Case assignment

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Learning Objectives

After reading this chapter, you should have a good understanding of:

5-1 The central role of competitive advantage in the study of strategic management and the three generic strategies: overall cost leadership, differentiation, and focus.

5-2 How the successful attainment of generic strategies can improve the firm’s relative power vis-à-vis the five forces that determine an industry’s average profitability.

5-3 The pitfalls managers must avoid in striving to attain generic strategies.

5-4 How firms can effectively combine the generic strategies of overall cost leadership and differentiation.

5-5 What factors determine the sustainability of a firm’s competitive advantage.

5-6 The importance of considering the industry life cycle to determine a firm’s business-level strategy and its relative emphasis on functional area strategies and value-creating activities.

5-7 The need for turnaround strategies that enable a firm to reposition its competitive position in an industry.

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The Central Role of Competitive Advantage

Consider . . .

In order to create and sustain a competitive advantage, companies need to stay focused on their customers’ evolving wants and needs and not sacrifice their strategic position as they mature and the market around them evolves.

They also have to have a strategy…

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Discussion Question 1: What decisions did A&P make when it was successful that led to its later failure?

A&P failed to reinvest in its business to sustain either its differentiation or its cost leadership.

Instead of reinvesting to continue to refresh the interior of its stores, expand its stores to carry more products, or enhance the service level it offered, A&P paid out large dividends to its shareholders.

In short, A&P fell prey to a common attitude of a market leader. It got complacent. This left an opportunity for aggressive competitors to come in and take A&P’s business.

As a result, A&P lost its differentiation advantage.

As other competitors grew larger and larger, A&P also lost its scale-based cost advantage.

By the time the company realized its mistakes, it no longer generated sufficient profits to invest enough to engineer a turnaround.

Discussion Question 3: What firms do you see today that face similar challenges? How should these firms respond to and act to reinforce their strategic positions?

Mainline supermarkets - face the challenge of Aldi, Walmart, and Amazon—with its Whole Foods subsidiary.

Clothing retailers – Abercrombie &Fitch, department stores, JCPenney.

Auto manufacturers - upstart competitors, such as Tesla, and the looming threat of a shift from car ownership to auto sharing and autonomous car services.

Challenge students to consider how the market is changing, what the capabilities of competitors are, and a clear understanding of what is the distinct strategic position of the focal firm. They should show they understand the specific form of differentiation the firm is pursuing or the foundation of its cost leadership and evaluate whether this is the correct path for the firm to continue to pursue, what the alternative path might be, and the actions to take to develop or reinforce this strategic position.

Question

The primary aim of strategic management at the business level is:

A – maximizing risk to return trade-offs through diversification

B – maximizing differentiation of products and/or services

C – achieving competitive advantage

D – achieving a low-cost position

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Sustaining a Competitive Advantage

Business-level strategies require a choice.

How to overcome the five forces and achieve competitive advantage?

Suggestion – Use Porter’s three generic strategies.

Overall cost leadership

Differentiation

Focus

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Business-level strategy is a strategy designed for a firm or a division of the firm that competes within a single business. Generic strategies = basic types of business level strategies based on breadth of target market (industrywide versus narrow market segment) and type of competitive advantage (low-cost versus uniqueness).

Three Generic Strategies

Exhibit 5.1 Three Generic Strategies

Source: Adapted from Competitive Strategy: Techniques for Analyzing Industries and Competitors. Michael E Porter, 1980, 1998, Free Press.

Jump to Appendix 1 for long image description.

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The overall cost leadership and differentiation strategies strive to attain advantages industrywide, while focusers have a narrow target market in mind. Generic strategies are plotted on two dimensions: competitive advantage and market served.

Three Generic Strategies

Overall cost leadership is based on:

Creating a low-cost position relative to a firm’s peers

Managing relationships throughout the entire value chain to lower costs

Differentiation implies:

Products and/or services that are unique & valued

Emphasis on nonprice attributes for which customers will gladly pay a premium

A focus strategy requires:

Narrow product lines, buyer segments, or targeted geographic markets

Advantages obtained either through differentiation or cost leadership

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Discussion Question 5: What are some examples of firms that have successfully implemented a cost leadership strategy?

Spirit Airlines – Is Spirit able to obtain parity on differentiation? Must obtain parity on differentiation

TJ Maxx, Marshalls, Home Goods – gets inventory to stores and on shelves quickly, looks to buy good merchandise steeply discounted, extensive training program for buyers

A differentiated strategy? BMW, Nordstrom, Prosche

Combined multiple strategies?

Question

If the overall cost leadership strategy is to provide sustainable competitive advantage, all activities in the value-chain need to be evaluated including the relationships among the value-chain activities.

A – True

B - False

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True – too often managers make big cuts in operating expenses but do not question year-to-year spending on capital projects. Or cut sales and marketing but ignore manufacturing expenses.

Combination Strategies: Integrating Low-Cost and Differentiation

Integration of low-cost and differentiation strategies makes it difficult for competitors to duplicate or imitate strategy.

The goal of a combination strategy is to provide unique value in an efficient manner.

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Walmart – quick response to customer demand & low cost

Often done by extending value chain, using data analytics

Question

One aspect of using a cost leadership strategy is that experience effects may lead to lower costs. Experience effects are achieved by

A – spreading out a given expense or investment over a greater volume

B – hiring more experienced personnel

C – repeating a process until a task becomes easier

D – competing in an industry for a long time

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C – experience curve – how business learns to lower costs as it gains experience with production processes.

Porter’s Five Forces Model of Industry Competition

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Cost Leadership

Differentiation

Integrated

Three Generic Strategies (3 of 3)

Exhibit 5.2 Competitive Advantage and Business Performance

Particulars	Differentiation and Cost	Differentiation	Cost	Differentiation and Focus	Cost and Focus	Stuck in the Middle
Return on Investment (%)	35.5	32.9	30.2	17.0	23.7	17.8
Sales growth (%)	15.1	13.5	13.5	16.4	17.5	12.2
Gain in market share (%)	5.3	5.3	5.5	6.1	6.3	4.4
Sample Size	123	160	100	141	86	105

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Both casual observation and research supports the notion that firms that identify with one or more of the forms of competitive advantage outperform those that do not. According to the above study, businesses combining multiple forms of competitive advantage (differentiation and overall cost leadership) outperformed businesses that used only a single form. The lowest performers were those that did not identify with any type of advantage. They were classified as “stuck in the middle.”

Question 1

Which statement regarding competitive advantages is true?

If several competitors pursue similar differentiation tactics, they may all be perceived as equals in the mind of the consumer.

With an overall cost leadership strategy, firms need not be concerned with parity on differentiation.

In the long run, a business with one or more competitive advantages is probably destined to earn normal profits.

Attaining multiple types of competitive advantage is a recipe for failure.

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Answer: A. Recall the discussion of competitive advantage and business performance, Exhibit 5.2, and reflect on whether competitive strategies can be sustained. See the case example in the textbook of Atlas Door, a company that, so far, has been able to sustain a competitive advantage over time.

Industry Life Cycle Stages

The industry life cycle

Introduction

Growth

Maturity

Decline

Generic strategies, functional areas, value-creating activities, and overall objectives all vary over the course of an industry life cycle.

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Industry life cycle = the stages of introduction, growth, maturity, and decline that typically occur over the life of an industry. Managers must become even more aware of their firm’s strengths and weaknesses in many areas to attain competitive advantages. Factors such as generic strategies, market growth rate, intensity of competition, and overall objectives can change over the course of an industry life cycle. Managers must strive to emphasize the key functional areas during each of the four stages and to attain a level of parity in all functional areas and value-creating activities. Note: products and services go through many cycles of innovation and renewal. Typically, only fad products have a single lifecycle. Maturity stages of an industry can be transformed or followed by the stage of rapid growth if consumer tastes change, technological innovations take place, or new developments occur.

Industry Life Cycle Stages

Exhibit 5.6 Stages of the Industry Life Cycle

Factor	Introduction	Growth	Maturity	Decline
Generic strategies	Differentiation	Differentiation	Differentiation Overall cost leadership	Overall cost leadership Focus
Market growth rate	Low	Very large	Low to moderate	Negative
Number of segments	Very few	Some	Many	Few
Intensity of competition	Low	Increasing	Very intense	Changing
Emphasis on product design	Very high	High	Low to moderate	Low
Emphasis on process design	Low	Low to moderate	High	Low
Major functional area(s) of concern	Research and development	Sales and marketing	Production	General management and finance
Overall objective	Increase market awareness	Create consumer demand	Defend market share and extend product life cycles	Consolidate, maintain, harvest, or exit

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Introduction stage

products are unfamiliar to consumers.

Market segments are not well defined

product features are not clearly specified.

low sales growth,

rapid technological change,

operating losses,

need for strong sources of cash to finance operations.

competition tends to be limited.

Growth

strong increases in sales.

strong sales (and profits) attracts other rivals

Marketing & sales efforts directed toward stimulating selective demand, in which a firm’s product offerings are chosen with those of its rivals.

New customers trying product

Satisfied customers are making repeat purchases

Maturity

demand begins to slow.

few opportunities to attract new adopters.

direct competition becomes more predominant

competition intensifies (often on the basis of price).

Reverse positioning—a change in industry tendencies to continuously improve products by offering products with fewer product attributes and lower prices.

Breakaway positioning—a break in industry tendencies to incrementally improve by offering products that are still in the industry but are perceived by customers as being different.

Decline

Exit

Stay and attempt to consolidate the industry

Maintaining refers to keeping a product going without significantly reducing marketing support, technological development, or other investments in the hope that competitors will eventually leave the market.

Harvesting involves obtaining as much profit as possible and requires that costs in the decline stage be decreased quickly.

Exiting the market involves dropping the product from a firm’s portfolio.

Consolidating involves one firm acquiring the best of the surviving firms in an industry at a reasonable price. (We provide the example of Lockheed Martin, the giant in the defense industry.)

Question

As markets mature,

costs continue to increase.

applications for patents increase

differentiation opportunities increase.

there is increasing emphasis on efficiency.

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Answer: D. See stages in the maturity cycle.

Turnaround Strategies

A turnaround strategy involves reversing performance decline and reinvigorating growth toward profitability through

Asset and cost surgery

Selected market and product pruning

Piecemeal productivity improvements

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Turnaround strategy = a strategy that reverses a firm’s decline in performance and returns it to growth and profitability.

The need for turnaround may occur at any stage in the life cycle but is more likely to occur during maturity or decline.

Most turnarounds require a firm to carefully analyze the external and internal environments.

The external analysis leads to identification of market segments and customer groups that may still find the product attractive.

Internal analysis results in actions aimed at reduced costs and higher efficiency.

Question

A need for turnaround occurs only during the maturity or declining stage of the life cycle?

A – True

B - False

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False – may occur at any stage in the life cycle but is more likely to occur during maturity or decline

An overall low-cost position

Protects a firm against rivalry from competitors

Protects the firm against powerful buyers

Provides more flexibility to cope with demands from powerful suppliers who want to increase input costs

Provides substantial entry barriers due to economies of scale and cost advantages

Puts the firm in a favorable position with respect to substitute products

Improving Competitive Position vis-à-vis the Five Forces: Cost Leadership

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Pitfalls

Too much focus on one or a few value-chain activities;

Increase in the cost of the inputs on which the advantage is based;

The strategy is imitated too easily;

A lack of parity on differentiation;

Reduced flexibility;

Obsolescence of the basis of cost advantage.

整体低成本的位置

保护公司免受竞争对手的竞争

保护公司免受强大买家的影响

提供更大的灵活性，以满足想要增加投入成本的强大供应商的需求

由于规模经济和成本优势，提供了大量的进入障碍

使公司在替代产品方面处于有利地位

陷阱

过分关注一个或几个价值链活动;

增加优势所依赖的投入成本;

这个策略很容易被模仿;

差异化缺乏平等;

灵活性降低;

过时是成本优势的基础。

Improving Competitive Position vis-à-vis the Five Forces: Differentiation

An overall differentiation strategy

Creates higher entry barriers due to customer loyalty

Provides higher margins that enable the firm to deal with supplier power

Reduces buyer power because buyers lack suitable alternatives

Establishes customer loyalty and hence less threat from substitutes

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Pitfalls

Uniqueness that is not valuable

Too much differentiation

Too high a price premium

Differentiation that is easily imitated

Dilution of brand identification through product-line extensions

Perceptions of differentiation may vary between buyers and sellers

Improving Competitive Position vis-à-vis the Five Forces: Combination

An integrated/combination overall low-cost and differentiation strategy

Creates higher entry barriers due to both cost leadership and differentiation

Can provide higher margins that enable the firm to deal with supplier power

Reduces buyer power because of fewer competitors

Overall value proposition reduces threat from substitutes

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Firms that attain both types of competitive advantage enjoy high returns. However, as with each generic strategy taken individually, there are some pitfalls to avoid:

Pitfalls

Firms that fail to attain both strategies may end up with neither and become “stuck in the middle.”

Underestimating the challenges associated with coordinating value-creating activities in the extended value chain.

Miscalculating sources of revenue and profit pools in your industry.

Pitfalls of Combination Strategies

Firms that fail to attain both overall low-cost and differentiation strategies may end up with neither and become “stuck in the middle.”

Firms can also underestimate the challenges and expenses associated with coordinating value-creating activities in the extended value chain.

Firms can also miscalculate sources of revenue and profit pools in the firm’s industry.

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A key issue in strategic management is the creation of competitive advantages that enable the firm to enjoy above average returns. Some firms may become “stuck in the middle” if they try to attain both cost and differentiation advantages. While integrating activities across a firm’s value chain, firms must consider the expenses linked to technology and investment, managerial time and commitment, and the involvement and investment required by the firm’s customers and suppliers. The firm must be confident that it can generate a sufficient scale of operations and revenues to justify all associated expenses. Finally, firms may fail to accurately assess sources of revenue and profits in their value chain.

Strategies in the Introduction Stage

The introduction stage is when:

Products are unfamiliar to consumers.

Market segments are not well-defined.

Product features are not clearly specified.

Competition tends to be limited.

Strategies:

Develop a product and get users to try it.

Generate exposure so the product becomes “standard.”

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Introduction stage = the first stage of the industry life cycle, characterized by (1) new products that are not known to customers, (2) poorly defined market segments, (3) unspecified product features, (4) low sales growth, (5) rapid technological change, (6) operating losses, and (7) a need for financial support. Since there are few players and not much growth, competition tends to be limited. Success requires an emphasis on research and development and marketing activities to enhance awareness. The challenge becomes one of developing the product and finding a way to get users to try it, and generating enough exposure so the product emerges as the “standard” by which all other rivals’ products are evaluated. There’s an advantage to being the “first mover” in a market.

Strategies in the Growth Stage

The growth stage is:

Characterized by strong increases in sales

Attractive to potential competitors

When firms can build brand recognition

Strategies:

Create branded differentiated products

Stimulate selective demand

Provide financial resources to support value-chain activities

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Growth stage = the second stage of the product life cycle, characterized by (1) strong increases in sales; (2) growing competition; (3) developing brand recognition; and (4) a need for financing complementary value-chain activities such as marketing, sales, customer service, and research and development. In the growth stage, the primary key to success is to build consumer preferences for specific brands. This requires strong brand recognition, differentiated products, and the financial resources to support a variety of value chain activities such as marketing and sales, and research and development. Efforts in the growth stage are directed towards stimulating selective demand in which a firm’s products offerings are chosen instead of a rival’s. Revenues can increase at an accelerating rate because new consumers are trying the product and a growing proportion of satisfied consumers are making repeat purchases.

Strategies in the Maturity Stage

The maturity stage is when:

Aggregate industry demand slows

Market becomes saturated, few new adopters

Direct competition becomes predominant

Marginal competitors begin to exit

Strategies:

Create efficient manufacturing operations

Lower costs as customers become price-sensitive

Adopt reverse or breakaway positioning

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Maturity stage = the third stage of the product life cycle, characterized by (1) slowing demand growth, (2) saturated markets, (3) direct competition, (4) price competition, and (5) strategic emphasis on efficient operations. As markets become saturated, there are few new adopters. Rivalry among existing rivals intensifies because of fierce price competition at the same time that expenses associated with attracting new buyers are rising. Advantages based on efficient manufacturing operations and process engineering become more important for keeping costs low as customers become more price sensitive. It also becomes more difficult for firms to differentiate their offerings because users have a greater understanding of products and services. Firms can affect consumers’ mental shifts through (A) reverse positioning = a break in industry tendency to continuously augment products, characteristics of the product life cycle, by offering products with fewer product attributes and lower prices; or (B) breakaway positioning = a break in industry tendency to incrementally improve products along specific dimensions, characteristic of the product life cycle, by offering products that are still in the industry but that are perceived by customers as being different.

Strategies in the Decline Stage

The decline stage is when:

Industry sales and profits begin to fall.

Price competition increases.

Industry consolidation occurs.

Strategies:

Maintaining the product position

Harvesting profits and reducing costs

Exiting the market

Consolidating or acquiring surviving firms

Decline stage = the fourth stage of the product life cycle, characterized by (1) falling sales and profits, (2) increasing price competition, and (3) industry consolidation. Firms must face up to the fundamental strategic choices of either exiting or staying and attempting to consolidate their position in the industry. In the decline stage, a firm’s strategic options become dependent on the actions of rivals. If many competitors leave the market, sales and profit opportunities increase. On the other hand, prospects are limited if all competitors remain. Maintaining refers to keeping a product going without significantly reducing marketing support, technological development, or other investments, in the hope that competitors will eventually exit the market. A harvesting strategy = a strategy of bringing as much profit as possible out of the business in the short to medium term by reducing costs. Exiting the market involves dropping the product from the firm’s portfolio. A consolidation strategy = a firm’s acquiring or merging with other firms in an industry in order to enhance market power and gain valuable assets. Firms can also resurrect old technologies by retreating to more defensible ground, using the new to improve the old, or improving the price-performance trade-off.

Industry and Firm Effects Jointly Determine Competitive Advantage

Jump to Appendix 2 long image description

Generic Business Strategies

Differentiation

Seeks to create higher value than competitors

Offers products or services with unique features

Keeps the firm’s cost structure as low as possible

Charges higher prices

Cost Leadership

Seeks to create similar value than competitors

Products or services delivered at lower cost

Charges lower prices

Exhibit 6.3 Achieving Competitive Advantage with a Differentiation Strategy

Competitive advantage achieved as long as economic value created (V - C) is greater than competitors

Jump to Appendix 3 long image description

Firm A in this image produces a generic commodity. Firm B and Firm C represent two efforts at differentiation. Firm B not only offers greater value than Firm A, but also maintains cost parity, meaning it has the same costs as Firm A. However, even if a firm fails to achieve cost parity (which is often the case because higher value creation tends to go along with higher costs in terms of higher-quality raw materials, research and development, employee training to provide superior customer service, and so on), it can still gain a competitive advantage if its economic value creation exceeds that of its competitors. Firm C represents just such a competitive advantage. For the approach shown either in Firm B or Firm C, economic value creation, (V - C)B or (V – C)C, is greater than that of Firm A (V - C)A. Either Firm B or C, therefore, achieves a competitive advantage because it has a higher value gap over Firm A [(V - C)B > (V - C)A, or (V – C)C > (V – C)A], which allows it to charge a premium price, reflecting its higher value creation. To complete the relative comparison, although both companies pursue a differentiation strategy, Firm B also has a competitive advantage over Firm C because although both offer identical value, Firm B has lower cost, thus (V - C)B > (V - C)C.

Three Drivers That Can Increase Value

Product features

Increases perceived value

Turns commodity products into differentiated products

Strong R&D capabilities often needed

Customer service

Increases perceived value, Ex: Trader Joe’s (stock local products); Zappo’s (free shipping both ways)

Complements

Increases perceived value, Ex: AT&T U-verse bundles

Consumed in tandem, Ex: DVR

Differentiation Strategies:

Add value to products and services

Are responsive to customer preferences

Can increase costs

Additional R&D is needed

Innovation is needed

But customers are willing to pay a premium

Achieving Competitive Advantage with a Cost Leadership Strategy

Firms that keep their costs low while offering acceptable value gain a competitive advantage

Jump to Appendix 4 long image description

In both approaches to cost leadership in this image, Firm B’s economic value creation is greater than that of Firm A and Firm C. Yet, both firms B and C achieve a competitive advantage over Firm A. Either one can charge prices similar to its competitors and benefit from a greater profit margin per unit, or it can charge lower prices than its competition and gain higher profits from higher volume. Both variations of a cost-leadership strategy can result in competitive advantage. Although Firm B has a competitive advantage over both firms A and C, Firm C has a competitive advantage in comparison to Firm A.

Three Cost Drivers That Help Keep Costs Low

Cost of input factors

Raw materials, capital, labor, IT services

Economies of scale

Spread costs over larger output, Big Box stores stock more merchandise

Experience-curve effects

Learn how to be more efficient, takes less time to produce same output

Measured by increased cumulative output

Cost Leadership Strategies

Appeal to the bargain-conscious buyer

Offer lower prices than competitors

Attract an increased volume of sales

Can be profitable over a long period of time

What Is Blue Ocean Strategy?

Successfully combining differentiation and cost-leadership activities

Uses value innovation to reconcile trade-offs

The metaphor of blue ocean means:

Untapped market space

The creation of additional demand

The opportunity for highly profitable growth

https://www.youtube.com/watch?v=cpb9UgXWf6Q&t=65s 8:12

Instructors:

The digital companion to this book McGraw-Hill Connect has an interactive exercise on this section of the textbook. It builds student confidence on blue ocean strategy and value innovation (LO 6-5).

Value Innovation

Accomplished through the simultaneously pursuing differentiation (V ↑) and low cost (C ↓)

SOURCE: Adapted from C.W. Kim and R. Mauborgne (2005), Blue Ocean Strategy: How to Create Uncontested Market Space and Make Competition Irrelevant (Boston, MA: Harvard Business School Publishing).

Lowering a firm’s costs is primarily achieved by eliminating and reducing the taken-for-granted factors that the firm’s rivals in their industry compete on. Perceived buyer value is increased by raising existing key success factors and by creating new elements that the industry has not offered previously.

Example of a Successful Blue Ocean Strategy: Trader Joe’s

A regional grocer

Offers high value and health conscious foods

Offers much lower costs than Whole Foods

To Achieve Successful Value Innovation, Answer These Questions

Lowering costs

Eliminate: Which of the factors that the industry takes for granted should be eliminated?

Reduce: Which of the factors should be reduced well below the industry’s standard?

Increasing perceived consumer benefits

Raise: Which of the factors should be raised well above the industry’s standard?

Create: Which factors should be created that the industry has never offered?

Blue Ocean: How IKEA Did It

Eliminate

Sales people

After sales service

Reduce

Warranties

Raise

Offers tens of thousands of home furnishing items

Create

New way to shop for furniture

Blue Ocean Strategy is Difficult to Implement

Jump to Appendix 8 long image description

Strategy Highlight

How JCPenney Sailed Deeper into the Red Ocean

Ron Johnson hired as CEO

He previously led Apple’s retail stores

Attempted a strategic change:

From cost leadership

To a blue ocean strategy

Many changes implemented: