Subject: Strategy in Action
Case study: Airborne express, question to answer: What must Robert Brazier, Airborne’s President and COO, do in order to strengthen the company’s position?
It is critical thinking in order to answer question, data tables could be used for help for analysis. Class concept should be used: VRIO framework, competitive advantage, industry lifecycle, accounting and economic profitability(will attach the course notes)
Added on 17.02.2015 01:21
Not all concept need to be used, only important one”s that writer wants to analyze and suggest to strengthen company position
Cost Leadership & Product Differentiation
Chapter 6 marks the beginning of Section 2 of the textbook. This section covers business level strategies. This is the beginning of the “Strategic Choices” element of the strategic management process. Having gone through external and internal analysis we are now ready to begin learning about how to use external and internal analysis to make important strategic decisions.
Business level strategy refers to the strategic choices managers make about how to position a specific business and/or product line to gain competitive advantage in a single market or industry. Of course, managers’ decisions concerning the positioning of businesses will be influenced by the results of their external and internal analyses.
Cost leadership and product differentiation are the two main business level strategies that can be further decomposed into broad and focused strategies while a combination of the two strategies will be called an integration strategy. In other words we have five strategies for staking out a market position, operating the business, and delivering value to customers and depend on two major factors: (1) whether a company’s market target is broad or narrow and (2) whether the firm is pursuing a competitive advantage linked to low costs or product differentiation (increase the willingness to pay). These strategies are described below:
1. Broad Cost Leadership: striving to achieve lower overall costs than rivals on products that attract a broad spectrum of buyers.
2. Broad Differentiation: seeking to differentiate the firm’s product offering with attributes that will appeal to a broad spectrum of buyers.
3. Focused (or market niche) Cost Leadership: concentrating on a narrow buyer segment and outcompeting rivals on costs, thus being in position to win buyer favor by means of a lower-priced product offering.
4. Focused (or market niche) Differentiation: concentrating on a narrow buyer segment and outcompeting rivals with a product offering that meets the specific tastes and requirements of niche members better than the product offering of rivals.
5. Integration: giving customers more value for the money by offering upscale product attributes at a lower cost than rivals. Being the lowest cost producer of an upscale product allows a firm to underprice rivals whose products have similar upscale attributes.
Cost leadership and product differentiation are sometimes referred to as generic business level strategies because they represent heuristically two extremes that a firm could choose to pursue. However, as with most of the concepts covered in this course, some firms are better able to gain competitive advantage by pursuing these generic strategies than other firms.
1. COST LEADERSHIP
As the name implies, a cost leadership strategy is intended to generate competitive advantage by achieving costs that are lower than all competitors on products of comparable quality. Of course, if it is relatively easy or inexpensive for rivals to imitate the low-cost firm’s methods, then only a temporary competitive advantage will result.
Our definition of competitive advantage is: the ability to create more economic value than competitors. A firm with lower costs than competitors creates more value because of the greater difference between the firm’s costs and the price the firm is able to charge (i.e., higher profit margins).
1) In a market where competitive pressures (e.g., a commodity-type product) do not allow one firm to charge higher prices than other firms, the firm with a cost advantage will be able to generate more value than competitors.
2) Cost leadership is not necessarily synonymous with low price. It is true, by definition, that the cost leader in a market can charge the lowest price and still have a positive profit. However, a firm pursuing a cost leadership strategy would want to have the advantage of the lowest costs without being forced to charge the lowest price.
3) Firms in a market have a strong incentive not to compete on price with the low cost leader. This is akin to the old boxing adage that: One’s success in the ring has a lot to do with choosing one’s opponent.
Firms have a strong incentive to compete on cost (not price) because of the advantages explained above. Therefore, firms enjoying cost advantages typically face strong competitive pressures on their cost positions. The durability of cost advantages will be discussed later in the Cost Leadership and Competitive Advantage section.
What can we do with this cost leadership?
• Underprice competitors and attract price-sensitive buyers in great enough numbers to increase total profits.
• Refrain from price cutting to steal sales from rivals (might start a price war) and instead charge a comparable price to other low-priced rivals. This will not increase the firm’s market share but it will result in larger profit margin per unit sold and so higher total profits and return on investment.
1.1 SOURCES OF COST ADVANTAGES
Managers facing a strategic decision about how to position a business within an industry need to understand several fundamental cost issues. A sound understanding of these issues will help managers determine whether their focal firm is likely to generate competitive advantage by competing on cost. Alternatively, managers may recognize that other firms have a clear cost advantage and therefore their focal firm should choose to compete on some other basis—such as product differentiation.
Important Point: Sources of cost advantage should be analyzed very objectively. Finding out that the focal firm is not likely to have a cost advantage may be just as valuable as finding out that the focal firm is likely to have a cost advantage.
Six Sources of Cost Advantage (How can we achieve cost leadership)
We will begin with a brief explanation of each one of these sources and move on to a discussion of how managers can determine if these sources of cost advantage are likely to lead to competitive advantage.
Economies of Scale
• exist if the average per unit cost of production falls with an increase in the quantity produced
• exist because of the ‘fixed’ nature of some costs
• suppose the investment cost of a machine is $50,000—whether the machine produces 1,000 pieces or 10,000 pieces the investment cost is the same, the per unit cost falls from $50 to $5
• fixed overhead costs may be spread over larger volumes of production—lowering per unit cost of production
• imply that there is some minimum efficient scale—firms that operate at the minimum per unit cost will have an advantage over firms that have not reached the minimum efficient scale
• exist because of specialized machines and the specialization of employees
• may be achieved through international expansion that increases sales to the point that minimum efficient scale may be reached
Diseconomies of Scale
• arise as production moves beyond the minimum efficient scale—average per unit cost increases as quantity produced increases the firm (or business) has become too large
• physical diminishing returns to scale—machines able to handle larger volumes may be prone to more defective pieces and/or may be so expensive as to result in higher average per unit costs
• transportation costs—trying to cover a vast geographic area from a very large plant may contribute to diseconomies of scale
• human factors—overly bureaucratic, de-motivated
• may result from international expansion if bureaucracy increases and/or if the necessary scale of production exceeds the minimum efficient scale
Learning Curve Economies
• result from people learning a production process so that they get better at the process
• result from cumulative experience
• do not suffer from diseconomies—costs continue to fall with increasing cumulative experience
• typically increase as market share increases—however, market share may be expensive to acquire, potentially offsetting learning curve economies
• may be accelerated through international expansion because of larger volumes
Differential Low-Cost Access to Productive Inputs
• result when firms are able to access inputs at less cost than competitors
• are one of the main motivations behind international expansion—low cost labor and raw materials have often been the target of international expansion
• usually result from some historical artifact—being the first firm to discover the value of a raw material and being able to lock up the source
• are very difficult to achieve if the input is found in competitive markets where the value of the input is known and is subject to any form of bidding
Technological Advantages Independent of Scale
• arise when a technology allows a firm to produce something at lower cost than competitors who do not possess the technology
• fresh vegetable packing operations have traditionally relied on manual inspection of the produce—new technology allows much faster, more reliable, lower cost inspection by passing ultra-violet light through the produce and using pneumatic devices to discard bad produce from the production line
• can sometimes be acquired by firms from developing economies by partnering with international partners from developed economies
• may create cost advantages in two ways:
? firms may decide to produce low cost, highly standardized products and compete on price, and/or,
? firms may develop a cost conscious culture in which managers and other employees are given incentives to constantly look for ways to reduce per unit costs (increase efficiency)
1.2 COST LEADERSHIP AND COMPETITIVE ADVANTAGE – VRIO
To explain how a cost leadership position may generate competitive advantage we will be applying the VRIO model to the cost advantage a firm may have. Recall from Chapter 4 that a resource, in this case the source of a cost advantage, may lead to competitive advantage if it meets the VRIO criteria. The ‘Value’ question is addressed by using the Five Forces model to explain how a cost advantage may generate value for a firm. Thus, the Five Forces model is nested within the VRIO model.
The Value of Cost Leadership
This analysis would be used after it has been determined that the focal firm has a cost leadership position stemming from a source of cost advantage as described above. Also, if competing firms are found to have cost advantages the same logic could be applied to them in explaining why the focal firm probably would not be able to generate a competitive advantage based on cost leadership.
Five Forces Model.
The value of a cost advantage can be explained, at least in part, by showing how the cost advantage may help to neutralize threats in the external environment. If a cost advantage helps to neutralize one or more of the threats, then the cost advantage would be considered ‘valuable’ within the VRIO model.
Threat of Entry
• a cost advantage presents a barrier to entry because would-be entrants face the investment cost of matching an incumbent’s cost position
? incumbents typically face lower opportunity costs because they have made a series of investments over time that are now sunk costs whereas entrants face relatively higher opportunity costs with a large one-time investment to enter a new business
• the threat of entry by international competitors should be taken into account
Threat of Rivalry
• a cost advantage can be used to manage the threat of rivalry
? a recognized cost leader can establish a price in a competitive market and other firms will not rationally go below that price, thus attenuating rivalry
? an unrecognized cost leader can choose to either:
? meet the competitive price and enjoy wider margins than competitors without alarming competitors with lower prices, or
? offer a lower price to gain market share from competitors—this is rational only if the increased market share offsets the lower margins
• if a firm chooses to offer lower prices, then it can expect increased rivalry
? a lower price strategy gives competitors incentive to focus on lowering costs which may put the focal firm’s cost advantage in jeopardy
? thus, the focal firm should carefully analyze the likely responses of competitors
Threat of Substitutes
• a cost leader’s market offering is more attractive if the price to consumers is less than the price of substitutes
? cost leaders are in a position to respond with lower prices, if necessary, to keep their offerings more attractive vis-à-vis substitutes
Threat of Suppliers
• cost leaders in a market typically have large market share—meaning they will be important customers to the suppliers in the industry
? the threat of suppliers will be reduced because of the suppliers desire to keep the cost leader as a customer—nobody wants to lose their best customers
• cost leaders will be better able to absorb price increases than higher cost competitors, thus the threat of suppliers is greater for higher cost competitors than for the cost leader
Threat of Buyers
• cost leaders in a market typically have large market share—meaning they will probably be among the largest, most powerful suppliers in an industry
? buyers will naturally be more dependent on such supplier firms
• a cost leadership position will create a disincentive for buyers to vertically integrate backwards for all the reasons listed in the Threat of Entry section above
• cost leaders can more easily absorb demands for lower prices or increased service and/or quality from powerful buyers compared to higher cost competitors
Rareness of Sources of Cost Advantage
The source of a cost advantage will confer competitive advantage only if the source is rare. Remember that we said the starting point in this competitive advantage analysis of a cost advantage is at the point where it has been determined that the focal firm has a cost advantage. Well, by definition, if a firm has a cost advantage it must be relatively rare. The real question then becomes, “How long is it likely to remain rare?” Of course, answering this question is really a matter of assessing the costs of imitation, which will be addressed in the next sub-section. However, it is useful to understand why a source of cost advantage is rare at a given point in time.
In most cases the rareness of a source of cost advantage at a given point in time is dependent on the interaction of two things: 1) the life cycle stage of the industry, and 2) the imitability of the source of the cost advantage. Some sources of cost advantage will be rare in the emerging stages of an industry and then become less rare as the industry matures—some will remain rare. Yet other sources may be rather common
in the emerging stage of an industry and become more rare as the industry matures—some will remain common.
The Six Sources of Cost Advantage
Economies of Scale:
• are less likely to be rare in emerging industries because multiple firms are discovering where the minimum efficient scale is
• may become more rare as the industry matures if the minimum efficient scale is discovered to be quite large and if industry demand roughly equals industry capacity—such that an incremental plant at minimum efficient scale would vastly exceed industry demand—this is even more likely as an industry declines
Diseconomies of Scale:
• are likely to be rare in emerging and mature industries because most firms will not exceed the minimum efficient scale
• may become less rare in a declining industry if demand falls sharply leaving most firms with excess capacity—this is not a likely scenario
(Remember diseconomies of scale refer to other firms, not the focal firm)
Learning Curve Economies:
• are likely to be rare in an emerging industry because the first-mover is moving along the learning curve ahead of competitors
• are likely to become less rare as the industry matures as competitors also move along the learning curve—as the learning curve flattens the advantage of more cumulative experience lessens
Differential Low-Cost Access to Inputs:
• may be rare in emerging industries if the inputs themselves are rare, such as mineral deposits or input factor markets that are of limited size, otherwise there is not likely to differential low-cost access
• may arise (and be rare by definition) as the industry matures if a firm is able to tie-up sources of supply by acquiring suppliers or forming exclusivity agreements with suppliers
• are likely to be rare in emerging industries as the new technologies are developed
• usually become less rare over time as duplication occurs or as competitors are able to buy the same technology—some technology can remain rare if the firm is able to protect its proprietary nature, especially software technology as opposed to hardware technology
• valuable policies may be rare in emerging industries as many different firms establish various policies—some firms will adopt policies that prove to be valuable and others will adopt policies that prove to have little, if any, value
• some valuable policy choices will remain rare if those policies are 1) difficult to observe and/or understand, or 2) if the adoption of those policies is costly for competitors because of path dependency—other airlines face a large cost disadvantage in attempting to adopt some of Southwest Airlines’ human resource policies
Imitability of Sources of Cost Advantage
The resource-based view logic introduced in Chapter 4 holds that a firm’s cost advantage will generate competitive advantage only if competitors face a cost disadvantage in attempting to imitate the cost advantage. Understanding the imitability of a source of cost advantage is important from at least two perspectives. First, if the focal firm is found to have a cost advantage, managers would want to know if that advantage is costly for competitors to imitate. Second, if a competitor is found to have a cost advantage, managers of the focal firm would want to know if the focal firm faces a cost disadvantage in imitating the source of cost advantage.
Any of the sources of cost advantage described in this chapter may be costly to imitate depending on the conditions that gave rise to the advantage in the first place and on the conditions faced by would-be imitators. Conversely, circumstances could make any of the sources of cost advantage less costly to imitate.
Several conditions that give rise to low costs and high costs of imitation are presented below. Keep in mind that each of these conditions could affect more than one of the sources of cost advantage.
Low Cost Imitation Conditions
Unbalanced Industry Capacity and Demand
• when an industry has excess demand, economies of scale advantages are imitated at relatively low cost because competitors have an incentive to expand capacity
• when an industry has excess demand, learning curve advantages are less costly to imitate because there is room in the market for several firms to be moving down the learning curve simultaneously (this is observed in the memory chip industry)
• when an industry has excess capacity, diseconomies of scale advantages will disappear more rapidly because firms operating beyond the minimum efficient scale will quickly realize their diseconomies and correct them
• technology cost advantages based on technology that is not owned and tightly controlled by the focal firm will be less costly to imitate, especially if vendors can sell the technology to the focal firm’s competitors
Highly Observable Technology
• technology advantages based on technology that is highly observable can be imitated at lower cost, even when the technology is proprietary because competitors can more easily see a way around the protection (patents)
• cost advantages such as differential low cost access to inputs and policy choices that are based on transactional exchanges (purely arm’s length transactions) are easily imitated
• Example: The bonus policy of an appliance manufacturer that has a cost advantage because it uses a bonus system with production line employees to reduce defective parts can easily be imitated.
High Cost Imitation Conditions
Balanced Industry Capacity and Demand
• economies of scale advantages are more costly to imitate in balanced industries because would-be imitators face a lower net benefit if they add industry capacity (excess capacity will lead to lower overall prices for output, lowering the net benefit of entry)—economies of scale present a barrier to entry
• diseconomies of scale may be more difficult to recognize for firms that have expanded beyond the minimum efficient scale, making the advantage for the focal firm more durable
Path Dependence (Historical Uniqueness)
• cost advantages that developed through a set of unique historical circumstances may be very costly, if not impossible, to imitate
• Example: A grain elevator built decades ago along the Columbia River in Washington State provides a cost advantage for its owners. The elevator occupies the only location for miles along the river in which an elevator could be built without incurring tremendous earth-moving expenses.
• a technology protected by patent, copyright, trademark, etc. will present a higher cost of imitation than unprotected technologies—although such protection does not guarantee that imitation will not occur
Highly Unobservable Technology (Causal Ambiguity)
• a cost advantage based on a relatively unobservable technology will present a high cost of imitation to competitors because they will not know what to imitate
Relational Exchange (Social Complexity)
• cost advantages that stem from socially embedded exchanges are more costly to imitate because competitors face the cost (or impossibility) of recreating socially complex relationships
• Example: Suppose the appliance manufacturer in the example above had a corporate culture based on years of experience and life long employees that encouraged low defect rates. Such an advantage would be much more difficult to imitate than an advantage based simply on paying people for lower defect rates.
2. Product Differentiation
Product differentiation is a business level strategy in which firms attempt to create and exploit differences between their products and those offered by competitors. These differences may lead to competitive advantage if customers perceive the difference and have a preference for the difference. Of course, such differences will lead to competitive advantage only if the differences meet the VRIO criteria.
The critical element of a product differentiation strategy is that customers perceive a difference. There may or may not be an actual difference in the product itself. If the firm can convince the customer that there is a difference, even if there is no actual difference, then a product differentiation strategy can have the desired effect of creating a preference on the part of customers.
A product differentiation strategy requires that a firm be able to effectively communicate with customers through advertising, public relations, sponsoring of events, etc. In fact, advertising usually plays a critical role in an effective product differentiation strategy.
Ironically, a firm does not have to be able to create a product with actual differences if it can convince customers that differences exist. Firms that do create products with actual differences have a much easier time convincing customers that those differences exist.
Nike’s capabilities lie primarily in design and marketing. The vast majority of Nike’s production of shoes and clothing is outsourced to other firms. Nike’s base of differentiation is not proprietary high-tech manufacturing of superior athletic shoes. Rather, Nike’s base of differentiation is a well-orchestrated marketing effort that has spanned decades.
2.1 Bases of Differentiation
The notion of a base of differentiation is important because it allows a firm to focus its efforts on creating and exploiting a particular difference between its products and competitors’ products. Managers need to understand their own bases of differentiation and the bases of differentiation of competitors so that they can make informed strategic choices.
External and internal analysis help managers discover the bases of differentiation of competitors, what bases of differentiation might be valuable in a market, and what bases of differentiation the focal might be able to create and/or exploit. Bases of differentiation thus identified should be subjected to a VRIO analysis to determine if such bases are likely to lead to competitive advantage—for the focal firm or for competitors.
Almost anything could be a base of differentiation. The key is that some set of customers must find value in the base of differentiation. Everything from tangible product characteristics to abstract intangible concepts like national or regional pride could potentially be a base of differentiation. Managers can create and exploit bases of differentiation from a seemingly infinite number of ideas.
There are three broad categories for categorizing bases of differentiation. All of these bases of differentiation represent attempts to create preferences for the focal firm’s products and/or services. The three broad categories and the logic underlying each one are:
Differentiation based on:
Attributes of the product or service
• preferences are created by actual differences in the tangible product or service offered by the focal firm vis-à-vis competitors’ offerings
• product features (Arm & Hammer’s baking soda toothpaste)
• product complexity (new digital cameras compared to single use film cameras)
• timing of product introduction (release of movies during the Holiday and Summer seasons)
• location (Chevron’s company-owned, combined c-stores & gas stations are situated in prime traffic locations)
Relationship between the focal firm and its customers
• preferences are created as the focal firm develops and exploits relationships with customers based on what the focal firm’s target customers want
• product customization (Dell Computers-customers get exactly the features desired)
• consumer marketing (Mountain Dew-changed the image of the product through marketing-product stayed the same)
• product reputation (Harley-Davidson Motorcycles-reputation is so strong that some people tattoo the logo on their bodies)
Linkages within or between firms
• preferences are created as the focal firm combines the competencies of different functions within or across organizations to produce tangible and/or intangible differences between the focal firm’s offerings and those of competitors
• linkages among functions within the focal firm (Ford Motor Company’s combination of auto manufacturing and financing)
• linkages with other firms (Mattel toys in McDonald’s Happy Meals)
• product mix (Cisco’s wide range of Internet technology products)
• distribution channels (Coke & Pepsi vending machines)
• service and support (Lexus service)
2.2 Product Differentiation and Competitive Advantage – VRIO
Value of Differentiation
Product differentiation can produce value for a firm by neutralizing environmental threats and/or exploiting environmental opportunities.
Neutralizing Threats. Here is a brief description of how product differentiation can neutralize the threats of the forces mentioned in the Five Forces Model along with an example of each one. If the focal firm’s product differentiation strategy is effective:
Threat of Entry
• would-be entrants face the costs of overcoming customers’ preferences for the focal firm’s products and/or services
• Example: Toyota was protected from Hyundai’s entry into the U.S. market because Hyundai had to enter at a low price and advertise heavily to attract customers away from Toyota’s well-established Corolla.
Threat of Rivalry
• customers have, to some extent, segmented themselves based on their preferences for the products of the several competing firms in a market. Thus, the rivalry is generally lower among firms competing in a market of differentiated products.
• Example: Allen Edmonds men’s dress shoes sell for around $300. Most models have thick leather soles that conform comfortably to the foot. Once a customer wears Allen Edmonds shoes, he tends to be very loyal to the brand. Cole Hahn is a competitor at the high end of the market. Some people prefer Cole Hahn, some prefer Allen Edmonds and once the customer decides on a preference, there is little competition remaining between Cole Hahn and Allen Edmonds. Product differentiation attenuates rivalry for Allen Edmonds because competition for customers is minimized due to customers’ self-selected segmentation.
Threat of Substitutes
• customers will find the focal firm’s products and services substantially more attractive than substitute products (i.e., customers are less inclined to even try the substitute product and the focal firm is therefore insulated from the threat of the substitute)
• Example: Printing digital photographs on a personal printer at home may be viewed as a substitute for professional printing at a photo shop. Photo shops that advertise that their digital prints are superior to what can be printed at home are attempting to create a preference for their product. Shops that successfully convince customers that their product is superior are insulated from the competitive pressure of the in-home substitute.
Threat of Suppliers
• the power of suppliers may be mitigated in two ways. First, the focal firm will likely be able to pass supplier price increases along to customers who have a preference for the focal firm’s differentiated product (customers with a preference for a differentiated product tend not to be price sensitive). Second, a firm that enjoys the strong preference of customers will usually have more bargaining power with suppliers compared to competitors that do not have differentiated products and services.
• Example: Recent spikes in the price of beef are easily passed on to customers of high-end steak houses like Spencer’s. McDonald’s, Wendy’s, and Burger King’s customers are more sensitive to price increases that make the $.99 burger a thing of the past.
Threat of Buyers
• the power of buyers is reduced because the focal firm enjoys a quasi-monopoly. By definition, if a firm has a highly differentiated product, then the firm is the only firm in that market that can offer that particular product. Customers with a preference for the focal firm’s products and services must buy from the focal firm, thus reducing the power of buyers.
• Daimler-Chrysler’s Crossfire sports car has allowed dealers to enjoy a quasi-monopoly as evidenced by the “local market adjustment” (of about $5,000) that dealers are able to tack onto the price of the car. The car is different from other cars and a set of customers has a strong preference for the car. There are a limited number of the cars being built. These factors serve to greatly reduce the power of buyers of the Crossfire.
A product differentiation strategy can be used to exploit opportunities in several different ways. In addition to industry-type opportunities, there are many other opportunities that arise in the external environment that firms can exploit. In a sense, a firm is exploiting an opportunity in the external environment any time it is able to fill some customer need in a new or different way.
Important Point: Successful product differentiation results in two important outcomes that generate value for the focal firm. First, customers develop preferences for the focal firm’s products and/or services. Second, when customers perceive a benefit to themselves they become willing to pay a premium for the differences that create that benefit. If the benefit is great enough that customers are willing to pay a price that is above the focal firm’s average total cost, then we can conclude that the product differentiation strategy has created value for the firm. The firm whose customers have a preference for its products and a willingness to pay a premium price for its products is in an enviable position.
• product differentiation through branding can take a commodity-type product and make it a differentiated product
• Kellogg’s Corn Flakes is a classic example of this
• first mover advantages (brand loyalty, switching costs, technology standards, etc.) may accrue to the firm that can quickly differentiate its products in the minds of customers
• Motorola did this in the cell phone market. They used their brand equity from the telecommunications and technologies businesses to differentiate their cell phones early.
• firms attempt to differentiate products by “refining” the product (new and improved) in order to “establish” the product in the market as different that customers see a superior value in buying it.
• firms attempt to differentiate products by focusing on incremental innovation, increasing the intensity of marketing/sales activities, and continuous quality improvement..
• firms attempt to differentiate established products by “refining” the product—new and improved
• firms may also differentiate a product by offering new levels of service to accompany the product
• Ford Motor Company has tried to differentiate the repair and maintenance services offered by its dealers. Auto service is a very mature industry but product differentiation can still be quite valuable to a firm.
• product differentiation in declining industries is usually a matter of moving toward specialization and/or niches
• by definition, the number of customers in a declining industry is decreasing and firms recognize that remaining customers must have a strong need to remain customers in the industry—therefore, firms can move to meet those remaining needs in specialized ways
• Up until the mid-20th century, hats were an important part of most dress wardrobes. As hats became less popular, hat manufacturing and retailing declined. However, some hat manufacturers and retailers remained in business. These firms typically became very specialized. An example of this phenomenon is the NEWT at the Royal Hawaiian on Waikiki Beach in Hawaii. This small shop sells very high end Panama straw hats and resort attire. Some hats are priced as high as $5,000. These hats are made for a small niche that appreciates the features of these hats. Most people do not place such a high value on a fine hat, but there are some who do and NEWT caters to them.
Other Opportunities in the External Environment
Trends or Fads:
• firms can provide a differentiated product to satisfy the needs of customers who are responding to trends or fads
• custom wheel “spinners” are a current example
• changes in government policy can provide many opportunities for firms to develop differentiated products
• significant tax incentives exist in the U.S. and Europe for highly efficient automobiles that help make cars like the Toyota Prius and the SMARTCAR attractive to customers
• social causes can create demand for differentiated products that help people further their cause of choice
• credit cards issued by causes (in partnership with an issuer) have become a point of differentiation in the credit card business—World Wild Life Fund, alumni associations, etc.
• almost any economic condition creates opportunities for product differentiation (high unemployment, low unemployment; high interest rates, low interest rates; high inflation, low inflation; etc)
• first Hyundai and then Suzuki tried to differentiate their low priced cars by offering the “best” warranties in America in response to stagnating car sells brought on by economic conditions
Rareness and Imitability of Product Differentiation
Remember that the notion of ‘costly to imitate’ means that the cost of imitating the strategy would prove to be greater than the benefit of imitating the strategy. This implies that would-be imitators would rationally choose not to attempt imitation. Only product differentiation strategies based on resources and capabilities that are the result of unique historical circumstances, causally ambiguous, and/or socially complex will be costly to imitate.
Based on this logic, the bases of differentiation discussed earlier can be categorized into three groups: bases that are easily duplicated, bases that may be costly to imitate, and bases that are usually costly to imitate. The bases are listed below under the appropriate category along with the logic as to their categorization.
Easy to Duplicate
• are easy for competitors to observe
• unless there is a patent, competitors face little cost in imitation
• may lead to temporary competitive advantage until competitors are able to imitate
• Example: Wrinkle-free, 100% cotton in shirts, blouses, and pants is a product feature that has been rapidly duplicated. This innovation meant that customers could enjoy the feel of 100% cotton without having to iron or professionally launder their clothing. Nordstrom was an early adopter with its SmartCare line. Most other department stores now have their own line of all cotton clothing that is wrinkle-free.
May be Costly to Duplicate
Links with other firms
• these bases all entail a relationship and/or the need for coordination
• if any of these relationships and/or coordination efforts are marked by unique historical circumstances, causal ambiguity, or more likely, social complexity, then it may be costly for other firms to imitate these relationships
• Example: iTunes is part of Apple’s product mix. iTunes depends on links with several other firms in the music, entertainment, and technology industries. The product is customizable and, to some extent, complex. Consumer marketing is definitely a part of the iTunes strategy. As time goes on, the iTunes model is becoming increasingly costly to imitate as these relationships and coordination efforts mature. Customers face switching costs that imitators would have to overcome.
• these relationships could exist without being historically unique, causally ambiguous or socially complex, in which case, they could be easily imitate
Usually Costly to Duplicate
Links between functions
Service and support
• all have the common element of uniqueness in some way, most of the time (specific linkages can exist only in the focal firm, there is only one ‘first mover’, there is only one of a prime location, there is only one firm reputation, etc.)
• in many cases, it would be impossible for a competitor to duplicate the base of differentiation
• links, reputation, distribution channels, and service and support all depend on relationships
• these relationships are usually marked by historical uniqueness, social complexity, and often by causal ambiguity—making it very costly for competitors to duplicate the relationships
• differentiated service and support is usually the result of social complexity within the firm and between firm employees and customers
• the relationships that lead to happy employees, that in turn, lead to happy customers through differentiated service are costly, if not impossible, to imitate
Substitutes for Product Differentiation Strategies
The ability of a base of differentiation to generate a competitive advantage also depends on the proximity of close substitutes. One base of differentiation may be a substitute for another base of differentiation. There is constant competition among firms to create customer preferences for their respective products.
For example, for several years WordPerfect was the undisputed market leader in word processing software. WordPerfect was loaded with innovative product features that were superior to competitors’ offerings. Microsoft began to bundle its Word product with Excel, PowerPoint, and Outlook. Users could seamlessly cut and paste from one program to another. Microsoft’s bundling was a substitute for WordPerfect’s product features. Eventually, Microsoft’s bundled products became the undisputed market leaders.
Although some substitutes may be apparent in a market, many substitutes for a differentiated product may ‘pop up’ in the marketplace at any time. Managers should monitor the environment for potential substitutes. Bases of differentiation may need adjustment in order to keep potential substitutes from becoming close substitutes.
3. Pursuing Product Differentiation and Cost Leadership Strategies
For years management scholars have debated whether firms can simultaneously pursue cost leadership and product differentiation. When a store advertises its low prices like Wal-Mart does, is that evidence of a cost leadership strategy or is that evidence of a product differentiation strategy? The answer is: Yes.
Most firms’ strategies contain elements of both cost leadership and product differentiation. But, in the vast majority of firms one is clearly emphasized over the other. The relatively few firms that can effectively pursue both strategies are in an enviable position indeed.
In order for the integration strategy to succeed, firms must have the resources and capabilities to incorporate attractive or upscale attributes into its product offering at a lower cost than rivals. To lever the trade-offs between the cost leadership and differentiation drivers (e.g., achieving higher differentiation implies higher costs for say advertising and marketing) a firm can use:
1. Quality: the quality of the product denotes its durability and reliability. Techniques such as six sigma and total quality management can raise quality of the product (that raises willingness to pay) and at the same time reduce cost of production.
2. Economies of Scope: It refers to the savings that come from producing two (or more) outputs at less cost than producing each output individually.
3. Product or Process Innovation.
4. Structure, culture, and routines.
Many firms that attempt to follow an integration strategy fail because they are stuck in the middle. In other words, they do not succeed in either cost leadership or differentiation strategy.
Anecdotal evidence suggests that firms that are able to simultaneously pursue both strategies started out with a sharp focus on one and in time were able to pursue the other as well. Conversely, anecdotal evidence also suggests that some firms that have tried to do both and failed weren’t really achieving one before they started to pursue the other. Here are some quick examples from the discount retail market and the auto industry:
Wal-Mart started out with a sharp focus on cost leadership. This strategy allowed them to gain market share and become very profitable. In time, the firm could afford to advertise heavily to convince customers that they had the low price. Always. This heavy advertising is indicative of a product differentiation strategy. It is also interesting to note that local store managers, although obligated to follow fairly strict guidelines, are able to carry items of local interest that are not part of the national buying program.
Toyota developed a manufacturing system that drove costs to a minimum. Toyota recognized that they could achieve low manufacturing costs and very high quality simultaneously with their system. Most American consumers initially viewed Toyota as a low cost alternative to higher priced American cars. In time, Toyota began to differentiate its products on quality. Its Lexus line is very much a differentiated product that is manufactured at a very competitive cost among luxury car makers.
Mercedes developed a strong reputation for high quality cars. For many years, cost was not a critical issue for Mercedes. The introduction of car lines like the Lexus and the rising popularity of SUVs have forced Mercedes to focus more on cost. In other words, Mercedes is being forced to be concerned about cost. It remains to be seen if Mercedes will become competitive on cost or if Mercedes will
further differentiate its cars on quality. Some industry analysts worry that Mercedes may hurt its reputation for quality if it tries to focus on cost too much.
Ford very successfully introduced the Taurus. However, in 1996 Ford tried to move the Taurus up market. Other car makers had imitated many of the Taurus’ most distinguishing features. Ford tried to differentiate the Taurus with even more ‘rounding’ of the body. The sticker price was raised about $2,500. This attempt to differentiate the Taurus was a failure. Many customers turned to the Toyota Camry and the Honda Accord. By 1996 the Taurus wasn’t a cost leader and it wasn’t highly differentiated. It seems to have become stuck in the middle.
K-Mart tried to differentiate itself by moving upscale in the mid-1990s. Having realized it couldn’t compete with Wal-Mart on price, K-Mart seems to have decided to adopt a level of differentiation. Celebrities such as Kathy Ireland and Martha Stewart were used to try to generate more sales in clothing and household goods, respectively. Stores were remodeled. Many were converted to “Big K” stores. Several years of financial performance, including a bankruptcy, suggest that this attempt at differentiation did not work. K-Mart seems to have tried to abandon cost leadership in favor of differentiation. In the end, it seems to have become stuck in the middle.
4. Going on the Offensive – Strategic Options to Improve a Firm’s Market Position
Strategic offensives should, as a general rule, be based on exploiting a firm’s strongest strategic assets – its most valuable resources and capabilities (e.g., satisfy VRIO). The principal offensive strategies options include the following:
1. Using a cost-based advantage to attack competitors on the basis of price or value.
2. Leapfrogging competitors by being the first adopter of next-generation technologies or being first to market with next-generation products.
3. Pursuing continuous product innovation to draw sales and market share away from less innovative rivals.
4. Adopting and improving on the good ideas of other firms (rivals or otherwise)
5. Using hit-and-run or guerilla warfare tactics to grab sales and market share from complacent or distracted rivals. Options for “guerilla offensives” include occasional lowballing on price (to win a big order or steal a key account), surprising rivals with sporadic but intense bursts of promotional activity (e.g., offering a special trial offer for new customers to draw them away from rivals), or undertaking special campaigns to attract buyers away from rivals plagued with a strike or problems in meeting buyer demand. These offensives are particularly suited to small challengers that have neither the resources nor the market visibility to mount a full-fledged attack on industry leaders and that may not merit a full retaliatory response from larger rivals.
6. Launching a preemptive strike to secure and advantageous position that rivals are prevented or discouraged from duplicating. What makes a move preemptive is its one-of-a-kind nature- whoever strikes first stands to acquire competitive assets that rivals can’t readily match. Examples of preemptive moves include:
a. Securing the best distributors in a particular geographic region or country
b. Obtaining the most favorable sites in terms of customer demographics, cost characteristics, or access to raw materials supplies, or low-cost inputs
c. Tying up the most reliable, high-quality suppliers via exclusive partnerships, long-term contracts, or acquisition
d. Moving swiftly to acquire the assets of distressed rivals at bargain prices. To be successful, a preemptive move doesn’t have to totally block rivals from following. It merely needs to give a firm a prime position that is not easily duplicated or circumvented.
Which Rivals to Attack
• Market leaders that are vulnerable (e.g., weak competitive strategy with regards to cost-leadership or differentiation, unhappy buyers, etc.)
• Runner-up firms with weaknesses in areas where the challenger is strong
• Struggling enterprises that are on the verge of going under.
• Small local and regional firms with limited capabilities.
A blue ocean strategy seeks to gain a sustainable competitive advantage by abandoning efforts to beat out competitors in existing markets and, instead, inventing a new industry or distinctive market strategy that renders existing competitors largely irrelevant and allows the firm to create and capture altogether new demand. Examples: eBay, Starbucks, FedEx in overnight delivery.
How can we achieve cost leadership?
A. Cost-efficient management of value chain activities
a. Strive to capture all available economies of scale. That is, a firm should have experienced constant returns to scale in order to have minimum efficient scale (MES) of production (see book pages 149-150).
b. Take full advantage of experience and learning-curve effects (see book pages 151-152).
c. Try to operate facilities at full capacity (capacity utilization) but be careful of diseconomies of scale.
d. Improve supply chain efficiency (e.g., streamline ordering and purchasing process to reduce inventory carrying costs via JIT inventory practices, to economize on shipping and materials handling, etc).
e. Using lower cost inputs wherever doing so will not entail too great a sacrifice in quality.
f. Using the company’s bargaining power against the suppliers or others in the value chain system to gain concessions.
g. Using communication systems and information technology to achieve operational efficiencies (e.g., use enterprise resource planning – ERP, if applicable)
h. Employing advanced production technology and process design to improve overall efficiency.
i. Examine cost advantages of outsourcing or vertical integration. (these are corporate strategies).
j. Motivating employees through incentives and company culture.
B. Revamping the Value Chain System to Lower Costs
a. Selling direct to consumers and bypassing the activities and costs of distributors and dealers.
b. Coordinating with suppliers to bypass the need to perform certain value chain activities, speed up their performance, or otherwise increase overall efficiency.
c. Reducing materials handling and shipping costs by having suppliers locate their plants or warehouses close to the firm’s own facilities.
When a Cost Leadership strategy works best?
1. Price competition among rival sellers is fierce.
2. Products of rival sellers are essentially identical and readily available from many eager sellers
3. There are a few ways to achieve product differentiation that have value to buyers.
4. Most buyers use the product in the same ways.
5. Buyers incur low costs in switching their purchases from one seller to another.
6. Buyers are large and significant power to bargain down prices.
7. Industry newcomers use introductory low prices to attract buyers and build a customer base.
What can we do with differentiation?
Successful differentiation allows a firm to do one or more of the following:
• Command a premium price for its product.
• Increase unit sales (because additional buyers are won over by the differentiating features – depends of course on industry dynamics)
• Gain buyer loyalty to its brand (because some buyers are strongly bonded to the differentiating features of the firm’s product offering).
How can we achieve differentiation?
1. Strive to create superior product features, design, and performance.
2. Improve customer service or add additional services.
3. Pursue production R&D activities.
4. Strive for innovation and technological advances
5. Pursue continuous quality improvement
6. Increase the intensity of marketing and sales activities.
7. Seek-out high quality inputs.
8. Seek customization (allows firms to tailor products and services to specific customers).
9. Identify complements and take advantage of them or offer them.
10. Improve employee skill, knowledge, and experience through human resource management activities.
11. Revamp the value chain system to increase differentiation
a. Coordinate with channel allies to enhance customer perceptions of value.
b. Coordinate with suppliers to better address customer needs.
How can we deliver superior value through a differentiation strategy?
Differentiation strategies depend on meeting customer needs in unique ways or creating new needs, through activities such as innovation or persuasive advertising. The objective is to offer the customers something that rivals can’t – at least in terms of satisfaction. There are four basic routes to achieving this:
1. Lower buyer’s overall costs by incorporating product attributes and user features.
2. Incorporate tangible features that increase customer satisfaction with the product such as product specifications, functions, and styling.
3. Incorporate intangible features that enhance buyer satisfaction in noneconomic ways (e.g., Prius appeals to environmentally conscious consumers not because of emission reduction but also because they identify with the image conveyed).
4. Signal the value of the company’s product offering to buyers. Typical signals include a high price, more appealing or fancier packaging than competing products, ad content that emphasizes a product’s standout attributes, quality of brochures and sales presentations, luxuriousness of seller’s facilities,…, etc.
When a Differentiation strategy works best?
1. Buyer needs and uses of the product are diverse.
2. There are many ways to differentiate the product or service that have value to buyers.
3. Few rival firms are following a similar differentiation approach.
4. Technological change is fast-paced and competition revolves around rapidly evolving product features.
When it fails?
A differentiation strategy is always doomed when competitors are able to quickly copy most or all of the appealing product attributes a firm comes up with.
When a Focused Cost-Leadership and Differentiation make sense?
A focused strategy aimed at securing a competitive edge based on either on low cost or differentiation becomes increasingly attractive as more of the following conditions are met:
• The target market niche is big enough to be profitable and offers good growth potential.
• Industry leaders do not see that having a presence in the niche is crucial to their own success – in which case focusers can often escape battling head to head against some of the industry’s biggest and strongest competitors.
• It is costly or difficult for multisegment competitors to put capabilities in place to meet the specialized needs of buyers constituting the target market niche and at the same time satisfy the expectations of their mainstream customers.
• The industry has many different niches and segments, thereby allowing a focuser to pick a competitively attractive niche suited to its most valuable resources and capabilities. Also, with more niches there is more room for focusers to avoid each other in competing for the same customers.
• Few, if any, other rivals are attempting to specialize in the same target segment.
• The focuser has a reservoir of customer goodwill and loyalty (accumulated from having catered to the specialized needs and preferences of niche members over many years) that it can draw on to help stave off ambitious challengers looking to enter its business.