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Learning Objectives

LO 6-1 Define business-level strategy and describe how it determines a firm’s strategic position.

LO 6-2 Examine the relationship between value drivers and differentiation strategy.

LO 6-3 Examine the relationship between cost drivers and the cost-leadership strategy.

LO 6-4 Assess the benefits and risks of differentiation and cost-leadership strategies vis-à-vis the five forces that shape competition.

LO 6-5 Evaluate value and cost drivers that may allow a firm to pursue a blue ocean strategy.

LO 6-6 Assess the risks of a blue ocean strategy, and explain why it is difficult to succeed at value innovation.

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Generic Business Strategies: Strategic Position and Competitive Scope

Exhibit 6.2

Jump to Appendix 3 long image description

In a specific product market

Tension: Value creation and pressure to keep cost in check

Who: which customer segments?

What: customer needs will we satisfy?

Why: do we want to satisfy them?

How: will we satisfy our customers’ needs?

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These two business strategies are called generic strategies because they can be used by any organization—manufacturing or service, large or small, for-profit or nonprofit, public or private, domestic or foreign—in the quest for competitive advantage, independent of industry context. Differentiation and cost leadership require distinct strategic positions, and in turn increase a firm’s chances to gain and sustain a competitive advantage.

The automobile industry provides an example of the scope of competition. Alfred P. Sloan, longtime president and CEO of GM, defined the carmaker’s mission as providing a car for every purse and purpose. GM was one of the first to implement a multidivisional structure in order to separate the brands into strategic business units, allowing each brand to create its unique strategic position (with its own profit and loss responsibility) within the broad automotive market. For example, GM’s product lineup ranges from the low-cost-positioned Chevy brand to the differentiated Cadillac brand. In this case, Chevy is pursuing a broad cost-leadership strategy, while Cadillac is pursuing a broad differentiation strategy. The two different business strategies are integrated at the corporate level at GM.

JetBlue attempts to combine a focused cost-leadership position with a focused differentiation position. Although initially successful, JetBlue has been consistently outperformed for several years by airlines that do not attempt to straddle different strategic positions, but rather have a clear strategic profile as either a differentiator or a low-cost leader. For example, Southwest Airlines competes clearly as a broad cost leader (and would be placed squarely in the upper-left quadrant. The legacy carriers—Delta, American, and United—all compete as broad differentiators (and would be placed in the upper-right quadrant. Regionally, we find smaller airlines that are ultra low cost, such as Allegiant Air, Frontier Airlines, or Spirit Airlines, with a very clear strategic position. These smaller airlines would be placed in the lower-left quadrant because they are pursuing a focused cost-leadership strategy.

Exhibit 6.3 Achieving Competitive Advantage with a Differentiation Strategy

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

- Product features

- Customer service

- Complements

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Under a differentiation strategy, firms that successfully differentiate their products enjoy a competitive advantage. Firm A’s product is seen as a generic commodity with no unique brand value. Firm B has the same cost structure as Firm A but creates more economic value, and thus has a competitive advantage over both Firm A and Firm C because (V − C)B > (V − C)C > (V − C)A. Although, Firm C has higher costs than Firm A and B, it still generates a significantly higher economic value than Firm A.

Several competitors in the bottled-water industry provide a prime example of pursuing a successful differentiation strategy. As more and more consumers shift from carbonated soft drinks to healthier choices, the industry for bottled water is booming—growing about 10 percent per year. In the United States, the per person consumption of bottled water surpassed that of carbonated soft drinks for the first time in 2016. Such a fast-growing industry provides ample opportunity for differentiation. In particular, the industry is split into two broad segments depending on the sales price. Bottled water with a sticker price of $1.30 or less per 32 ounces (close to one liter) is considered low-end, while those with a higher price tag are seen as luxury items. For example, PepsiCo’s Aquafina and Coca-Cola’s Dasani are considered low-end products, selling purified tap water at low prices, often in bulk at big-box retailers such as Walmart. On the premium end, PepsiCo introduced Lifewtr with a splashy ad during Super Bowl LI (2017), while Jennifer Aniston markets Smartwater, Coca-Cola’s premium water.

Example of customer service: Zappo’s offers free shipping both ways, they do not outsource customer service, and they don’t use pre-determined scripts for service. Trader Joe’s stores stock local products as requested by the community.

Example of complements: smartphones and cellular services. A smartphone without a service plan is much less useful than one with a data plan. Traditionally, the providers of phones such as Apple, Samsung, and others did not provide wireless services. AT&T and Verizon are by far the two largest service providers in United States, jointly holding some 70 percent of market share. To enhance the attractiveness of their phone and service bundles, phone makers and service providers frequently sign exclusive deals. When first released, for instance, service for the iPhone was exclusively offered by AT&T. Thus, if you wanted an iPhone, you had to sign up for a two-year service contract with AT&T.

Exhibit 6.4 Achieving Competitive Advantage with a Cost Leadership Strategy

- (1) Cost of input factors (raw material, capital, labor)

- (2) Economies of scale

- (3) Learning-curve effects

- (4) Experience-curve effects

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As an example, GM and Korean car manufacturer Kia offer some models that compete directly with one another, yet Kia’s cars tend to be produced at lower cost, while providing a similar value proposition.

Under a cost-leadership strategy, firms that can keep their cost at the lowest point in the industry while offering acceptable value are able to gain a competitive advantage. Firm A has not managed to take advantage of possible cost savings, and thus experiences a competitive disadvantage. The offering from Firm B has the same perceived value as Firm A but through more effective cost containment creates more economic value (over both Firm A and Firm C because (V − C)B > (V − C)C > (V − C)A. The offering from Firm C has a lower perceived value than that of Firm A or B and has the same reduced product cost as with Firm B; as a result, Firm C still generates higher economic value than Firm A.

Cost of input: In the market for international long-distance travel, the greatest competitive threat facing U.S. legacy carriers—American, Delta, and United—comes from three fast-growing airlines located in the Persian Gulf states—Emirates, Etihad, and Qatar. These airlines achieve a competitive advantage over their U.S. counterparts thanks to lower-cost inputs—raw materials (access to cheaper fuel), capital (interest-free government loans), labor—and fewer regulations (for example, regarding nighttime takeoffs and landings, or in adding new runways and building luxury airports with swimming pools, among other amenities).

Economies of Scale: Reaping economies of scale and learning is critical for the airframe-manufacturing industry in order to ensure cost-competitiveness. The market for commercial airplanes is often not large enough to allow more than one competitor to reach sufficient scale to drive down unit cost. Boeing chose not to compete with Airbus in the market for superjumbo jets; rather, it decided to focus on a smaller, fuel-efficient airplane (the 787 Dreamliner, priced at roughly $250 million) that allows for long-distance, point-to-point connections. By 2017, it had built over 530 Dreamliners with more than 1,200 orders for the new airplane. Boeing can expect to reap significant economies of scale and learning, which will lower per-unit cost. At the same time, Airbus had delivered 210 A-380 superjumbos (sticker price: $430 million) with more than 100 orders on its books. If both companies would have chosen to compete head-on in each market segment, the resulting per-unit cost for each airplane would have been much higher because neither could have achieved significant economies of scale (overall their market share split is roughly 50–50).

Learning curve effects: Learning drives down cost, because it takes less time to produce the same output. Professionals learn how to be more efficient with cumulative experience, for example: writing computer code, developing new medicines and building submarines.

1) Uneven unionization (Roth, TWSJ, 03/25/09, B1)

FedEx	UPS
Formed as an airline in the 1970s Railway Act	Formed as a trucking company National Labor Relations Act

Company-wide employee votes required for labor representation

Location-by-location basis unionization permitted

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Exhibit 6.5 Economies of Scale

Decreases in per unit costs as output increases

Diseconomies of Scale:

Firm too big

Coordination complexities

Inflexible and slow

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Firms with greater market share might be in a position to reap economies of scale, decreases in cost per unit as output increases. This relationship between unit cost and output is depicted in the first (left-hand) part of this image. Cost per unit falls as output increases up to point Q1. A firm whose output is closer to Q1 has a cost advantage over other firms with less output. In this sense, bigger is better.

The output range between Q1 and Q2 in the figure is considered the minimum efficient scale (MES) to be cost-competitive. Between Q1 and Q2, the returns to scale are constant. It is the output range needed to bring the cost per unit down as much as possible, allowing a firm to stake out the lowest-cost position achievable through economies of scale.

Benefits to scale cannot go on indefinitely, though. Bigger is not always better; in fact, sometimes bigger is worse. Beyond Q2, firms experience diseconomies of scale—increases in cost as output increases. As firms get too big, the complexity of managing and coordinating the production process raises the cost, negating any benefits to scale.

(2) Economies of Scale Drivers

(a) Spread fixed costs over a larger output

(b) Employ specialized systems and equipment

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Spread fixed costs over a larger output example: Microsoft spent $25 billion on R&D for Windows 7 before a single copy was sold

Employ specialized systems and equipment example: Demand for Tesla’s Model S sedan allowed it to employ cutting-edge robotics

Take advantage of certain physical properties example: Big box stores can stock more merchandise and handle inventory efficiently

(2c) Cube-Square Rule: “Big Box” Retailers’ Advantage

Dimension increases from 2 to 3

6-8

Surface area increases from 24 to 54 (by 125%)

Volume increases from 8 to 27 (by 238%)

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(3) Learning Curve Effects

We learn how to be more efficient with experience

First noted during aircraft manufacturing in the 1930s: When production doubled, per-unit cost dropped by a predictable and constant rate (approximately 20%)

The more complex the underlying process the more learning effect we can expect with experience

How this may apply to you at School?

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Gaining Competitive Advantage Through Learning Curve and Experience Curve Effects

Exhibit 6.7

Jump to Appendix 7 long image description

(4) Experience curve: When technology is changed while output is constant (e.g., new production process)

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Firm A produces eight aircraft and reaches a per-unit cost of $73 million per aircraft. Firm B produces 128 aircraft using the same technology as Firm A (because both firms are on the same [90 percent] learning curve), but given a much larger cumulative output, its per unit-cost falls to only $48 million. Thus, Firm B has a clear competitive advantage over Firm A, assuming similar or identical quality in output. Firm C realizes a positive impact of change due to technology and process innovation.

Benefits & Risks of Competitive Positioning

Competitive Force	Differentiation Benefits	Differentiation Risks	Cost Leadership Benefits	Cost Leadership Risks
Threat of Entry	Protection against entry due to intangible resources such as a reputation for innovation, quality, or customer service	Erosion of margins Replacement	Protection against entry due to economies of scale	Erosion of margins Replacement
Power of Suppliers	Protection against increase in input prices, which can be passed on to customers	Erosion of margins	Protection against increase in input prices, which can be absorbed	Erosion of margins
Power of Buyers	Protection against decrease in sales prices, because well-differentiated products or services are not perfect imitations	Erosion of margins	Protection against decrease in sales prices, which can be absorbed	Erosion of margins
Threat of Substitutes	Protection against substitute products due to differential appeal	Replacement, especially when faced with innovation	Protection against substitute products through further lowering of prices	Replacement, especially when faced with innovation
Rivalry Among Existing Competitors	Protection against competitors if product or service has enough differential appeal to command premium price	Focus of competition shifts to price Increasing differentiation of product features that do not create value but raise costs Increasing differentiation to raise costs above acceptable threshold	Protection against price wars because lowest-cost firm will win	Focus of competition shifts to non-price attributes Lowering costs to drive value creation below acceptable threshold

There is no single correct business strategy for a specific industry. The deciding factor is that the chosen business strategy provides a strong position that attempts to maximize economic value creation and is effectively implemented.

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Reference section 6.4 for additional details.

Exhibit 6.9 Blue Ocean Strategy: Value Innovation

Simultaneously pursue differentiation (V ↑) and low cost (C ↓)

Blue ocean metaphor:

Untapped market space

Creation of additional demand Highly profitable growth

Trader Joe’s: Offers high value at much lower costs than Whole Foods

Toyota: Delivers higher quality cars at lower cost

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.

Achieving Successful Value Innovation

Lowering costs (Ikea)

Eliminate: Which of the factors that the industry takes for granted should be eliminated? (No salespeople and after sales service)

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

Increasing perceived consumer benefits (Ikea)

Raise: Which of the factors should be raised well above the industry’s standard? (Thousands of home furnishing items)

Create: Which factors should be created that the industry has never offered? (New way to shop for furniture)

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.

Consider IKEA:

Eliminated: sales people, and after sales service

Reduced: warranties

Raised: offers tens of thousands of home furnishing items

Created: a new way to shop for furniture

Exhibit 6.10 Value Innovation vs. Stuck In the Middle

Being stuck in the middle leads to inferior performance and a resulting competitive disadvantage.

Exhibit 6.10 Strategy Canvas in the Airline Industry

Graphical depiction of a company’s performance relative to its competitors viewed across the industry’s key success factors

The Value Curve: Horizontal connection points located on the strategy canvas. Helps strategists determine courses of action

Legacy carriers tend to score highly among most competitive elements in the airline industry, including different seating class choices (such as first class, business class, economy comfort, basic economy, and so on), a high level of in-flight amenities such as Wi-Fi, personal video console to view movies or play games, complimentary drinks and meals, coast-to-coast coverage via connecting hubs, plush airport lounges, international routes and global coverage, high customer service, and high reliability in terms of safety and on-time departures and arrivals. As is expected when pursuing a generic differentiation strategy, all these scores along the different competitive elements in an industry go along with a relative higher cost structure.

In contrast, the low-cost airlines tend to hover near the bottom of the strategy canvas, indicating low scores along a number of competitive factors in the industry, with no assigned seating, no in-flight amenities, no drinks or meals, no airport lounges, few if any international routes, low to intermediate level of customer service. A relatively lower cost structure goes along with a generic low-cost leadership strategy.

JetBlue value curve follows a zigzag pattern. JetBlue attempts to achieve parity or even out-compete differentiators in the U.S. airline industry along the competitive factors such as different seating classes (e.g., the high-end Mint offering discussed in the ChapterCase), higher level of in-flight amenities, higher-quality beverages and meals, plush airport lounges, and a large number of international routes (mainly with global partner airlines). JetBlue, however, looks more like a low-cost leader in terms of the ability to provide only a few connections via hubs domestically, and it recently has had a poor record of customer service, mainly because of some high-profile missteps as documented in the ChapterCase

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