Midterm
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Chapter6.pptxChapter 6
Business Strategy: Differentiation, Cost Leadership and Blue Oceans
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Learning Objectives
Define business-level strategy and describe how it determines a firm’s strategic position.
Examine the relationship between value drivers and differentiation strategy.
Examine the relationship between cost drivers and cost-leadership strategy.
Assess the benefits and risks of differentiation and cost-leadership strategies.
Evaluate value and cost drivers that may allow a firm to pursue a blue ocean strategy.
Assess the risks of a blue ocean strategy and explain why it is difficult to succeed at value innovation.
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The AFI Strategy Framework
Access the text alternative for slide images.
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Case Study: jetBlue
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Launched in 2000 by David Neeleman, a former SWA exec whose previous airline had been bought out by SWA.
Blue Oceans strategy. Low cost like SWA (point to point, one airline type), with value options of legacy carriers like free bags, wifi and live reservations, (plus Mint upgrade). Focused on transcontinental nonstop flights.
Strategy was Hi-touch to enhance the customer experience and Hi-tech to lower the costs.
Early had a competitive advantage, but could not sustain it (started charging for bags, reduced legroom). Fundamentally, could not balance providing superior customer service and limit costs. Today they are similar to Alaska Airlines and are not longer unique.
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What Is Business Level Strategy?
Goal-directed actions:
The goal-directed actions managers take in their quest to achieve a competitive advantage in a single product market.
“How should we compete?”
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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To formulate an effective business strategy, managers need to keep in mind that competitive advantage is determined jointly by industry and firm effects.
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Industry and Firm Effects Jointly Determine Competitive Advantage
Exhibit 6.1
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Industry and firm effects are not independent, but rather they are interdependent, as shown by the two-pointed arrow connecting industry effects and firm effects.
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Strategic Position
A strategic profile based on value creation and cost in a specific product market.
Refresher: the greater the economic value created, the greater the firm’s competitive advantage. (V-C)
A valuable and unique position, which:
meets customer needs…
at the highest possible product value…
for the lowest possible product cost…
to create a competitive advantage.
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It is useful here to remind the students of the (V-C) value creation introduced earlier…the consumers max willingness to pay less the firms cost = economic value
Competitive advantage is based on having the higher economic value
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Strategic Trade-Offs
Choices between a cost OR value position.
Tension between value creation and pressure to keep cost in check.
Purpose to maximize the firm’s:
Economic value creation.
Profit margin.
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Generic Business Strategies
Differentiation:
Seeks to create higher value vs. competitors.
Offers unique features.
Charges higher prices.
Cost Leadership:
Seeks to create similar value vs. competitors.
Charges lower prices.
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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.
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Focused Business Strategies
Narrower competitive scope.
Focused Differentiation:
Mont Blanc: exquisite pens at several hundred dollars…”writing instruments”
Focused Cost Leadership:
BIC: disposable pens and lighters at low cost.
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BIC pursues a focused cost-leadership strategy, designing and producing disposable pens and cigarette lighters at a low cost, while Mont Blanc pursues a focused differentiation strategy, offering exquisite pens—what it calls “writing instruments”—frequently priced at several hundred dollars.
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Focused Business Strategies
Broader competitive scope.
Broad Differentiation:
Cadillac: Luxury cars for the more discerning driver.
Broad Cost Leadership:
Chevy: reliable and functional cars for the masses.
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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.
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Strategic Position and Competitive Scope: Generic Business Strategies
Jump to Appendix 3 long image description
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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.
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Differentiation Strategy
Unique features that increase value, so that consumers pay a higher price.
The focus of competition:
Unique product features.
Service.
New product launches.
Marketing and promotion.
Complements.
Competitive advantage achieved when:
Value – Cost > Competitors.
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Three Key drivers for increasing value are:
Unique features
Great customer service
Complementary products that drive more sales
Whole foods video - https://www.youtube.com/watch?v=PhOI-HGR7zQ
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Differentiation Strategies: Summary
Focused on adding value
Unique features
Customer service
Complements (add value to a product or service when they are consumed in tandem).
Can increase costs through R&D and whatever innovation is needed.
The result is that the customers are willing to pay a premium.
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These logos represent companies that provide a commodity product, but sell them at a premium.
Ex. Complements: smartphones and cellular services, Apple Watch to iPhone
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Differentiation Strategy
What triggers consumers to pay a higher price?
Competitive advantage achieved when:
Value – Cost > competitors
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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 US, 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.
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Cost Leadership Strategy
Goals:
Reduce cost below competitors.
Offer adequate value.
Reduce prices for customers.
Optimize the value chain for low cost.
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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.
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Drivers That Keep Costs Low
Managers can manipulate cost drivers to keep costs low
Cost of input factors:
Raw materials, capital, labor, and IT services.
Economies of scale:
Decreases in cost per unit as output increases.
Learning-curve effects:
Less time to produce output with experience.
Experience-curve effects:
Improvements to technology & production processes.
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Non union labor and fuel cost negotiations allow SWA to be low cost provider
Think about Budweiser vs. your favorite craft beer.
The first time you do something is difficult but becomes easier with time.
New technology can equate to better efficiency. Assembly lines have become more robotic
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Economies of Scale and Scope
Economies of Scale:
Decreases in cost per unit.
Achieved as output increases.
Economies of Scope:
Savings that come from producing two outputs at less cost.
Shares the same resources or technology.
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Economies and Diseconomies of Scale
Economies of Scale:
Spreads fixed costs over a larger output.
Employs specialized systems and equipment.
Takes advantage of certain physical properties.
Diseconomies of Scale:
Firms too big.
Complexities of too much coordination.
Inflexible and slow.
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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
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Tesla’s Learning Curve Producing the Model S
Exhibit 6.6
Source: Depiction of functional relationship estimated in J. Dyer and H. Gregersen (2016, Aug. 24), “Tesla’s innovations are transforming the auto industry,” Forbes
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Tesla was able to drive down the unit cost for each car as production volume ramped up. Initially, Tesla lost a significant amount of money on each Model S sold because of high upfront R&D spending to develop the futuristic self-driving car. When producing only 1,000 vehicles, unit cost was $140,000. As production volume of the Model S reached some 12,000 units per year (in 2014), unit cost fell to about $57,000. Although still high, Tesla was able start making money on each car, because the average selling price for a Model S was about $90,000.
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Cost Leadership Strategies: Summary
Focus on:
Offering lower costs than competitors.
Maintaining acceptable quality.
Appeals to the bargain-conscious buyer:
Attracts increased sales.
Can be profitable over a long period of time.
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Ryanair: Lower Cost than the Low-Cost Leader!
Ryanair has unbundled air travel to its extreme.
More than 20% of Ryanair’s revenues flow from ancillary services: premium-rate phone line to contact them, checked bags, checking in, pillows, blankets, water.
Ryanair offers the basic service (air travel only) for a low price, but charges a steep premium for all other items and upgrades.
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What Is Blue Ocean Strategy?
A strategy that combines both differentiation and cost-leadership activities.
A firm offers a differentiated product or service at a low cost.
Ex: Trader Joe’s, Cirque du Soleil.
Uses value innovation to reconcile trade-offs.
Blue oceans represent:
Untapped market space.
Creation of additional demand.
Opportunities for highly profitable growth.
Disruption!!!
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(Red oceans are the known market space of existing industries)
In red oceans the rivalry among existing firms is cut-throat because the market space is crowded and competition is a zero-sum game. Products become commodities, and competition is focused mainly on price. Any market share gain comes at the expense of other competitors in the same industry, turning the oceans bloody red.
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Blue Oceans are uncontested market spaces such as: new customer segments for or reconceptualizations of existing products, or novel recombinations of product attributes. The Strategy Canvas can help identify blue ocean strategies by exploring new combinations of product attributes. E.g. Cirque du Soleil.
Price
Low
High
Performing animals
Humor
Acrobatics
Thrills/danger
Dance
Costumes
Music
Visual experience
Comfort
Attractive venue
Appeal to children
Appeal to adults
Cirque du Soleil
Traditional circus
Blue Ocean Strategy
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Traditional circuses were costly due to Animal care and competing for talent, (taking from each other to create demand). Commodity services, (like wireless carriers). Cirque created a market for both circus and theatre that emphasizes the show, not the talent.
Red Ocean vs. Blue Ocean
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Casper Mattress
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How are they using a Blue Ocean strategy? And are they alone? Leesa, Eve, Keetsa
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Value Innovation Accomplished through Simultaneously Pursuing Differentiation (V ↑) and Low Cost (C ↓)
Exhibit 6.9
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).
Access the text alternate for slide image.
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Successful value innovation requires that a firm’s strategic moves lower its costs and also increase the perceived value for buyers. Lowering a firm’s costs is primarily achieved by eliminating and reducing the taken-for-granted factors that the firm’s industry rivals 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.
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To Achieve Successful Value Innovation
Lower costs:
Eliminate: Which of the factors should be eliminated?
Reduce: Which of the factors should be reduced?
Increase perceived consumer benefits:
Raise: Which of the factors should be raised?
Create: Which factors should be created?
It is difficult to succeed at value innovation
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Consider IKEA:
Eliminated: salespeople, and after-sales service.
Reduced: warranties.
Raised: offers tens of thousands of home furnishing items.
Created: a new way to shop for furniture.
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Value Innovation: Combining the best of both.
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Value Innovation vs. Stuck in the Middle
Exhibit 6.10
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This image suggests how a successfully formulated blue ocean strategy based on value innovation combines both a differentiation and low-cost position. It also shows the consequence of a blue ocean strategy gone bad—the firm ends up being stuck in the middle, meaning the firm has neither a clear differentiation nor a clear cost-leadership profile. Being stuck in the middle leads to inferior performance and a resulting competitive disadvantage.
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Successful Business Strategy
A successful strategy:
Leverages the firm internal strengths.
Mitigates internal firm weaknesses.
Exploits external opportunities.
Avoids external threats.
There is no single correct business strategy for a specific industry.
Choose a strategy that:
Provides a strong position that attempts to maximize economic value creation.
Is effectively implemented.
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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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Remember…
Business strategy is more likely to lead to a competitive advantage if it allows firms to either…
perform similar activities differently
or
perform different activities than their rivals
which result in creating more value and/or offer similar products/services at lower cost.
Good/fast/cheap…pick two
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Cheap + fast = lower quality work
Fast + good = expensive
Good + cheap = not delivered anytime soon
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Breakout exercise
With your assigned industry, identify the players and then identify which of the business-level strategies they employ.
If you identify them as value innovation, tell us how you feel they accomplished that role and where they successful.
Team 1 – Grocery suppliers Team 2 – Beer makers
Team 3 – Clothing stores Team 4 – Car companies
Team 5 – Smartphone firms Team 6 - Restaurants
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© 2019 McGraw Hill. All rights reserved. Authorized only for instructor use in the classroom.
No reproduction or further distribution permitted without the prior written consent of McGraw Hill.
Because learning changes everything.®
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