1. MKT 450 Strategic Management Mishari Alnahedh

2. LECTURE 5: COMPETITIVE ADVANTAGE

3. Learning Objectives: What is the value of strategic flexibility?
The Nature and Sources of Competitive Advantage
Mishari Alnahedh
Learning Objectives:
What is the value of strategic flexibility?
Under what conditions are strategic commitments more likely to lead to sustainable competitive advantage?
How can game theory tools and cash-flow analyses be used together?
When are first-mover advantage and second-mover advantage applicable?

4. What is the value of strategic flexibility?
Mishari Alnahedh
What is the value of strategic flexibility?
Responsiveness to the opportunities provided by external change requires
Information (a key resource)
Flexibility (a key capability)
Information is necessary to identify and anticipate external changes.
This is dependent on a firm’s environmental scanning capability through “early warning systems”
Largely based on relationships with customers, suppliers, and competitors

5. What is the value of strategic flexibility?
Mishari Alnahedh
What is the value of strategic flexibility?
Flexibility of response requires that a firm swiftly redeploys its resources to meet changes in external conditions.
This is dependent on “organizational software”
Largely based on organizational structure, decision-making systems, job design, and culture.

6. Strategic Flexibility
Mishari Alnahedh

7. Benetton’s responsiveness
Strategic Flexibility
Mishari Alnahedh
Benetton’s responsiveness
Flexibility typically requires:
Fewer levels of hierarchy
Greater decentralization of decision making
Informal patterns of cooperation and coordination
Responding to emerging market trends and changing customer preferences
Benetton uses a vertically integrated network
● At the retail level, a system of country and regional agents who coordinate the franchised retail outlets
● At the production level, more than 2,000 subcontractors, but no formal contracts

8. Strategic Flexibility
Mishari Alnahedh

9. Dell’s Responsiveness
Strategic Flexibility
Mishari Alnahedh
Dell’s Responsiveness
The greater a company’s flexibility in responding to changing market circumstances, the less dependent it is on its ability to forecast
Dell operates with under 14’s days’ inventory
This not only cuts costs, but also permits Dell to adjust rapidly and effortlessly to fluctuations in market demand and upgrade its products quickly to take advantage of technical advances in components
Dell’s entire logistics are outsourced
Some components (e.g., monitors) are delivered to customers without passing through Dell’s hands

10. Strategic Flexibility
Mishari Alnahedh

11. IKEA’s responsiveness
Strategic Flexibility
Mishari Alnahedh
IKEA’s responsiveness
Strategic flexibility depends on core competencies for repositioning product offerings
IKEA uses computer-based coordination to organize its 1,800 “loosely-coupled” suppliers of modular ready-to-assemble furniture components
A 50-country global product creation and production network

12. Strategic Commitment vs. Flexibility
Strategic Flexibility
Mishari Alnahedh
Strategic Commitment vs. Flexibility
Commitment
Game Theoretic preemption strategy
Flexibility
Real (Strategic) Options Analysis
Flexibility is analogous to “having options” and commitment is analogous to the “exercise of an option”
The greater the uncertainty the firm faces, the more valuable are its strategic options.
The resolution of uncertainty over time is the catalyst which induces a manager to make (sunk cost) commitments.

13. + - Traditional Evaluation of Financial Projects
Game Theory and Cash-Flow Analysis
Mishari Alnahedh
Traditional Evaluation of Financial Projects
Net Present Value (NPV) or Discounted Cash Flow Analysis
time CF + -

14. Cost to Build Plant = $1600 Cost of Capital = 10%
The Value of Time: Commitment vs. Flexibility
Mishari Alnahedh
Cost to Build Plant = $1600
Cost of Capital = 10%
Price(t=1) = $100
Price(t=0) = $200
Price(t=1) = $300 .5
Price = $100
Price = $300

15. The Value of Time: Commitment vs. Flexibility
Mishari Alnahedh

16. Build now (classic NPV) versus value of waiting
The Value of Time: Commitment vs. Flexibility
Mishari Alnahedh
Build now (classic NPV) versus value of waiting
NPV calculation
($1400) in year 0
.5($300) + .5($100) = $200 for each year after
Value of $200 perpetuity=$2000
Expected NPV ($1400) + $2000=$600
Waiting
Year 0 = $0
Scenario 1 (price = $300)
Yr. 1=($1300)
Perpetuity of $300
NPV =$1545
Scenario 2 (price = $100)
Yr. 1=($1500)
Perpetuity of $100
NPV =($455)
NPV of waiting:
.5($1545) + .5(0) = $773
What is the value of the option to wait a year ?

17. Waiting in a real option
Mishari Alnahedh
An increase in the variance, increases the value of the option.
better
Outcome

18. ABC Corp is planning to establish four new plants to make rubber bands, each for a different type of rubber bands. The investment costs of the four plants are known. The future prices of rubber bands, however, are unknown. Two possible scenarios of the future prices of rubber bands are shown in tables 1 and table 2 below for the four plants or projects. If ABC Corp can buy a real option to delay the decision of which plant to invest in, which project will have a real option with the highest value?
Table1. The Up Scenario
Project A
Project B
Project C
Project D
Cost of the plant
$55,000
$1,000,000
$25,000
Price in year 1
$ 5.00
$ 10.00
$ 50.00
Price in year 2
$ 15.00
$ 55.00
Price in years 3-10
$ 25.00
$ 60.00
Table2. The Down Scenario
Project A
Project B
Project C
Project D
Cost of the plant
$55,000
$1,000,000
$25,000
Price in year 1
$ 5.00
$ 45.00
$ 1.00
Price in year 2
$ 10.00
$ 50.00
$ 2.00
Price in years 3-10
$ 20.00
$ 55.00
$ 4.00

19. Strategic Commitment
Mishari Alnahedh

20. Game-theoretic Approach to Strategy
Mishari Alnahedh
What prior strategic commitments has the competitor made?
How “reversible” is your action or the competitor’s potential response?
credible threat
Does the potential market fit with the competitor’s existing strategy?
What are the payoffs relative to other actions the competitor could take?

21. Strategic Commitments and Competitive Advantage
Mishari Alnahedh
Under what conditions are strategic commitments more likely to lead to sustainable competitive advantage?
When the commitments are credible (sunk investments);
When you understand what strategic investments are important in your business and how “sunk” those investments are.
When you pay attention to how your competitors’ returns vary under different strategic scenarios;
When you communicate the commitment to the other firms (for both competition and cooperation);

22. How Can “Commitment” Affect a Competitor’s Response?
Strategic Commitments and Competitive Advantage
Mishari Alnahedh
How Can “Commitment” Affect a Competitor’s Response?
Commitment (sunk costs) can be used to pre-commit to a certain strategy and, thus, influence competitor response
Preemption of Strategically Valuable Assets - Access to raw materials (e.g., Alcoa; Royal Dutch Shell)
Reduce incentives for imitation
Commitment (sunk costs) can be used to achieve cooperation

23. How can game theory tools and cash-flow analyses be used together?
Game Theory and Cash-Flow Analysis
Mishari Alnahedh
How can game theory tools and cash-flow analyses be used together?
Strategy: Games against other people
Our actions affect the payoffs we are likely to experience (Game-theoretic analysis)
Finance: Games against “Nature”
Payoffs are determined exogenously or by chance (Decision-theoretic analysis)

24. Strategic Commitment : First-mover Advantage
Game Theory and Cash-Flow Analysis
Mishari Alnahedh
Strategic Commitment : First-mover Advantage

25. Speed of response: First-mover vs. second-mover
Strategic Commitments and Competitive Advantage
Mishari Alnahedh
Speed of response: First-mover vs. second-mover
Sources of first-mover advantages
Economies of Scale
Experience or Learning Curve Effects
Brand Equity and customer loyalty
“Network Externalities”
First-mover disadvantages
High risk
High development costs
High demand uncertainty

26. Strategic Commitments and Competitive Advantage
Mishari Alnahedh

27. New Bala is a successful second mover in the athletic shoe industry.
Strategic Commitments and Competitive Advantage
Mishari Alnahedh
A second mover : is a (second, third, fourth, etc.) firm that responds to a first mover’s competitive action often through imitation or a move designed to counter the effects of the initial action.
New Bala is a successful second mover in the athletic shoe industry.

28. Speed of response: First-mover vs. second-mover
Strategic Commitments and Competitive Advantage
Mishari Alnahedh
Speed of response: First-mover vs. second-mover
Second-mover advantages
Reduction in demand uncertainty
Market research to improve satisfying customer needs
Learn from the first mover’s successes and shortcomings
Gaining time for R&D to develop a superior product

29. First Mover Disadvantages May Lead to Second Mover Advantages
Strategic Commitments and Competitive Advantage
Mishari Alnahedh
First Mover Disadvantages May Lead to Second Mover Advantages
The Costs of Early Adoption
The “Bleeding Edge” of Technology
Changing Technology
Product Technology
Process Technology
Changing Consumer Tastes
Saturn & Chrysler
Given that a second mover’s product development costs can be much lower than the first mover’s product development costs, first-mover advantages must be substantial to justify first moving as a strategy

30. Trading markets vs. Production markets
Competitive process in different market settings
Mishari Alnahedh
For competitive advantage to exist, there must be some imperfection (or inefficiencies) of competition
What types of resources and capabilities are necessary to compete?
What are the circumstances of the availability of the resources and capabilities?
Trading markets vs. Production markets
Trading involves arbitrage across space (trade) and time (speculation)
Production involves the physical transformation of inputs into outputs

31. Competitive advantage and imperfections in the competitive process
Mishari Alnahedh
SOURCE OF
IMPERFECTION
OF COMPETITION
OPPORTUNITY
FOR COMPETITIVE
ADVANTAGE
MARKET
TYPE
TRADING
MARKETS
None (efficient markets)
Imperfect information availability
Transactions costs
Systematic behavioral trends
Overshooting
None
Insider trading
Cost minimization
Superior diagnosis
(e.g.... chart analysis)
Contrarianism
Barriers to imitation
Barriers to innovation
Identify barriers to imitation (e.g. deterrence, preemption, causal ambiguity, resource immobility, barriers to resource replication) & base strategy upon them.
Difficult to influence or exploit.
PRODUCTION
MARKETS

32. Trading markets Production markets
Sources of imperfections to the competitive process
Mishari Alnahedh
Trading markets
Imperfect availability of information
Transaction costs
Systematic behavioral trends
Overshooting as a result of imitation
Production markets
Barriers to imitation
Barriers to innovation

33. How long will it be before the first rival imitates the first mover?
Barriers to Imitation
Mishari Alnahedh
How long will it be before the first rival imitates the first mover?
How fast does new imitation occur once it starts?
These two factors determine “appropriability”

34. Barriers to Imitation REQUIREMENT FOR IMITATION ISOLATING MECHANISM
Mishari Alnahedh
REQUIREMENT FOR IMITATION
ISOLATING MECHANISM
Identification - Obscure superior performance
- Deterrence--signal aggressive
Incentives for imitation intentions to imitators
- Pre-emption--exploit all available
investment opportunities
- Rely upon multiple sources of
Diagnosis competitive advantage to create
“causal ambiguity”
- Base competitive advantage upon
Resource acquisition resources and capabilities that are
immobile and difficult to replicate

35. Barriers to Innovation
Mishari Alnahedh
The more complex an industry in terms of multi-dimensionality of customer choice criteria and the number of value chain activities, the greater the potential for creating “new game” strategies
New rules of the game
Value chain reconfiguration such as disintermediating
Innovative business models to create value for customers from novel experiences, products, product delivery or bundling, process technologies, and organizational formats

36. How does one generate competitive advantage?
Generating and Sustaining Competitive Advantage
Mishari Alnahedh
How does one generate competitive advantage?
How does one sustain competitive advantage?
Consider the following three strategies
Market Share
Learning curves
Corporate Culture

37. Market share is no guarantee of success. - Remember Kodak ?
Does market share generate competitive advantage
Mishari Alnahedh
The computer industry is an excellent example of the lack of correspondence between market share and profit rates.
IBM was a clear market leader in terms of market share, but had only mediocre profit performance relative to its rivals.
Market share is no guarantee of success. - Remember Kodak ?

38. Perhaps high market share causes high profit rates.
Does market share generate competitive advantage
Mishari Alnahedh
Perhaps high market share causes high profit rates.
But it could equally well be that there is a third factor (e.g., good service capabilities), unobserved by us, that causes both high profitability and high market share.
In this case, we would see a correlation between profitability and market share, but no causal explanation.
Costs of acquiring market share offset the returns to market share.
Market share can generate advantage when there are significant economies of scale.

39. When can market share work to generate and sustain and advantage?
Does Market Share Generate Competitive Advantage?
Mishari Alnahedh
When can market share work to generate and sustain and advantage?
Scale economies, combined with high exit costs, may show a defensible advantage.
High exit costs:
Invest in large and specialized assets (commitments) that make exit difficult.
These “exit barriers are entry barriers.”

40. How does a learning curve effect generate an advantage?
Learning curve and competitive advantage
Mishari Alnahedh
How does a learning curve effect generate an advantage?
To the extent that the firm is first in the market, it may, through the operation of the learning curve, have lower costs than new rivals.
Thus, learning curve effects may meet our first criterion of giving initial relative advantage.

41. What about the imitation issues for sustaining advantage?
Learning curve and competitive advantage
Mishari Alnahedh
What about the imitation issues for sustaining advantage?
Learning curve effects can lead to sustained competitive advantage:
If the learning curve effects remain within the firm; and
If the learning curve effects persist in the face of technological change.

42. Corporate culture and competitive advantage
Mishari Alnahedh
Organizational culture refers to the complex set of ideologies, symbols, and core values shared throughout the firm and that influences the way it conducts business. It is the social energy that drives --- or fails to drive --- the organization.

43. How can corporate culture generate advantage?
Corporate culture and competitive advantage
Mishari Alnahedh
How can corporate culture generate advantage?
An organization’s culture creates value, because it allows that organization to strike deals with its suppliers, customers, and employees that are not available to other firms.
Thus, culture is an organizational asset.

44. Corporate culture and competitive advantage
Mishari Alnahedh
How can corporate culture be a source of sustained competitive advantage?
Corporate culture is hard for another firm to imitate.
In fact, an organization may have difficulty in replicating its own culture in other geographic areas.
“Invisible” or intangible assets like corporate culture are often the only sustainable source of competitive advantage, primarily because such advantages are so difficult to imitate.

45. Today’s Main Takeaway
Mishari Alnahedh
A firm can earn a rate of profit in excess of its cost of capital either
by locating in an attractive industry or
by establishing a competitive advantage over its rivals
Of these two sources of superior profitability, competitive advantage is the more important
Two primary components of the analysis of competitive advantage are:
External sources of competitive advantage
Internal sources of competitive advantage
In this session, we focused on the relationship between competitive advantage and the competitive process