Strategic Positioning for Competitive Advantage Besanko, Dranove, Shanley, and Schaefer Chapter 11

Agenda Define Competitive Advantage Discuss Maximum Willingness-to-Pay and Consumer Surplus Discuss Value Map and Value Creation Look at the Logic of Cost Leadership and Benefit Leadership Discuss the importance of Elasticity to Competitive Advantage

Defining Competitive Advantage It is the ability of a company to outperform the average performers in an industry. One of the keys to this definition is defining the industry. The performance measure for this definition is usually economic profitability.

Maximum Willingness-to-Pay A consumer’s maximum willingness-to-pay is the maximum amount of money the consumer is willing to give up to get a good. Any amount above this would cause the consumer to not want the good.

Consumer Surplus One definition of consumer surplus is that it is the difference between the consumer’s maximum willingness-to-pay and the price the consumer must pay for the product. Given competing goods, the consumer would prefer to purchase the one with the highest consumer surplus.

A Value Map Price Indifference Curve A Indifference Curve B Quality

Value Map Questions Any two products that is on a particular indifference curve has the same consumer surplus. Indifference curve B represents a higher consumer surplus. Why? Why does the shape of the indifference curve make sense? What does the slope of the indifference curve tell us?

Competition Between Firms Considering the Value Map Each firm must decide on the price it is going to charge as well as the quality that it will provide in the product. The consumer is going to choose the product that gives him the highest consumer surplus.

Value-Created Define: Value Created = B-C = (B-P)+(P-C) B as the maximum willingness-to-pay for a consumer C as the cost of production for the producer P as the products price Value Created = B-C = (B-P)+(P-C) Value Created = Consumer Surplus + Producer Surplus

Value Creation and Competitive Advantage Positive value creation is a necessary condition for a firm to be viable, but it is not sufficient. Competition can bid prices down to cost, leading the producer with no surplus. This implies that a firm must create more economic value than its rivals to be successful. This value must be difficult for other firms to replicate.

Value Creation and the Value Chain At each step of the vertical chain of a product, it is expected that a company is creating some form of value in the product. Each point in the value chain can add both benefits and costs, but in the end the benefits should outweigh the costs. When might this not be true?

Cost Leadership Strategies A firm can choose to: Offer a product with the same benefits as the other firm’s products (benefit parity) at a lower cost. Offer a product with the slightly lower benefits than the other firm’s products (benefit proximity) at a lower cost. Offer a product with strictly lower benefits (qualitatively different) than the other firm’s products at a lower cost.

Logic of Cost Leadership $ As long as PA – PB < CA – CB, then cost leadership and offering a lower quality product makes sense Indifference Curve A • PA B • PB CA CB Quality QB QA

Benefit Leadership Strategies A firm can choose to: Offer a product with the same cost as the other firm’s products (cost parity) with a higher benefit. Offer a product with the slightly higher cost than the other firm’s products (cost proximity) with a higher benefit. Offer a product with strictly higher costs than the other firm’s products with much higher benefits.

Logic of Benefit Leadership $ As long as PA – PB > CA – CB, then cost leadership and offering a lower quality product makes sense Indifference Curve A • PA B • PB CA CB Quality QB QA

High Price Elasticity with a Cost Advantage Under this situation the firm can greatly increase market share from a price cut. The firm should exploit its advantage by gaining market share by under-pricing its competitor.

High Price Elasticity with a Benefit Advantage Under this situation the firm can lose market share from a price increase. The firm should exploit its advantage by gaining market share by maintaining pricing parity with its competitor and gain share through higher benefits.

Low Price Elasticity of Demand with a Cost Advantage Under this situation the firm gains little market share by cutting prices. The firm should exploit its advantage by maintaining pricing parity with its competitor and exploit its advantage of higher profit margins.

Low Price Elasticity of Demand with a Benefit Advantage Under this situation the firm loses little market share by increasing prices. The firm should exploit its advantage by increasing prices over its competitor and exploit its advantage of higher profit margins.

“Stuck in the Middle” When a firm tries to engage in both cost and benefit leadership simultaneously and fails at both, it is known as being “stuck in the middle.” While it is possible for companies to focus both on costs and benefits, there is evidence that it can have an adverse effect on competitiveness. This does not imply that the two are completely incompatible.

Broad Coverage Strategy Vs. Focus Strategies A broad coverage strategy is going to try to serve all customer groups with a full line of related products. A focus strategy will focus on either a particular group of customers for a single product, a particular product for many customer groups, or focus on selling a variety of products to a variety of customer groups in a narrowly defined geographic area.