0. Crafting Business Strategy
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 5
Evaluate the quality of the firm’s strategy

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

3. A FIRM’S CHOICE OF POSITION DEPENDS ON TWO FACTORS
Firm’s resources and capabilities 1
Industry structure 2

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

5. THE STRATEGIC POSITIONING MODEL
Broad (i.e., industry wide)
Broad low-cost leadership
Broad differentiation
Strategic target
Narrow (i.e., particular segment only)
Focused cost leadership
Focused differentiation
Low-cost
Differentiation
Strategic advantage
Adapted from poster, M Competitive strategy, 1980.

6. LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET SHARE AND/OR PROFITS
Examples
Benefits
Low-cost leadership
Differentiation
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. STRATEGIC POSITIONING EXAMPLES
Wal-Mart
Gallo Wines
Trek Bicycles
Coca-cola
Broad
Strategic target
Montague
Mercedes Benz (in US)
Narrow
Jet Blue
Low-cost
Differentiation
Strategic advantage

8. LOW-COST AND DIFFERENTIATION CAN GENERATE HIGH MARGINS2
LOW-COST AND DIFFERENTIATION CAN GENERATE HIGH MARGINS
Product cost
Producer’s margin
Buyer’s cost*
Price
Hyundai Elantra
Hyundai has a cost advantage
Price
Chevy Cavalier
Price
Honda has a differentiation advantage
Honda Civic
* Including maintenance and other intangibles

9. RESULTS OF DIFFERENTIATED, LOW-COST, AND INTEGRATED POSITIONS40
RESULTS OF DIFFERENTIATED, LOW-COST, AND INTEGRATED POSITIONS
Price
Cost
Industry average price
Industry average cost
Industry average competitor
Successful differentiated competitor
Successful low-cost competitor
Competitor with both advantages (integrated)

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

11. ECONOMIES OF SCALE Economies of scale
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)
Learning
Economies of scope
Production technology
Product design
Location

12. DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE
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
Learning
Economies of scope
Production technology
Product design
Location

13. MINIMUM EFFICIENT SCALE (MES)
Average cost
Economies of scale
Minimum efficient scale: The minimum scale needed to achieve maximum cost savings (i.e., minimum costs)
Learning
Economies of scope
Production technology
Product design
Scale of operations
Location
Economies of scale
Diseconomies of scale

14. LEARNING CURVE AS A SOURCE OF COST ADVANTAGE
Economies of scale
How Learning Differs from Scale
Learning
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
Economies of scope
Production technology
Product design
Location

15. LEARNING CURVE (continued)
Step 1: Measure
Economies of scale
No. of bikes produced
Hours spent on last bike
Step 2: Calibrate 1 2 4 8 16 32 64
128
30.00 actual
27.00 actual
24.30 actual
21.87 est.
19.68 est.
17.71 est.
15.92 est.
14.34 est.
y = ax-b
Learning
Economies of scope
Production technology
Product design
Step 3: Project
Location

16. ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE
Economies of scale
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
Learning
Economies of scope
Production technology
Product design
Location

17. PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE
Economies of scale
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)
Learning
Economies of scope
Production technology
Product design
Location

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

19. LOCATION AS A SOURCE OF COST ADVANTAGE
Economies of scale
Learning
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)
Economies of scope
Production technology
Product design
Location

20. KEY DRIVERS OF DIFFERENTIATION ADVANTAGES
Purpose
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
Recoup added costs and
Generate enough profits to make strategy worthwhile

21. DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE
Economies of scale
Learning
Economies of scope
Superior technology
Product design
Location
Drivers
Threats
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

22. STRATEGIES FOR DIFFERENT PHASES OF THE INDUSTRY LIFE CYCLE
Phases of in- dustry life cycle
Arenas
Vehicles
Differentiators
Staging
Economic Logic
Local
Internal 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
Embryonic
Growth
Mature
Decline

23. TESTING THE QUALITY OF A STRATEGY
Key Evaluation Criteria
Sub-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?

24. SUMMARY
Define generic strategies and show how they relate to a firm’s strategic position 1
Describe the drivers of low-cost, differen-tiation, 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

25. Class Exercise Find a strategy concept for a new Las Vegas restaurant
Use concepts from this chapter to show how it will make money

26. Competitive Positioning: Game Theory
Companies are players that are simultaneously making choices
The potential profitability varies depending on the strategy one company selects and the strategies that its rivals select
Sequential move and simultaneous move games
Look forward and reason back

27. A Decision Tree for UPS’s Pricing Strategy

28. A Payoff Matrix for GM and Ford

29. Extension
IPDEO
Australian auction