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

62

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.

63

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

64

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.

65

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
66

EXHIBIT 6.1

Industry and Firm Effects Jointly Determine Competitive Advantage

68

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.

69

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.

610

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.

612

Sustainable Competitive Advantage

Costly Duplication due to:

Historical Conditions; Uncertainty; Social Complexity; and

Property Rights Protection.

613

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.

614

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

615

Forms of Competitive Advantage

Cost Advantage Similar Product At Lower Cost

Competitive Advantage

Price Premium From Unique Product

Differentiation Advantage

616

EXHIBIT 6.2

Strategic Position and Competitive Scope: Generic Business Strategies

617

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.

618

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.

622

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
623

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
124 6

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

625

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

126 6

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

627

EXHIBIT 6.5

Economies of Scale and Diseconomies of Scale

30

"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) !!
631

Learning Curve: Sources of Gain

Need less time to instruct workers Workers become more skillful in their movements

Develop better operation sequences

Machines and tooling are continually improved Rejections and rework decrease Management controls improved Engineering changes become less frequent Cost-effective improvements in product design Enriched knowhow in managing and operating business More efficient inventory handling and distribution methods
632

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;

Experience advantages are often nullified by product

obsolences and innovations.

633

Learning Curve
The following discussion and applications focus on direct labor hours per unit, although we could as easily have used costs. In developing a learning curve, we make these assumptions:
Direct labor requirements will decrease at a declining rate as

cumulative production increases. The reduction in time will follow an exponential curve. In other words, the production time per unit is reduced by a fixed percentage each time production is doubled. We can use a logarithmic model to draw a learning curve. The direct labor required for the nth unit, kn, is

kn = k1 nb where k1 = direct labor hours for the first unit n = cumulative number of units produced b = log r/log 2 r = learning rate

634

Learning Curve
Example: The Bellweather Company has a contract for 60 portable electric generators. The labor-hour requirement for manufacturing the first unit is 100. With that as given, Bellweather planners develop an aggregate capacity plan using learning-curve calculations. They use a 90 percent learning curve, based on previous experience with generator contracts.

The labor requirement for the second generator is: k 2 = k 1 nb = 100 (2)log 0.9/log 2 = 100 (2)-.152 = 100 (.9) = 90 hours
This result for the second unit, 90, is expected, since for a 90% learning curve there is a 10% percent learning between doubled quantities.

635

Learning Curve
Example: The Bellweather Company
For =

the 8th unit,

100 (8)-.152 = 100 (0.729) = 72.9 hours

This

result is also obtained by 100 (.9) (.9) (.9) = 72.9 hours.

Learning curves can be used for:

Bid Preparation Financial Planning Production Scheduling
636

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

638

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.

639

EXHIBIT 6.7

Competitive Positioning and the Five Forces

640

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.

641

EXHIBIT 6.8

Avon Pursuing an Integration Strategy

642

EXHIBIT 6.9

Value and Cost Drivers

643

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

644

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.

645

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
646

EXHIBIT 6.10

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

6-47

648