by: absorbing price increases due to higher margins passing along higher supplier prices because buyers are loyal to differentiated brand Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Threat of New Entrants Can defend against new entrants because: new products must surpass proven products or, new products must be at least equal to performance of proven products, but offered at lower prices Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Differentiation Strategy and the Five Forces of Competition Threat of Substitute Products Well positioned relative to substitutes because: brand loyalty to a differentiated product tends to reduce customers’ testing of new products or switching brands Rivalry Among Competing Firms Bargaining Power of Buyers Bargaining Power of Suppliers Threat of New Entrants Substitute Products Threat of Five Forces of Competition

Focus Strategy Not selling to the entire potential market, but … Selling to a subset of customers, or Operating in a particular section of the industrial value chain, or Selling only a few of all product possible in the market or industry, or Selling to a narrow geographic market

Focus Strategy Principles Goal is to earn greater profits while accepting lower sales revenues Identify a subset of customers with more specific preferences that are not being met Might pay a premium to have them satisfied Business has resources and competencies to create the desired products At a cost that returns it above-average profits

When Focus Strategy Makes Sense Total market composed of numerous segments with distinctive feature preferences that can be satisfied profitably - YES Homogenous total market – NO Segment differences too subtle – NO Too few customers in the segments – NO Competitor operating in the segment – NO

Focus Strategy Success Factors (I) At least one definable segment of total market Product or value preferences are substantially different Enough customers to generate sales/profits worth trying to serve them Clear understanding of unique product features the customers seek

Focus Strategy Success Factors (II) Capable of manufacturing such a product Customers willing to pay a price that allows business to earn an acceptable profit Low enough competitive intensity that business can establish a competitive advantage Resist impulse to broaden the segment served or to serve more segments to increase revenues

Focus Strategy Negatives If successful, competitors will be attracted to the segment Full market competitors may tweak their products to appeal to the segment as well Competitors may focus on even narrower sub-segments Segment customer preferences may shift, making the strategy irrelevant

“Stuck-in-the-Middle” Strategy Combination of low-cost leadership and differentiation Differentiating features add cost, therefore … Cost disadvantage to competitor pursuing a low-cost leadership strategy Feature disadvantage to competitor pursuing a multi-feature differentiation strategy This is a strategy to be avoided … or is it?

Choosing a Generic Business-Level Strategy MY FIRM HAS A COMPETITIVE ADVANTAGE MY FIRM HAS A COMPETITIVE ADVANTAGE STUCK IN THE MIDDLE 14

Hybrid Strategy (“Stuck-in-the-Middle”) Businesses lacking strategic discipline may wind up with products not different enough to attract discriminating customers or low enough in cost to attract price-sensitive customers They are in a dead zone between these two distinct strategic extremes … and they suffer competitively and financially That was the traditional thinking

Integrated Competitive Strategy Cost Leadership and Differentiation Cost Leadership Benefits Differentiation Benefits 9

Integrated Competitive Strategy Cost Leadership and Differentiation Value-Added Or Integrated Cost Leadership Benefits Combined Benefits Differentiation Benefits 10

Hybrid Strategy (Offering “Best Value”) Artful combinations of low cost and differentiation Providing “best value” to the customer Not the lowest price, but a reasonable one, not excessive Not elaborate multiple features, but something a little extra and distinctive Difficult balance to establish and maintain

Benefits of Integrated Strategy Successful firms using this strategy have above-average returns Firm offers two types of values to customers some differentiated features (but less than a true differentiated firm) relatively low cost (but now as low as the cost leader’s price)

Major Risks of Integrated Strategy An integrated cost/differentiation business level strategy often involves compromises (neither the lowest cost nor the most differentiated firm) The firm may become “stuck in the middle” lacking the strong commitment and expertise that accompanies firms following either a cost leadership or a differentiated strategy

Functional Area Strategies In support of the SBU strategies Integrated with other functional area strategies Consistent with current operational activities Means by which SBU strategies are implemented

Examples of Functional Area Strategic Activities (I) Clinical Operations Capacity Location Organizational Structure Quality Assurance and Improvement Reporting and Control Marketing and Promotion Market Research Advertising and Promotion Product and Service offerings

Examples of Functional Area Strategic Activities (II) Human Resources Staffing Motivation and Incentives Culture and Working Conditions Employee Development Information and Clinical Technologies Information Systems Communication Systems Clinical Medical Technologies

Examples of Functional Area Strategic Activities (III) Financial Resources Availability of Investment Capital Capital Structure and Creditworthiness Financial Controls