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CHAPTER

Business Strategy: Differentiation, Cost Leadership, and Integration

McGraw-Hill/Irwin

Copyright 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Part 2 Strategy Formulation

LO 6-1
LO 6-2

Define business-level strategy and describe how it determines a firms strategic position.
Examine the relationship between value drivers and differentiation strategy.

LO 6-3
LO 6-4

Examine the relationship between cost drivers and cost-leadership strategy.


Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.

LO 6-5
LO 6-6 LO 6-7

Explain why it is difficult to succeed at an integration strategy.


Evaluate value and cost drivers that may allow a firm to pursue an integration strategy. Describe and evaluate the dynamics of competitive positioning.

Chapter Case 6 Trimming Fat at Whole Foods Market


Whole FoodsBusiness Strategy Revitalization
Started as small natural-foods store 1980 Became market leader; differentiation through

organics and quality


Competitive

advantage through 2008

CEO John Mackey: Refocused Mission, Reduced Costs

Business Strategy and Competitive Advantage A business-level strategy is an integrated and coordinated set of commitments and actions designed to provide value to customers and gain a competitive advantage by utilizing core competencies in specific individual product markets.

Business-Level Strategy: How to Compete for Advantage?


Answer the Who, What, Why, and How
Who - which customer segments to serve?
What needs, wishes, desires will we satisfy? Why do we want to satisfy them? How will we satisfy customers needs?

Details actions managers take in quest for competitive advantage


Single product or group of similar products

EXHIBIT 6.1

Industry and Firm Effects Jointly Determine Competitive Advantage

Business Strategy and Competitive Advantage


Two fundamental questions:
How do you generate advantage? How do you sustain advantage?

Key idea for sustainability is barriers to imitation.


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.

Business Strategy and Competitive Advantage


Does market share generate competitive advantage?
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 economic performance relative to its rivals. High market share is no guarantee of high rates of profitability.

Business Strategy and Competitive Advantage


Does market share generate competitive advantage?
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 at Caterpillar), 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.

Business Strategy and Competitive Advantage When can market share work to generate and sustain an advantage?
Scale economies combined with high exit costs may make

market share a defensible advantage.

Sustainable Competitive Advantage

Costly Duplication due to:


Historical Conditions; Uncertainty; Social Complexity; and

Property Rights Protection.

Business Strategy and Competitive Advantage


An organizations knowledge or expertise can lead to sustainable advantage if:
The knowledge is tacit rather than articulable;
Tacit Knowledge: We know more than we can tell. Tacit Skills: Riding a bike, swimming, learning by doing, which is critical for maintaining a manufacturing base

The knowledge is not observable in use; The knowledge is (socially) complex, rather than simple.

Strategic Position
Determined by Firms Business-Level Strategy
Two primary competitive levers:
Value (V) Cost (C)

Economic Value Created: (V-C)


The greater (V-C) = Competitive Advantage

Strategic Position Based on:


Value creation
Cost

Forms of Competitive Advantage

Cost Advantage Similar Product At Lower Cost

Competitive Advantage

Price Premium From Unique Product

Differentiation Advantage

Generic Business Strategies


Different generic strategies can lead to competitive advantage in the same industry. Differentiation
Higher Value; Unique Features Rolex

Cost-Leadership
Similar Value; Lower Cost Timex

Scope of Competition
Narrow (Focused) Rolex Broad Timex

EXHIBIT 6.2

Strategic Position and Competitive Scope: Generic Business Strategies

LO 6-1 LO 6-2 LO 6-3 LO 6-4 LO 6-5 LO 6-6 LO 6-7

Define business-level strategy and describe how it determines a firms strategic position. Examine the relationship between value drivers and differentiation strategy. Examine the relationship between cost drivers and cost-leadership strategy. Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition. Explain why it is difficult to succeed at an integration strategy. Evaluate value and cost drivers that may allow a firm to pursue an integration strategy. Describe and evaluate the dynamics of competitive positioning.

Types of Competitive Advantage


Buyer value generated (willingness to pay) $ Costs incurred (including opportunity cost of capital)

Value Created

Industry average competitor

Successful differentiated competitor

Successful low-cost competitor

Competitor with dual advantage

2005 Mara Lederman, Rotman School of Management

Differentiation Advantage

Differentiation Advantage, a concept developed by economist Joan Robinson, occurs when a firm is able to obtain from its differentiation a price premium in the market which exceeds the cost of providing differentiation.

EXHIBIT 6.3

Value Drivers: Differentiation

Differentiation:
Product features, customer service, customization, and complements Competitive advantage = economic value created (V-C) > competitors Marriott line of Hotels

STRATEGY HIGHLIGHT 6.1

Toyota: From Perfect Recall to Recall Nightmare

Toyotas strategic challenges.


Launched Lexus 1989

Luxury car segment dominated by Mercedes-Benz, BMW, Cadillac

LS400 line required recall a little over a year after launch

Turned threat into opportunity to establish reputation for superior customer service Two years after launch Lexus ranked first on quality and customer satisfaction by J.D. Powers

2010 Toyota has largest recall in automotive history


Needed to exhibit superior customer responsiveness again 8 million vehicles recalled was much more challenging
125

EXHIBIT 6.4

Cost Drivers: Cost-Leadership

Cost Leadership:
Cost of input factors, economies of scale, and learning-curve and

experience-curve effects
Competitive advantage = economic value created (V-C) > competitors

Walmart vs. Kmart Dell vs. Compaq, Gateway, & HP

STRATEGY HIGHLIGHT 6.2

Ryanair: Lower Cost than the Low-Cost Leader!

The Southwest Airlines of Europe


Lowest-cost airline in the world

No window shades on older planes, seats dont recline, etc.

Fares as low as $8 Numerous fees and surcharges: pillows, blankets, check-in, etc.

20+% of revenues flow from ancillary services


127

Ryanair Sample Revenue Calculation

1 Bottle of Water, $3.50 Ad Revenue, $2 Priority Boarding, $4 Pillow & Blanket, $5 Subsidy from More Expensive Flights, $5.50

Ticket Price, $8

Credit Card Fee, $6

Revenue $87 Cost $70 Profit $17

Online Check-in, $7.50

Checking Two Bags, $45

EXHIBIT 6.5

Economies of Scale and Diseconomies of Scale

31

"Big Box" Retailers' Advantage

Box 2 x 2 x 2 Volume 8

Box 3 x 3 x 3 Volume 27

Cube-Square Rule:
Each dimension increases 50% (2 goes to 3) BUT Each volume increases 237.5% (8 goes to 27) !!

The Learning Curve


Per Unit Cost ($)
120

100

80

60

90%

80% 70% 40
Aircraft Assembly (1925-57): 80% Calculator (1975-78): 74%

20

0 0 50 100 150 200 250

Cumulative Output (units)

EXHIBIT 6.6

Gaining Competitive Advantage Through Learning and Experience Curves

Limits of Learning Curve Advantages


Copying and reverse engineering of products; Hiring a competitors employees; Purchasing the know-how from consultants; Obtaining the know-how from customers; and

Experience advantages are often nullified by innovations.

LO 6-1 LO 6-2 LO 6-3 LO 6-4 LO 6-5

Define business-level strategy and describe how it determines a firms strategic position. Examine the relationship between value drivers and differentiation strategy. Examine the relationship between cost drivers and cost-leadership strategy. Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition. Explain why it is difficult to succeed at an integration strategy.

LO 6-6
LO 6-7

Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.
Describe and evaluate the dynamics of competitive positioning.

EXHIBIT 6.7

Competitive Positioning and the Five Forces

LO 6-1

Define business-level strategy and describe how it determines a firms strategic position.

LO 6-2
LO 6-3

Examine the relationship between value drivers and differentiation strategy.


Examine the relationship between cost drivers and cost-leadership strategy.

LO 6-4
LO 6-5 LO 6-6 LO 6-7

Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.
Explain why it is difficult to succeed at an integration strategy. Evaluate value and cost drivers that may allow a firm to pursue an integration strategy. Describe and evaluate the dynamics of competitive positioning.

EXHIBIT 6.8

Avon Pursuing an Integration Strategy

EXHIBIT 6.9

Value and Cost Drivers

Integration Strategy Corporate Level


Conglomerates can coordinate above the SBU level
Tata Group from India

2008 bought Jaguar & Land Rover Prestigious differentiated products


2009 Tata Motors creates a Nano car Lowest-priced car in the world! Zero to 60 mph in 30 seconds No radio or glove box Targets bicyclists to move to cars

LO 6-1 LO 6-2 LO 6-3 LO 6-4 LO 6-5

Define business-level strategy and describe how it determines a firms strategic position. Examine the relationship between value drivers and differentiation strategy. Examine the relationship between cost drivers and cost-leadership strategy. Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition. Explain why it is difficult to succeed at an integration strategy.

LO 6-6
LO 6-7

Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.
Describe and evaluate the dynamics of competitive positioning.

The Dynamics of Competitive Positioning Strategic Positions need to change over time
eBay withdrew from selling new goods & sold Skype

Productivity Frontier
Value-cost relationship

Captures the best practices at a point in time

Mobile Devices

2005 Apple differentiator, Dell cost leader 2010 Apple still differentiator, HP moving to successful integrator, Dell shifting toward integrator

EXHIBIT 6.10

The Dynamics of Competitive Positioning: Apple, HP, and Dell

Take-Away Concepts
LO 6-1 Define business-level strategy and describe how it determines a

firms strategic position.


Business-level strategy determines a firms strategic position in its quest for competitive advantage in a single industry or product market.

Strategic positioning requires that managers address strategic trade-offs that arise between value and cost, because higher value tends to go along with higher cost.
Differentiation and cost leadership are distinct strategic positions.

Besides selecting an appropriate strategic position, managers must also define the scope of competitionwhether to pursue a specific market niche or go after the broader market.
LO 6-2 Examine the relationship between value drivers and

differentiation strategy.
The goal of a differentiation strategy is to increase the perceived value of goods and services so that customers will pay a higher price for additional features.

Take-Away Concepts
In a differentiation strategy, the focus of competition is on non-price attributes. Some of the unique value drivers managers can manipulate are product features, customer service, customization, and complements.

Value drivers contribute to competitive advantage only if their increase in value creation (V) exceeds the increase in costs (C).
LO 6-3

Examine the relationship between cost drivers and cost-leadership strategy.


The goal of a cost-leadership strategy is to reduce the firms cost below that of its competitors. In a cost-leadership strategy the goal is to reduce the firms costs below that of its competitors. The focus is on lowest-possible price with acceptable quality. Some of the unique cost drivers that managers can manipulate are the cost of input factors, economies of scale, and learning- and experience-curve effects. No matter how low the price, if there is no acceptable value proposition, the product or service will not sell.

Take-Away Concepts
LO 6-4 Assess the benefits and risks of cost-leadership and

differentiation business strategies vis--vis the five forces that shape competition.
The five forces model helps managers use generic business strategies to protect themselves against the industry forces that drive down profitability.
Differentiation and cost-leadership strategies allow firms to carve out strong strategic positions, not only to protect themselves against the five forces, but also to benefit from them in their quest for competitive advantage. Exhibit 6.7 lists benefits and risks of each business strategy.

Take-Away Concepts
LO 6-5 Explain why it is difficult to succeed at an integration strategy. A successful integration strategy requires that trade-offs between differentiation and low cost be reconciled. Integration strategy often is difficult because the two distinct strategic positions require internal value chain activities that are fundamentally different from one another. When firms fail to resolve strategic trade-offs between differentiation and cost, they end up being stuck in the middle. They then succeed at neither strategy, leading to a competitive disadvantage. LO 6-6 Evaluate value and cost drivers that may allow a firm to pursue

an integration strategy.
To address the trade-offs between differentiation and cost leadership at the business level, managers may leverage quality, economies of scope, innovation, and the firms structure, culture, and routines. The trade-offs between differentiation and low cost can either be addressed at the business level or at the corporate level.

Take-Away Concepts
LO 6-7 Describe and evaluate the dynamics of competitive

positioning.
Strategic positions need to change over time as the environment changes. Best practices determine the productivity frontier at any given time. Reaching the productivity frontier enhances the likelihood of obtaining a competitive advantage.

Not reaching the productivity frontier implies competitive disadvantage if other firms are positioned at the productivity frontier.