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Gaining and Sustaining Competitive Advantage

Firm strategy should develop and exploit valuable, rare and costly-to-imitate resources, leading to sustained competitive advantage and above normal performance

Preliminaries
Strategy formulation, not implementation No silver bullet, magic formula A bit of luck Proactive vs. reactive

The Many Definitions of Strategy


a firms theory about how to compete successfully. (J.

Barney) the way to achieve organizational objectives. (Hatten & Hatten) commitments and actions designed to exploit core competencies and gain competitive advantage. (Hitt, Ireland & Hoskisson) a plan that specifies which choices (the player) will make in every possible situation. (Von Neumann & Morgenstern)

Strategy and Competitive Advantage


Competitive advantage - when strategy (1) is consistent

with underlying economic processes, (2) creates value, and (3) is unique or rare.
Competitive parity - when strategy (1) is consistent with

underlying economic processes, (2) creates value, but (3) is not unique or rare
Competitive disadvantage when strategy fails to create

economic value.

General Model of Strategic Management

Company Profile ( SWOT )

Mission

Objectives

Strategies

Tactics

Industry & Environmental Analysis ( SWOT )

General Model of Strategic Management


Mission - Fundamental purpose, how firm differs from its

rivals
Objectives - Measurable performance targets, financial

and/or strategic
Strategies means, plans or commitments to achieve a

firms mission and objectives

Tactics - Actions or policies to implement strategy Company Profile strengths and weaknesses of a firm Environmental Analysis opportunities, threats,

characteristics and trends of the industry and society

Mission Statements

Benefits of having a mission statement

unanimity of purpose employee motivation culture / focal identity allocating resources

Disadvantages of mission statement? Improved performance?

Why dont all companies have mission statements?

Typical Components of a Mission Statement

Primary market or technology Goals: growth, profitability, survival Basic beliefs, company philosophy Public image, self-concept Customers Quality

Geisingers Mission Statement


Enhancing quality of life through an integrated health service organization based on a balanced program of patient care, education, research and community service.

Nikes Mission Statement


To bring inspiration and innovation to every athlete in the world.

Southwest Airlines Mission Statement


The mission of Southwest Airlines is dedication to the highest quality of customer service delivered with a sense of warmth, friendliness, individual pride, and company spirit.

Dells Mission Statement


Dell's mission is to be the most successful computer company in the world at delivering the best customer experience in markets we serve. In doing so, Dell will meet customer expectations of: Highest quality Leading technology Competitive pricing Individual and company accountability Best-in-class service and support Flexible customization capability Superior corporate citizenship Financial stability

UNLVs Mission Statement


The University of Nevada, Las Vegas, located in the vibrant and dynamic city of Las Vegas and surrounded by the Mojave Desert, is emerging as a premier urban university. UNLVs development embraces the traditional values of higher education adapted for the global community of the 21 st century. The university increasingly will concentrate its resources on programs that are student centered, demonstrably excellent, and responsive to the needs of the local and regional community. UNLV promotes an environment that encourages the full personal and professional development of those it serves and of those who serve the university. UNLV assists students in meeting the intellectual and ethical challenges of responsible citizenship and a full and productive life through opportunities to acquire the knowledge and common experiences that enhance critical thinking, leadership skills, aesthetic sensitivity, and social integrity. The university provides traditional and professional academic programs for a diverse student body and encourages innovative and interdisciplinary approaches to teaching, learning, and scholarship. Recognizing the individuality of each student, UNLV simultaneously engenders collegial relationships and a sense of community among its members. UNLV embraces the interdependence of quality instruction, scholarly pursuits, and substantive involvements in campus and community life. The university offers artistic, cultural, and technical resources and opportunities to the broadest possible community. It promotes research programs and creative activities by students and faculty that respond to the needs of an urban community in a desert environment. UNLV is committed to developing a synergy between professional and liberal studies, between undergraduate education and graduate programs, and between superior teaching and meaningful research. UNLV increasingly is a dynamic resource for, and partner with, the community that it serves.

Items Examined in the Company Profile


The general strengths and weaknesses of a firm
Performance and Financial position Leadership Org. structure Culture Strategic issues by functional area Value chain

Industry and Environmental Analysis


Opportunities, threats, characteristics and trends of the industry and society
Industry characteristics analysis Porters Five Forces Model

Stage of industry evolution


Stakeholder analysis Environmental assessment Competitor analysis

Setting Objectives
Purpose of setting Objectives is to:

convert mission into performance targets create yardsticks to track performance establish goals that require stretch push firm to be inventive, focused

Setting Objectives
Set challenging but achievable objectives, but guard

against: Complacency Drift Internal confusion Status quo performance


Financial and strategic objectives

Financial Objectives
Objectives that relate to improving firms financial

performance
Examples

increase ROI from 15% to 20% maintain AA bond rating increase earnings growth from 10% to 15% Other examples?

Strategic Objectives
Improvement in competitiveness or market position Examples

Increase market share from 15% to 18% Surpass rivals on customer service Achieve lower cost than competitors Achieve technological superiority Other examples?

Types of Strategies
Business strategies (competitive) Corporate strategies (alliances, M & A) Porters generic strategies the general strategic

orientation of the firm. Cost leadership Differentiation Focus or niche


Emergent strategies

Tactics
Actions to implement strategy Policies and procedures to get line employees to follow the

firms strategy
Messy issues of strategy implementation, not formulation

Measuring Performance

Organizational performance is a complicated concept multiple methods, each with different uses and flaws

Multiple Measures of Performance


Example Survival Stakeholder Accounting Measures Adjusted Accounting methods Pros Easy to apply Conceptually sound Popular, Easily understood Accuracy, Comparability Cons Bankruptcy or Death of a firm Difficult to apply Managerial discretion, Short-term bias, intangible resources Measurement problems, CAPM, intangible resources

Measures of How Well Present Strategy is Working


Performance Test (Thompson & Strickland)

Strategy fits firms environment Builds competitive advantage Improves strategy performance measures
Common measures of strategy performance

Change in firms market share Trend in profit margins relative to rivals or industry average Composite measures of financial strength Trend in firms stock price Firms reputation with its customers Product quality Service quality Employee satisfaction / morale

Accounting Measures of Performance: Liquidity Ratios


The ability of a company to meet its short-term obligations.

Current ratio

Current assets Current liabilities

Quick ratio

Current assets inventory Current liabilities

Accounting Measures of Performance: Solvency Ratios (Leverage)


Ability to meet long term debt payment Total debt Total assets Total debt Shareholders equity EBIT Total interest charges

Debt to assets

Debt to equity

Times interest earned

Leverage Example
Assumptions: 50 shares outstanding Option A: borrow $100 @ 10 % Option B: sell 50 shares @ $2 Good Year Option A Option B Sales Cost of Goods Gross Profit Admin. Interest exp Net Profit Shares Outstanding Profit / share 100 65 35 10 10 15 50 0.30 100 65 35 10 0 25 100 0.25 Bad Year Option A Option B 80 52 28 10 10 8 50 0.16 80 52 28 10 0 18 100 0.18

Accounting Measures of Performance: Funds Management / Activity Ratios


How the companys investment in productive assets is managed

Inventory turnover

Cost of goods sold Average inventory

Accounts receivable turnover

Annual credit sales Accounts receivable

Average collection period

Accounts receivable Average daily sales

Accounting Measures of Performance: Profitability Ratios


Profit or return on operations Return on assets (ROA)

Profit Total assets


Profit Stockholders equity Profit # shares outstanding

Return on equity

Earnings per share (EPS)

Gross profit margin

Sales cost of goods sold sales

Adjusted Accounting Measures of Performance


Return on invested capital (ROIC) Economic profit (EP) Market value added (MVA) Tobins q

Note:

these measures can be difficult to compute and more appropriate to finance than strategy. Our interest is in developing an intuitive understanding how they compare, contrast and can be used.

Return on Invested Capital


The return or profit a firm makes on the investment it has in

its operations + current assets + fixed assets - net other assets (other assets other liabilities) - non-interest bearing current liabilities (A.P.) Invested capital

Economic Profit
Reports, in dollar terms, the actual economic profit the firm

made EP = Invested capital x (ROIC WACC)

note:

ROIC and WACC are percentage terms. If the difference is positive, EP will also be positive.

Market Value Added


Measure that characterizes the long-term performance of a

firm market value of equity + market value of debt - economic book value MVA note: this measure is also difficult to calculate, especially determining the amount invested in the firm since inception.

Tobins q
Ratio of a firms market value to replacement cost of its

assets q = firm market value / firm book value

where

market value of common stock + market value of preferred stock + book value of short-term debt + book value of long=term debt firm market value

Make Meaningful Comparisons


Industry and sector data often readily available Comparison with past performance Stage of industry evolution Benchmarking with competitors US and industry averages Industry success factors

Evaluating Environmental Threats

A firms strategy should neutralize environmental threats.

General Model of Strategic Management

Company Profile ( SWOT )

Mission

Objectives

Strategies

Tactics

Industry & Environmental Analysis ( SWOT )

Evaluating Environmental Threats


Origins of the Structure Conduct Performance Model Tools to evaluate environmental threats

Industry characteristics analysis Stakeholder analysis Porters Five Forces Model Competitor analysis

The Structure Conduct Performance Model


Number of competing firms, homogeneity of products, cost of entry and exit Price taking, product differentiation, tacit collusion, exploit market power

Industry Structure

Firm Conduct

Performance

Firm: above, normal, below Society: social welfare implications

Type of Industry = Perfect Competition


Large number of firms, homogeneous products, low cost of entry and exit

Industry Structure

Firm Conduct

Price taking

Performance

Firm: normal Social welfare: maximized

Industry Examples?

Type of Industry = Monopolistic Competition


Large number of firms, heterogeneous products, low cost of entry and exit

Industry Structure

Firm Conduct

Cost leadership, Product differentiation

Performance

Firm: above normal Social welfare: less than perfect competition

Industry Examples?

Type of Industry = Oligopoly


Small number of firms, costly entry and exit

Industry Structure

Firm Conduct

Many options, including collusion


Firm: above normal Social welfare: less than monopolistic competition

Performance

Industry Examples?

Type of Industry = Monopoly

Industry Structure

Only one competing firm, costly entry

Firm Conduct

Uses market power to set prices

Performance

Firm: above normal Social welfare: less than oligopoly

Industry Examples?

Industry Characteristics Analysis


Market size Market growth rate Number and size of rivals Scope of rivalry Number and size of buyers Number and size of suppliers Substitute products Ease of entry / exit

Distribution channels Economies of scale Learning curve Capacity utilization Average industry profitability Pace of technological change

Stakeholder Analysis
People or groups who have an interest, claim, or stake in how well the firm performs shareholders employees suppliers unions general public managers customers government community

Evaluating Environmental Threats: Porters Five Forces Model


What determines the degree of industry competition and profitability?
Threat of entry Threat of rivalry

Threat of suppliers

Industry profitability

Threat of buyers

Threat of substitutes

Porters Five Forces Model Barriers to Entry


Economies of scale Product differentiation Cost advantages independent of size

(Technology, know-how, access to raw materials, geographic locations, learning curve)


Contrived deterrence Government policy Capital requirements *

Switching costs *
Access to distribution channels *

* Some disagreement among scholars

Porters Five Forces Model Intensity of Rivalry


Many competitors Similar in size Slow rate of industry growth Product lacks differentiation

Capacity added in large increments


High level of fixed costs Exit barriers are high Reputation or past history

Porters Five Forces Model Substitute Products


Products that appear to be different but satisfy the same

need Customer switching costs are low good examples butter vs. margarine calculators vs. slide rules tape b/u vs. CD burner bad examples Coke vs. Pepsi Honda vs. Toyota

Porters Five Forces Model Bargaining Power of Buyers/Customers


Small number of buyers Purchase products that are standard or undifferentiated Industry products represent a large share of buyers total

cost
Unimportant to final quality of product
Product does not save the buyer money Buyer may integrate backward

Porters Five Forces Model Bargaining Power of Suppliers


Supplier has few competitors Supplier offers a unique product Substitutes not readily available Supplier can integrate forward

Firm or industry purchases represent small share of

suppliers total sales

Evaluating Environmental Opportunities

A firms strategy should exploit environmental opportunities

General Model of Strategic Management

Company Profile ( SWOT )

Mission

Objectives

Strategies

Tactics

Industry & Environmental Analysis ( SWOT )

Evaluating Environmental Opportunities


Separation of opportunities and threats Tools to evaluate environmental opportunities

Industry structure Industry evolution Strategic group analysis Environmental assessment

Environmental Opportunities and Industry Structure


Industry structure Fragmented Opportunity Economies of scale through consolidation First mover or winner take all strategies

Networking

Hyper-competitive

Flexibility Proactive disruption


Collusion Government regulation Product differentiation

Empty-core

Environmental Opportunities and Stage of Industry Evolution


Determinants of success may differ depending on the stage of industry evolution

Emerging Growth Maturity Decline

Newly formed innovations, changes in demand, needs

Rapid increases in capacity and unit sales, dominant technology emerges


Slowing growth rate, increased competition, experienced customer base. Consistent decline in unit sales, overcapacity

Strategies and Stage of Industry Evolution: Emerging


What does it take to succeed in the Introduction / Emerging stage? Technological leadership Experience curve Dominant technology Preempt strategically valuable assets Create customer switching costs / loyalty Industry Examples?

Strategies and Stage of Industry Evolution: Growth Stage


What does it take to succeed in the growth stage?

Marketing and promotion aimed at brand recognition Expanding the product line Financial strength to accommodate growth Strong marketing channels

Industry Examples?

Strategies and Stage of Industry Evolution: Mature


What does it take to succeed in the mature stage?

Product refinement extensions, packaging Emphasis on process innovation Lower costs Higher quality Differentiation / emphasis on service Horizontal integration International expansion

Industry Examples?

Strategies and Stage of Industry Evolution: Decline


What does it take to succeed in the declining stage?

Market leadership Focus on growth segments niche strategy Emphasize production and distribution efficiency Gradually harvest the business Prune the product line Preferred customer selection Defer equipment maintenance and repair Divestment

Industry Examples?

Environmental Opportunities and Strategic Group Analysis


Strategic group a subset of firms in an industry that appear to compete on similar dimensions. Examples: Mercedes, Acura, Lexus Timex, Casio, Polar Nike, New Balance, Asics

Plotting a strategic group map: (1) Identify relevant dimensions (2) Locate firms (3) Group nearby firms (4) Look for potential opportunities

Strategic Group Map Athletic Shoes

Q u a l i t y

Nike Asics NB

Converse Keds

Number of Models

Environmental Assessment
Monitoring early signals, changes or trends in the firms external environment; anticipating or forecasting these trends; assessing how these changes or trends will affect firm operations.

Major components: Demographics Economic Political / legal Socio-cultural Technological

Evaluating Firm Strengths and Weaknesses

A firms strategy should exploit firm strengths while avoiding or correcting weaknesses

Three Traditional Perspectives on Firm Strengths and Weaknesses


1. Theories of distinctive competence

General managers their decisions have great impact Pros high appeal and validity Cons positive traits are ambiguous Institutional leadership - creates vision, organization and structure Pros intuition, strong appeal Cons sr. managers not only source of advantages

Three Traditional Perspectives on Firm Strengths and Weaknesses


2. Ricardian Economics

Little role for management Original, indestructible gifts of nature (land) Inelastic supply function High quality factors of production quantitative, testable theory numerous resources are inelastic natural shift in demand curve other contributing factors

Pros: Cons:

Three Traditional Perspectives on Firm Strengths and Weaknesses


3. Penroses Theory of Firm Growth

administrative framework bundle of productive, heterogeneous resources


Pros: Cons: introduced heterogeneity broad definition of productive resource

Other theories of the firm 4. Population Ecology 5. Transaction cost 6. Agency theory

Resource Based View of the Firm


Dominant theoretical perspective Resources, capabilities, competencies Assumptions

Resource heterogeneity Resource immobility Firms are bundles of productive resources Financial capital Physical capital Human capital Organizational capital

Discovering Sustained Competitive Advantage: The VRIO Framework


Value when resources and capabilities enable the firm to

respond to threats and opportunities


Rarity when resource is controlled by a small number of

competing firms
Imitability the degree that the resource can be duplicated

or substituted
Organization how the firm is structured, organized and

managed to exploit valuable, rare and costly to imitate resources.


Some examples

Applying the VRIO Framework


Costly to Imitate -Competitive Implication * Disadvantage Economic Performance Below Normal

Valuable No

Rare --

Yes
Yes Yes

No
Yes Yes

-No Yes

Parity
Temporary Advantage Sustained Advantage

Normal
Above Normal Above Normal

* Assumes firm is organized to exploit resource

Strategy Implications of the Resource-based View


Broader responsibility for competitive advantage Better to exploit firms existing valuable, rare and costly to

imitate resources, rather than mimic other successful firms Relative cost of difficult to implement strategy should be compared to its value Socially complex resources can be source of competitive advantage Firms structure, control systems and compensation policies should change if they conflict with firm resources or capabilities

Limitations of VRIO Framework


Sustained competitive advantage and unexpected

environmental change (Shumpeterian revolutions)


Managerial influence imitability paradox

Unit of analysis shifts from industry to intra-firm (consider

value chain example)

Generic Strategy: Cost Leadership

A cost-leadership strategy attempts to gain competitive advantage by reducing production or service costs below those of competitors

Sources of Cost Advantages


Economies of scale

Specialized machines Cost of plant and equipment Employee specialization Overhead

Diseconomies of scale

Physical limits to efficient size Managerial diseconomies Worker motivation Distance to markets and suppliers

Sources of Cost Advantages (contd.)


Learning curve

(learning curve v. economies of scale)


Access to factors of production

(land, labor, capital, raw materials)


Technological hardware

(other than what is used for production)


Technological software Policy choices

(choices about which products/services to offer)

Cost Leadership and Porters Five Forces


Reduces threat of entry how? Reduces threat of rivalry how? Reduces threat of substitutes how? Reduces threat of suppliers how? Reduces threat of buyers how?

Cost Leadership and VRIO Framework Which Sources of Cost Advantages Are Rare?

Learning curve

More likely to be rare

Factors of production Technological software Diseconomies of scale Policy choices

Less likely to be rare

Economies of scale Technological hardware

Cost Leadership and VRIO Framework Which Sources of Cost Advantages Are Costly to Duplicate?
Technological software

Costly to duplicate

Factors of production Policy choices Technological hardware Learning curve

Less costly to duplicate

Diseconomies of scale Economies of scale

Why Are These Sources Costly to Duplicate?


Source of Advantage
Technological software Factors of production Policy choices Technological hardware Learning curve Diseconomies of scale Economies of scale

History very likely very likely Somewhat likely -Somewhat likely ---

Uncertainty likely --Somewhat likely ----

Social Complexity very likely likely -Somewhat likely ----

Cost Leadership and VRIO Framework Organizing to Implement Cost Leadership


Simple U-form structure

(few layers, small staff, narrow range of business)


Tight management control systems

(close supervision, quantitative goals, cost-leadership orientation)


Compensation policies

(reward for cost reduction, incentives for all)

Generic Strategy: Product Differentiation

A product differentiation strategy attempts to gain competitive advantage by increasing the perceived value of products or services relative to that of the competition

Bases of Product Differentiation


Conceptual

Empirical

Product features Intra-firm linkages Timing Location Product mix Inter-firm linkages Reputation Product customization Product complexity Consumer marketing Distribution channels Service and support

Product Differentiation and VRIO Framework Which Bases Are Costly to Duplicate?
Reputation
Distribution channels

Costly to duplicate

Intra-firm linkages Timing Location Service and support Inter-firm linkages Product customization Product mix

Consumer marketing

Less costly to duplicate

Product complexity Product features

Why Are These Bases Costly to Duplicate?


History Reputation Distribution channels Intra-firm linkages Timing Location Service & support Inter-firm linkages Product customization Product mix Consumer marketing Product complexity Product features very likely Likely Somewhat very likely very likely Somewhat Somewhat Somewhat Somewhat -Somewhat -Uncertainty Complexity Likely Somewhat Somewhat Somewhat -Somewhat --Somewhat Likely --very likely Likely Likely --Likely Likely Likely Somewhat -Somewhat --

Resolving Organizing Dilemmas for Product Differentiation Strategies


Dilemma Intra-firm collaboration Potential resolution U-form structure Teams Decentralized decision making Employee empowerment

Institutional control

Connection to the past

Blend old and new Culture management


Policy of experimentation Tolerance for failure

Commitment to market vision

Implementing Both Cost Leadership and Product Differentiation Strategies


The Pros..
Product differentiation leads

The Cons..
Requires different

to increased sales, which lead to economies of scale, learning and other cost reductions
Empirical research supports

organizational structures
Management control systems

differ dual strategies


Porter has backed off the
Differences in compensation

policy design

stuck in the middle argument

Strategic Alliances

Types of alliances, sustained competitive advantage, and cheating in alliances.

Types of Strategic Alliances


Alliances exist whenever two or more independent firms cooperate to develop, manufacture or market products or services are governance mechanisms between the spot market and organizational hierarchy rapidly growing form of governance
Non-equity Alliances

Equity Alliance
Joint Venture

Motivations for Strategic Alliances: Economies of Scope


Economies of scale Learning from competitors Sharing risks and costs Facilitate tacit collusion Low-cost market entry Low-cost industry entry Low-cost exit Managing uncertainty

Cheating in Alliances
Adverse selection partner misrepresents skills and

abilities
Moral hazard partner has high quality skills and abilities,

but invests lower quality than promised


Holdup partner exploits transaction-specific investments

that other partner(s) make

Some examples

Strategic Alliances and Sustained Competitive Advantage


Evaluation of competitive advantage follows VRIO framework.
Value: NPV ( firm A + firm B ) > NPV ( A ) + NPV ( B )

i.e., synergy exists


Rare: depends on the number of competing firms

as well as the benefits.


Imitability: alliances can be imitated by direct duplication

and substitution
Organization: to minimize cheating; the key to success

Organizational Tools to Manage Alliances


Explicit contracts Legal sanctions Equity investment Firm reputation Joint venture Trust

Selecting Appropriate Strategies

Strategy should neutralize threats, exploit opportunities and strengths, address firm weaknesses

Types of Strategies
Business level Corporate strategies

Vertical integration Cost leadership Product differentiation Flexibility Tacit collusion

Strategic alliance Corporate diversification Mergers and acquisitions International strategies

Generic Strategies

Strategies To Avoid
Follow the leader Hit another home run Arms race Do everything Losing hand / Sunk cost Stuck in the middle

Some Final Thoughts on Selecting the Best Strategy


Re-examine SWOT analysis

compare expected outcomes to objectives construct corporate scenarios


Consider other behavioral factors

Current or past strategy Degree of external dependence Attitudes toward risk Internal politics Timing Competitive reaction

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