Blue Ocean Strategy Book Review

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CHAPTER

BUSINESS-LEVEL STRATEGY

Reinventing The New York Times

The 167-year-old New York Times has long been regarded as one of the premium newspapers in the Uni ted States, with a reputation for p rod uc- ing original , authoritative, in-depth , quality iournal ism The articulated stra tegy of the Times is to provide journal ism "so strong that several mil lion people around the world are willing to pay for it. " Maintai ning that rep utation does no t come cheap The Times employs some l , 300

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Chapter 5 Business-Level Strategy l 45

full-time jou rnalists, more tha n any other U S. newspaper. In 20 16 , the company's jour- nalists filed stories from more tha n 150 countries-nearly 80% of al l countries on the planet. This gives the Times an international reach that far outstrips its riva ls. Its reputa tion makes it the employer of choice for many top jou rn alists, and the paper has a reputatio n for hiri ng some of the field 's most creative people. But that top-tier journalistic brai n trust is an expensive asset to maintai n.

The evidence suggests that the Times has been successful in its q uest for quality. It is by far the most ci ted news publisher by other media organizations, the most d iscussed o n Twitter, and the most searched on Google. Tha t being said , like all trad itiona l p ri nt med ia outlets, the Times is facing an existential threat as the world transitions from p ri nt to d igita l media for its news . Print newspapers were once a high ly successful business, generating steady revenue g rowth from a combination of subscriptions and advertising, but the Internet has changed all of that. Today, revenue from print subscriptions and p ri nt ads are in decline. At the Times , the print business has been sh ri nking by 4% a year si nce 201 1.

To survive in this new world, the Times has pushed agg ressively on line. In 20 l l , it established a paywall for its d igital con tent. Cri tics pred icted that online readers would simply ignore th e Times and switch to news media sites where the content is pa id for by adve rtisi ng and is thus subsc riptio n fre e. In fact, the subsc riber base at the Times has surged, and its d igital revenues now tower above th ose of any other news competitor. By the end of 2017, it had 2 .2 mi llio n d ig ital subscribers-an increase of 47% over the prior year-and it earned $340 million from subsc ri ptions a lone . To put th is in context , the g rowth in subscription revenue sin ce 20 l l is si mi lar to the growth rate a chieved by Facebook and faster than that of G oog le. In 20 17 , the Times made another $240 million from digi tal ad vertis ing , a 14 % inc rease fro m the prior year.

Wh ile advertising revenue p lays a role, the strategy of the Times is clear: It wi ll go for subscription revenues over advertising revenues in order to d ifferentiate its offeri ng from advertisi ng saturated "free" new s sites like BuzzFeed, Th e Gua rdian, and Vice. So far the approach a ppears to be w o rking . A t its current pace, the Times is o n track to achieve d igita l revenues of $800 mi llion by 2020, a goal it set back in 2011 . A t that poi nt, the Times w ill be generating half of its revenue dig itally. If the company can ma inta in th is growth rate into the middle of the next d ecad e, it wi ll be able to suppo rt tho se 1,300 q uality journalists on its staff, even in the face of the continued , steady decl ine in p rin t newspaper c ircula tion .

Sources: "Journalism that Stands Apart," New York Times, January 2017; Gabri l Snyder, The New York Times claws its way into the future," Wired, February 12, 2017; E. lee and Roni Mollo, "The New York Times digital poywoll is growing as fast as Focebook, and foster tha n Google," Recode, February 8, 2018 .

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146 Part 3 Strategies

business-level strategy A business's overall competi tive theme ; the way it positions itself in the marketplace to gain a competi tive advantage, and the different positioning strategies that it can use in different industry setting s.

5-1 OVERVIEW In this chapter we look at the formulation of business-level strategy. As you may recall from Chapter 1, business-level strategy refers to the overarching competitive theme of a company in a given market. At its most basic, business-level strategy is about whom a company decides to serve (its customer segments), what customer needs and desires the company is trying to satisfy, and how the company decides to satisfy those needs and desires. 1 If this sounds familiar, it is because we have already discussed this in Chapter 1 when we considered how companies construct a mission statement.

The New York Times provides us with an illustration of how this works (see the Opening Case). The Times targets an educated, liberal-leaning demographic segment that desires to read original, high-quality journalism and opinions, and are willing to pay a premium price for that experience (most importantly, they are willing to sub- scribe to digital versions of the newspaper). The Times strives to satisfy the desires of this demographic by hiring talented journalists and retaining an unusually large newsroom for the postprint era so that it can continue to differentiate itself by produc- ing original high-quality news. In addition, the Tim es is conscious of not overloading this demographic with advertisements, so it strives to cover its costs by aggressively growing its digital subscriber base rather than focusing o n advertising. By 2017, six years after it first introduced digital subscriptions, the newspaper already has twice as many digital subscribers as print subscribers, suggesting that the strategy is working.

In this chapter, we will look at how managers decide what business-level strategy to pursue, and how they go about executing that strategy in o rder to attain a sustainable competitive advantage. We start by looking at the two basic ways that companies com- pete in a marketplace- by lowering costs and by differentiating their goods or services from those offered by rivals so that they create more value. Next, we consider the issue of customer choice and market segmentation, a nd discuss the decisions that managers must make when it comes to their company's segmentation strategy. Then, synthesizing this, we discuss the various business-level strategies that an enterprise can adopt, and what must be done to successfully implement those strategies. The chapter closes with a discussion of how managers can think about formulating an innovative, business-level strategy that gives their company a unique and defendable position in the marketplace.

5-2 LOW COST AND DIFFERENTIATION Strategy is about the search for competitive advantage. As we saw in Chapter 3, at the most fundamental level, a company has a competitive advantage if it can lower costs relative to rivals and/or if it can differentiate its product offering from those of rivals, thereby creating more value. We will look at lowering costs first , and then at differentiation. 2

5-2a Lowering Costs Imagine that all enterprises in an industry offer products that are very similar in all respects except for price, a nd that each company is small relative to total market

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C hapter 5 Business-Level Strategy 147

demand, so that they are unable to influence the prevailing price. This situation exists in commodity markets such as those for oil, wheat, aluminum, and steel. In the global oil market, for example, prices are set by the interaction of supply and demand. Even the wo rld 's largest private oil producer, Exxon Mobile, only produces around 3.5% of world output and cannot influence the prevailing price.

In commodity markets, competitive advantage goes to the company that has the lowest costs. Low costs enable a company to make a profit at price points where its rivals a re losing money. Low costs can also a llow a company to undercut rivals on price, gain market share, and maintain or even increase profitability. Being the low- cost player in an industry can be a very advantageous position.

Although lowering costs below those of rivals is a particularly powerful strategy in a pure commodity industry, it can also have great utility in other settings. General merchandise retailing, for example, is not a classic commodity business. Nevertheless, Wal-Mart has built a very strong competitive position in the U.S. market by being the low-cost player in its segment. Because its costs are so low, Wal-Mart can cut prices, grow its market share, and still make profits at price points where its competitors lose money. The same is true in the airline industry, where Southwest Airlines has estab- lished a low-cost position. Southwest's operating efficiencies have enabled it to make money in a n industry that has been hit by repeated bouts of price warfare, and where many of its rivals have been forced into bankruptcy.

5-2b Differentiation Now let's look at the differentiation side of the equation. Differentiation involves distinguishing your company from its rivals by offering something that they find hard to match. As we saw in the Opening Case, the New York Tim es differentiated itself from its rivals in the minds of its customers by producing original, high-quality jour- nalism. A company can differentiate itself from rivals in many ways. A product can be differentiated by superior reliability (it breaks down less often, or not at all), better design, superior functions and features, better point-of-sale service, better after-sales service and support , better branding, and so on. A Rolex watch is differentiated from a Timex watch by superior design, materials, and reliability; a Toyota car is differenti- ated from a General Motors (GM) car by superior reliability (historically, new Toyota models have had fewer defects than new GM models); Apple differentiates its iPhone from rival offerings through superior product design, ease of use, excellent customer service at its Apple stores, and easy synchronization with other Apple products such as computers, tablets, iTunes, and iCloud.

Differentiation gives a company two advantages. First, it can allow the company to charge a premium price for its good or service should it chose to do so. Second, it can help the company grow overall demand and capture market share from its rivals. In the case of the iPhone, Apple has reaped both of these benefits through its successful differentia- tion strategy. Apple charges more for its iPhone than people pay for rival smartphone offerings, and the differential appeal of Apple products has led to strong demand growth .

It is important to note that differentiation often (but not always) raises the cost structure of the firm. It costs the Times more to produce high-quality journalism. It is often the case that companies pursuing a differentiation strategy have a higher cost structure than companies pursuing a low-cost strategy. On the other hand, somewhat counterintuitively, there are situations where successful differentiation, because it in- creases primary demand so much, can actually lower costs. Apple's iPhone is a case in

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148 Part 3 Strateg ies

point. Apple uses very expensive materials in the iPhone- Gorilla Glass for the screen and brushed aluminum for the case. It could have used cheaper plastic, but then the product would not have looked as good and would have scratched easily. Although these decisions about materials originally raised the unit cost of the iPhone, the fact is that Apple has sold so many iPhones that it now enjoys economies of scale in pur- chasing and can effectively bargain down the price it pays for expensive materials. T he result for Apple- successful differentiation of the iPhone- not only has allowed the company to charge a premium price, it has also gown demand to the point where Apple can lower costs through the attainment of scale economies, thereby widening profit margins. This is why Apple captured 79% of all profits in the global smartphone business in the second half of 20 16.

The Apple example points to an essential truth: Successful differentiation gives managers options. One option is to raise the price to reflect the differentiated nature of the product offering and cover a ny incremental increase in costs (see Figure 5.1 ). Many firms pursue this option, which can by itself enhance profitability as long as prices in- crease more than costs. For example, Four Seasons hotels are very luxurious- and it costs a lot to provide that luxury- but it also charges very high prices for its rooms, and the firm is profitable as a result.

However, the Apple example also suggests that increased profitability and profit growth can come from the increased demand associated with successful differentia- tion, which enables the firm to use its assets more efficiently and thereby realize lower costs from scale economies. This leads to another option: The successful differentiator can hold prices constant, or only increase them slightly, sell more, and boost profit- ability through the attainment of scale economies (see Figure 5.1).3

Figure 5. l Options for Exploiting Differentiation

Option 1

Successfu l differentiation

N c: 0 ·.;::; c.

0

Moderate or no

price increase

Source: Charles W .L. Hill © Copyrig ht 20 13 .

Increase prices more t han costs

Increased demand

Higher profitability

and profit

growth

Economies of scale and

lower costs

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C hapter 5 Business-Level Strategy l 4 9

For another example, consider Starbucks. The company has successfully differenti- ated its product offering from that of rivals such as Tully's by the excellent quality of its coffee-based drinks; by the quick, efficient, friendly service that its baristas offer custom- ers; by the comfortable atmosphere created by the design of its stores; and by its strong brand image. This differentiation increases traffic volume in each Starbucks store, thereby increasing the productivity of employees (they are always busy) and the productivity of the capital invested in the store. Thus, each store realizes scale economies from greater volume, which lowers the average unit costs at each store. Spread across the 27,000 stores that Starbucks operates, this represents potentially huge cost savings that translate into higher profitability. Add this to the enhanced demand that comes from successful dif- ferentiation- which in the case of Starbucks not only enables the firm to sell more from each store, but also to open more stores- and profit growth will also accelerate.

5-2c The Differentiation-Low-Cost Trade-off The thrust of our discussion so far is that a low-cost position and a differentiated po- sition are two very different ways of gaining a competitive advantage. The enterprise striving for the lowest costs does everything it can to be productive and drive down its cost structure, whereas the enterprise striving for differentiation necessarily has to bear higher costs to achieve that differentiation. Put simply, one cannot be both Wal-Mart a nd No rdstrom, Porsche and Kia, Rolex and Timex. Managers must choose between these two basic ways of attaining a competitive advantage.

However, presenting the choice between different iation and low costs in these terms is something of a simplification. As we have already noted, the successful differentia- tor might be able to subsequently reduce costs if differentiation leads to significant demand growth and the attainment of scale economies. But in actuality, the relation- ship between low cost and differentiation is subtler than this. In reality, strategy is not so much about making discrete choices as it is about achieving the right balance is between differentiation and low costs.

To understand these iss ues, see Figure 5.2. The convex curve in Figure 5.2 illustrates what is known as an efficiency frontier (also known in economics as a production pos- sibility frontier). 4 The efficiency frontier shows a ll of the different positions that a com- pany can adopt with regard to differentiation and low cost, assuming that its internal functions and organizational arrangements a re configured efficiently to support a par- ticular position (note that the horizontal axis in Figure 5.2 is reverse scaled- moving along the axis to the right implies lower costs). The efficiency frontier has a convex shape because of diminishing returns. Diminishing returns imply that when an enter- prise already has significant differentiation built into its product offering, increasing differentiation by a relatively small amount requires significant additional costs. The converse also holds: A company that already has a low-cost structure must relinquish much differentiation in its product offering to achieve additional cost reductions.

The efficiency frontier shown in Figure 5.2 is for the U.S. retail apparel business (Wal-Mart sells more than apparel, but that need not concern us here). As you can see, the high-end retailer Nordstrom and the low-cost retailer Wal-Mart are both shown to be on the frontier, implying that both organizations have configured their inter- nal fun ctions and organizations efficiently. However, they have adopted very different positions; Nordstrom has high differentiation and high costs, whereas Wal-Mart has low costs and low differentiation. These are not the only viable positions in the indus- try, however. The Gap, too, is on the frontier. The Gap offers higher-quality apparel

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150 Part 3 Strategies

Figure 5.2 The Differentiation-Low-Cost Trade-off

c

c 2!

...

..c en = !:! .s Cl> =

Source: Charles W.L. Hill© Copyright 2013.

C* Low cost

Efficiency frontier

merchandise than does Wal-Mart, sold in a more appealing environment, but its of- fering is nowhere near as differentiated as that of Nordstrom; it is positioned between Wal-Mart and Nordstrom. This mid-level position, offering moderate differentiation at a higher cost than Wal-Mart, makes perfect sense because there are enough con- sumers demanding this option. They don't want to look as if they purchased their clothes at Wal-M art; they want fashionable, casual clothes that are more affordable than those available at Nordstrom.

The essential point is that there are often multiple positions on the differentiation- /ow-cost continuum that are viable in the sense that they have enough demand to support an offering. The task for managers is to identify a position in the industry that is viable and then configure the functions and organizational arrangements of the enterprise so that they are run as efficiently and effectively as possible, and enable the firm to reach the frontier. Not all companies are able to do this. Only those that can get to the fron- tier have a competitive advantage. Getting to the frontier requires excellence in strategy implementation. As has been suggested already in this chapter, business-level strategy is implemented through function and organization. Therefore, to successfully imple- ment a business-level strategy and reach the efficiency fi'ontier, a company must pursue the right functional-level strategies and be appropriately organized; business-level strategy, functional-level strategy, and organizational arrangem ent must all be in alignment.

It should be noted that not all positions on an industry's efficiency frontier are equally attractive. For some positions, there may not be sufficient demand to support a product offering. For other positions, there may be too many competitors going after the same basic position- the competitive space might be too crowded- and the resul t- ing competition might drive prices below acceptable levels.

In Figure 5.2, K-Mart is inside the frontier. K-Mart is trying to position itself in the same basic space as Wal-Mart, but its internal operations are not efficient (the

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C hapter 5 Business-Level Strategy l 5 l

company was operating under bankruptcy protection in the ea rly 2000s, although it is now out of bankruptcy). Also shown in Figure 5.2 is Seattle-based clothing re- tailer Eddie Bauer, which is owned by Spiegel. Like K-Mart, Eddie Bauer is not an efficiently run operation relative to its rivals. Its parent company has operated under bankruptcy protection three times in the last 20 years.

5-2d Value Innovation: Greater Differentiation at a Lower Cost The efficiency frontier is not static; it is continually being pushed outward by the efforts of managers to improve their firm 's performance through innovation. For example, in the mid-1990s, Dell pushed out the efficiency frontier in the personal computer (PC) industry (see Figure 5.3). Dell pioneered the online sale of PCs, allowing customers to build their own machines and effectively creating value through customization. In other words, the strategy of selling online allowed Dell to differentia te itself from rivals that sold PCs through retail outlets. At the same time, Dell used order information submit- ted over the Web to efficiently coordinate and manage the global supply chain, driving down production costs in the process. The net result was that Dell was able to offer more value (through superior differentiation) at a lower cost than its rivals. Through its process innovations, it redefined the frontier of what was possible in the industry.

We use the term value innovation to describe what happens when innovation pushes out the efficiency frontier in an industry, allowing for greater value to be offe red through superior differentiation at a lower cost than was previously thought possible. 5 When

Figure 5.3 Value Innovation in the PC Industry

High

= = .. :e Cl

Low High Cost

PC Industry Frontier 1985

Source: Charles W. l. Hill © Copyrig ht 20 13 .

PC Industry / Frontier 2005

We call this value innovation

Low Cost

value innovation W hen innovations push out the effic iency fron tier in an industry, a llow ing for greater value to be offered thro ugh superior differentia ti on a t a lower cost than was previously thoug ht po ssible.

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152 Part 3 Strateg ies

a company pioneers process innovations that lead to value innovation, it effectively changes the game in an industry and may be able to outperform its rivals for a long pe- riod of time. This is what happened to Dell. After harnessing the power of the Internet to sell PCs online and coordinate the global supply chain, Dell outperformed its rivals in the industry for over a decade while they scrambled to catch up with the industry leader.

Toyota too has benefitted from value innovation. As we have discussed in Chap- ters 3 and 4, Toyota pioneered lean production systems that improved the quality of automobiles while simultaneously lowering costs. Toyota redefined what was possible in the automobile industry, effectively pushing out the efficiency frontier and enabling the company to better differentiate its product offering at a cost level that its rivals couldn't match . The result was a competitive advantage that persisted for over two decades. For another example of value innovation, see Strategy in Action 5.1, which describes how IKEA redefined competition in the furniture business.

5.1 STRATEGY IN ACTION IKEA: Value Innovation in Furniture Retailing IKEA, th e privately held furniture retailer, is a global coloss us. The world's largest furniture retai ler, in 2014, IKEA had 361 stores around the globe, 164,000 em- ployees, revenues in excess of 30 billion Euros, and 86 1 million customer visits to its stores. The company started out with a single store in Sweden in 1958. The vision of the company's founder, lngvar Kamprad, was to "democratize furniture," making stylish, functional furniture available at a low cost.

Kamprad's vision was a reaction to the existi ng mar- ket for furniture . Furniture was either seen as an expen- sive hei rloom, w hich typically had to be ordered from the manufacturer after the consumer had made a purchase decision in a retail store, and might take 3 months to deliver, or was poorly designed, low-q uaity, cheap fur- niture sold in discount stores. As IKEAs strategy evolved, its core target market became young professionals look- ing to furnish their first apartments or homes with stylish but inexpensive furniture that could be disposed of when they were able to buy more traditional , heirloom-style furniture .

Over the years, Kamprad assembled a world- class team that designed stylish, quality furniture that

emphasized clean, "Swedish" lines. An important goal was to make IKEA offerings 30% cheaper than comparable items produced by rivals. To drive down costs, Kamprad and his associates worked out ways to reduce the costs of making and delivering this fur- niture. They cooperated closely with long-term suppl i- ers to drive down material and manufacturing costs . They designed furniture tha t could be flat packed , wh ich reduced transportation and storage costs . They pushed assembly onto the consumer, but gave them lower prices as part of the bargain. They even made the consumer responsible for pulling inventory out of the warehouse, whi c h was typically placed between the product-display areas and the cash registers . As a resu lt of these actions, all taken at the functional level within the company, IKEA was able to offer more value to its target market than its rivals , and to do so at a lower cost. Through astute market segmentation and a well-thought-ou t strategy of value innovation , IKEA re- defined the furniture market not ju st in Sweden but in coun tri es around the globe, in the process becoming the world 's largest furniture retailer and making lngvar Kamprad one of the world 's richest men.

Source: C. W . L. Hill, "IKEA in 20 13: Furniture Retailer to the World," in C.W.L Hill, G .R. Jones, and M . Shilling, Strategic Management, 11 th edition !Boston: Cengage, 2015).

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C hapter 5 Business-Level Strategy l 5 3

5-3 WHO ARE OUR CUSTOMERS? MARKET SEGMENTATION

As noted in the introduction to this chapter, business-level strategy begins with de- ciding who the company is going to serve, what needs or desires it is trying to satisfy, and how it is going to satisfy those needs and desires. Answering these questions is not straightforward, because customers in a market are not homogenous. They often differ in fundamental ways. Some are wealthy, some are not; some are old, some are young; some are women, some are men; some are influenced by popular culture, some never watch TV; some live in cities, some in the suburbs ; some care deeply about status symbols, others do not; some place a high value on luxury, oth- ers value for money; some exercise every day, others have never seen the inside of a gym; some speak English most of the time, while for others Spanish is their first language; and so on.

One fundamental decision that every company faces is whether to recognize such differences in customers, and if so, how to tailor its approach depending on which cus- tomer segment or segments it decides to serve. The first step toward answering these questions is to segment the market according to differences in customer demographics, needs, and desires.

Market segmentation refers to the process of subdividing a market into clearly identifiable groups of customers with similar needs, desires, and demand characteris- tics. Customers within these segments are relatively homogenous, whereas they differ in important ways from customers in other segments of the market. For example, Nike segments the athletic shoe market according to sport and gender because it believes that people participating in different sports expect different things from an athletic shoe (a shoe designed for running is not suitable for playing basketball), and that men and women desire different shoe styling and construction (most men don't want to wear pink shoes). Similarly, in the market for colas, Coca-Cola segments the market by needs- regular Coke for the average consumer, and diet cola for consumers concerned about their weight. The diet cola segment is further subdivided by gender, with Diet Coke targeted at women, and Coke Zero targeted at men.

5 -3a Three Approaches to Market Segmentation Companies adopt one of three basic approaches to market segmentation. The first is to not tailor different offerings to different segments and instead produce and sell a standardized product that is targeted at the average customer in that market. This was the approach adopted by Coca-Cola until the early 1980s, before the introduc- tion of Diet Coke and fl avored cola drinks such as Cherry Cola. In those days, Coke was the drink for everyone. Coke was differentiated from the offerings of rivals, particula rly Pepsi Cola, by lifestyle advertising that positioned Coke as the iconic American drink, the "Real Thing." Some network broadcast news programs ado pt this approach today. The coverage offered by ABC News, for example, is tailored towa rd the average American viewer. The giant retailer Wal-Mart ta rge ts the aver- age customer in the market, a lthough, unlike Coca-Cola, Wal-Ma rt 's goal is to drive down costs so that it can charge everyday low prices, give its customers value for money, and still make a profit.

market segmentation The way a company decides to g roup c ustomers, based on important d ifferences in the ir needs, in order to gain a competitive advantage.

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154 Part 3 Strategies

standardization strategy When a company decides to ignore different segments and p roduces a standardi zed p roduct for the average consumer.

segmentation strategy When a company decides to serve many segments, or even the entire market, producing different offerings for different segments

focus strategy When a company decides to serve a limited number of segmen ts, or just one segment.

A second approach is to recognize differences between segments a nd create differ- ent product offerings for each segment. Coca-Cola has adopted this approach since the 1980s. In 1982, it introduced Diet Coke, ta rgeting that drink at the weight and health conscious. In 2007, it introduced Coke Zero, also a diet cola, but targeted at men because company research found that men tended to associate Diet Coke with women. Since 2007, Diet Coke has been repositioned as more of a women's diet drink. Similarly, in the automobile industry, Toyota has brands t hat address the en- tire market- Scion for budget-constrained , young, entry-level buyers; Toyota for the middle market, and Lexus for the luxury end of the market. In each segment, Toyota tries to differentiate itself from rivals in the segment by the excellent reliability and high quality of its offerings.

A third approach is to target only a limited number of ma rket segments, or just one, and to become the very best at serving that particular segment. In the automobile market, Porsche focu ses exclusively on the very top end of the marke t, targeting wealthy, middle-aged , male consumers who have a passion for the speed , power, a nd engineering excellence associated with its range of sports cars. Porsche is clearly pursuing a differentiation strategy with regard to this segment, although it emphasizes a different type of differentiation than Toyota. Altern atively, Kia of South Korea got its start by positioning itself as low-cost player in the indus- try, selling vehicles that were aimed at value-con scious buyers in the middle- and lower-income brackets. In the network broadcasting news business, Fox News and MSNBC have also adopted a focused approach . Fox tailors its content toward viewers o n the right of the political spectrum, whereas MSNBC is differentiated towa rd viewers on the left.

When managers decide to ignore different segments and produce a standardized product for the average consumer, we say they are pursuing a standardization strategy. When they decide to serve many segments, or even the entire market, producing differ- ent offerings for different segments, we say they a re pursuing a segmentation strategy. When they decide to serve a limited number of segments, or just one segment, we say they are pursuing a focus strategy. Today, Wal-Mart is pursuing a standardization strategy, Toyota a segmentation strategy, and Nordstrom a focus strategy.

5-3b Market Segmentation, Costs and Revenues It is important to understand that these different approaches to market segmentation have different implications for costs a nd revenues. Consider first the comparison be- tween a standardization strategy and a segmentation strategy.

A standa rdization strategy, which is typically associated with lower costs than a segmentation strategy, involves the company producing one basic offering a nd trying to attain econo mies of scale by achieving high-volume sales. Wal-Mart pursues a stan- dardization strategy and achieves enormous economies of scale in purchasing, driving down its cost of goods sold.

In contrast, a segmentation strategy requires that the company customize its prod- uct offering to different segments, producing multiple offerings, one fo r each segment. Customization can drive up costs for two reasons; first, the company may sell less of each offering, making it harder to achieve economies of scale; second, products tar- geted at segments at the higher-income end of the market may require more functions and features, which can raise the costs of production and delivery.

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C hapter 5 Business-Level Strategy 155

On the other hand, it is important not to lose sight of the fact that advances in production technology, and particularly lean production techniques, have allowed for mass customization- that is, the production of more product variety without a large cost penalty (see Chapter 4 for details). In addition, by designing products that share common components, some manufacturing companies achieve substantial economies of scale in component production while still producing a variety of end products aimed at different segments. This approach is adopted by large automobile compa- nies, which try to utilize common components and platforms across a wide range of models. To the extent that mass customization and component sharing is possible, the cost penalty borne by a company pursuing a segmentation strategy may be limited.

Although a standardization strategy may have lower costs than a segmentation strategy, a segmentation strategy has one big advantage. It allows the company to cap- ture incremental revenues by customizing its offerings to the needs of different groups of consumers and thus selling more in total. A company pursuing a standardization strategy where a product is aimed at the average consumer may lose sales from custom- ers who desire more functions and features and are prepared to pay more for them. Similarly, it may lose sales from customers who cannot afford to purchase the average product but might enter the market if a more basic offering was available.

This reality was first recognized in the automobile industry back in the 1920s. The early leader in the automobile industry was Ford with its Model T offering. Henry Ford famously said that consumers could have it in " any color as long as it's black. " Ford was in essence pursuing a standardization strategy. However, in the 1920s, Ford rapidly lost market share to GM, a company that pursued a segmentation strategy and offered a range of products aimed at different customer groups.

For a focus strategy, the impact on costs and revenues is subtler. Companies that focus on the higher-income or higher-value end of the market will tend to have a higher cost structure for two reasons. First, they have to add features and functions to their products that appeal to higher-income consumers, and this raises costs. For example, luxury retailer Nordstrom locates its stores in areas where real estate is ex- pensive; its stores have costly fittings and fix tures and a wide-open store plan with lots of room to browse; the merchandise is expensive and does not turn over as quickly as the basic clothes and shoes sold at stores like Wal-Ma rt. Second, the relatively limited nature of demand associated with serving a given segment of the market may make it hard to attain economies of scale. Offsetting this, however, is the fact that the custom- ization and exclusivity associated with a strategy of focusing on the high-income end of the market may enable a firm to charge significantly higher prices than enterprises pursuing standardization and segmentation strategies.

For companies focusing on the lower-income end of the market, or a segment that desires value for money, a different calculus comes into play. First , such companies tend to produce a more basic offering that is relatively inexpensive to produce and deliver. This may help them to drive down their cost structure. The retailer Costco, for example, focuses on consumers who seek value for money and are Je ss concerned about brand than they a re about price. Costco sells a limited range of mercha ndise in la rge, warehouse-like stores. A Costco store has about 3,750 stock-keeping units (SKUs), compared to 142,000 SKUs at the average Wal-Mart superstore. Products are stored on pallets stacked on utilitaria n metal shelves. Costco offers consumers the opportunity to purchase basic goods such as breakfast cereal, dog food , and paper towels in bulk quantities and at lower prices than found elsewhere. It turns over inven- tory rapidly, typically selling it before it has to pay its suppliers and thereby reducing

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156 Part 3 Strateg ies

generic business-level strategy A strategy that gives a company a specific form of competitive position a nd advantage vis-0- vis its riva ls, resul ti ng in above-average p rofitability.

broad low-cost strategy When a compa ny lowers costs so that it can lower p rices a nd still make a p rofit.

broad differentiation strategy When a company differentiates its product in some way, such as by recognizing d ifferent segments or offering d ifferent prod ucts to each segment.

focus low-cost strategy When a company targets a certain segment or niche and tries to be the low-cost player in that niche.

focus differentiation strategy When a company targets a certain segmen t or niche and customizes its offering to the needs of that particular segment through the ad dition of features and functions.

its working capital needs. Thus, by tailoring its business to the needs of a segment, Costco is able to undercut the cost structure and pricing of a retail giant such as Wal-Mart, even though it lacks Wal-Mart's enormous economies of scale in purchas- ing. The drawback, of course, is that Costco offers much less choice than you will find at a Wal-Mart superstore; so, for customers looking for one-stop shopping at a low price, Wal-Mart is likely to be the store of choice.

r""S-4 BUSINESS-LEVEL STRATEGY CHOICES We now have enough information to identify the basic, business-level strategy choices that companies make. These ba sic choices, sometimes collectively called the generic business-level strategy, are illustrated in Figure 5.4.

Companies that pursue a standardized or segmentation strategy both target a broad market. However, those pursuing a segmentation strategy recognize different segments and tailor their offering accordingly, whereas those pursuing a standardiza- tion strategy focus on serving the average consumer. Companies that target the broad market can either concentrate on lowering their costs so that they can lower prices and still make a profit, in which case they are pursuing a broad low-cost strategy, or they can try to differentiate their product in some way, in which case they are pursuing a broad differentiation strategy. Companies that decide to recognize different segments and offer different product to each one are by default pursuing a broad differentiation strategy. It is possible, however, to pursue a differentiation strategy while not recogniz- ing different segments, as Coca-Cola did prior to the 1980s. Today, Wal-Mart pursues a broad low-cost strategy, whereas Toyota and Coca-Cola pursue a broad differentia- tion strategy.

Companies that target a few segments, or more typically just one, are pursuing a focus or niche strategy. These companies can either try to be the low-cost player in that niche, as Costco has done, in which case we say they are pursuing a focus low-cost strategy, or they can try to customize their offering to the needs of their particular seg- ment through the addition of features and functions, as Nordstrom has done, in which case we say they a re pursuing a focus differentiation strategy.

Figure 5.4 Generic Business-Level Strategies

- Broad differentiation Cl> Broad low cost -t: Broad ., Toyota E Wal-Mart Coca-Cola Cl> .s

..c ... Focus low cost ., Narrow Focus differentiation e

Cl.. (Niche) Costco Cl.. Southw est Airline Nordstrom c:c

Low cost Differentiation Strategic Emphasis

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C hapter 5 Business-Level Strategy l 5 7

It is important to understand that there is often no one best way to compete in an industry. Different strategies may be equally viable. Wal-Mart, Costco, and Nor- dstrom are all in the retail industry; all three compete in different ways; and all three have done very well financially. The important thing is that managers are confident in their business-level strategy, have clear logic for pursuing that strategy, have an offer- ing that matches their strategy, and have aligned functional activities and organiza- tional arrangements with that strategy in order to execute it well.

Michael Porter, the originator of the concept of generic business-level strate- gies, has argued that companies must make a clear choice between the differen t op- tions outlined in Figure 5.4.6 If they don't, he argues, they may become "stuck in the middle" and experience relatively poor performance. Central to Porter's thesis is the assertion that it is not possible to be both a differentiated company and a low-cost enterprise. According to Porter, differentiation by its very nature raises costs and makes it impossible to attain the low-cost position in an industry. By the same token, to achieve a low-cost position, companies necessarily mus t limit spending on product differentiation.

There is certainly considerable value in this perspective. As we have no ted, one company cannot be both Nordstrom and Wal-Mart, Timex and Rolex, or Porsche and Kia. Low cost and differentiation are very different ways of competing- they require different functional strategies and different organizational arrangements. Trying to do both at the same time may not work. On the other hand, there are important caveats to this argument.

First- as we have already seen in this chapter when we discussed value innova- tion through improvements in process and product- a company can push out the efficiency frontier in its industry, redefining what is possible, and deliver more differ- entiation at a lower cost than its rivals. In such circumstances, a company might find itself in the fortunate position of being both the differentiated player in its industry and having a low-cost position. Ultimately its rivals might catch up, in which case it may well have to make a choice between emphasizing low cost and differentiation, but as we have seen from the case histories of Dell and Toyota, value innovators can gain a competitive advantage that lasts for years, if not decades (another example of value innovation is given in Strategy in Action 5.2, which recounts the history of Microsoft Office).

Second, it is important for the differentiated company to recognize that it cannot waver in its focus on efficiency. Similarly, the low-cost company cannot ignore product differentiation. The task facing a company pursuing a differentiation strategy is to be as efficient as possible given its choice of strategy. The differentiated company should not cut costs so deeply that it harms its capability to differentiate its offering from that of rivals. At the same time, it cannot let costs get out of control. Nordstrom, for example, is very efficient given its choice of strategic position . It is not a low-cost com- pany by any means, but given its choice of how to compete it operates as efficiently as possible. Similarly, the low-cost company cannot totally ignore key differentiators in its industry. Wal-Ma rt does not provide the high level of customer service found at Nordstrom, but Wal-Mart cannot simply ignore customer service. Even though Wal- Mart has a self-service business model, employees are on hand to help customers with questions if needed. The task for low-cost companies such as Wal-Mart is to be "good enough" with regard to key differentiators. For another example of how this plays out, see Strategy in Action 5.2, which examines t he competition between Google and Microsoft in the market for office-productivity software.

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15 8 Part 3 Strateg ies

5.2 STRATEGY IN ACTION Microsoft Office Versus Google Apps Microsoft has long been the dominant player in the mar- ket for office productivity software with its Office suite of programs, which includes word processing, spreadsheet, and presentation software, and an e-mail client. Micro- soft's rise to dominance in this market was the result of an important innovation-in 1989, Microsoft was the first company to bundle word processing, spreadsheet, and presentation programs together into a single offering that was interoperable. At the time, the market leader in word- processing software was WordPerfect; in spreadsheet software it was Lotus; and in presentation software it was Harvard Graphics. Microsoft was number 2 in each of these markets. However, by offering a bundle and pric- ing it below the price of each program purchased on its own, Microsoft grabbed share from its competitors, none of which had a full suite of offerings. In effect, Microsoft Office offered consumers more value (interoperability), at a lower price, than could be had from rivals.

As demand for Office expanded , Microsoft was able to spread the fixed costs of product development over a much larger volume than its rivals, and unit costs fell, giving Microsoft the double advantage of a dif- ferentiated product offering and a low-cost position . The results included th e creation of a monopoly posi- tion in office-productivity software and two decades of extraordinary high returns for Microsoft in this market.

The landscape shifted in 2006, when Google intro- duced Google Apps, an online suite of office productiv- ity software that was aimed squarely at Microsoft's profit- able Office franchise. Unlike Office at the time, Google Apps was an online service. The basic program s reside on the cloud, and documents are saved on the cloud . At first, Google lacked a full suite of programs, and traction was slow, but since 2010 adoption of G oogle Apps has acce lerated . Today, Google Apps o ffers the same ba- sic programs as Office - word processing , spread sheet, and presentation software, and an e-mail client-but far fewer features. Google's approach is not to match Of- fice on features, but to be good enough for the majority of users. This helps to reduce development costs. Google also distributes Google Apps exclu sively over the Inter- net, which is a very-low-cost d istribution model, wh ereas

Office still has a significant presence in the physical re- tail channel, raising costs.

In other words, Google is pursuing a low-cost strat- egy with regard to Google Apps. Consistent with this, Google Apps is priced significantly below Office. Google charges $50 per year for each person using its product. In contrast, Microsoft Office costs $400 per computer for business users (although significant discounts are of- ten negotiated) . Initia lly, Google Apps was targeted at small businesses and start-ups, but more recently, Google seems to be gaining traction in the enterprise space, which is Microsoft's core market for Office. In 2012, Google scored an impressive string of wins, including licenses w ith the Swiss drug company Hoffman La Roche, where over 80,000 employees use the package, and with the U.S. Interior Department, where 90,000 use it. In total , Google Apps earned approximately $1 billion in revenue in 2012. Estimates suggest that the company has more than 30 million paying subscribers. This still makes it a small offering relative to Microsoft Office, which is installed on over 1 billion computers worldwide. Microsoft Office, which generated $24 billion in revenue in 2012, remains Microsoft's most p rofitable business. However, Microsoft cannot ignore Google Apps.

Indeed, M icrosoft is not standing still. In 2012, Microsoft rolled out its own cloud-based Office offering, Office 365 . Office 365 starts out at $69.99 per year, although most people p ay $99 .99 per year, for a ver- sion that can be downloaded onto mu ltiple devices. According to a Microsoft spokesperson, demand for Office 365 ha s been very strong . By late 2 017, 28 mil- lion consumers had purchased Office 365 licenses, and 120 million business licenses had been issued, while revenues surpassed those from the traditional Office of- fering for the first time . Microsoft argues that Google cannot match the quality of the enterprise experience that Microsoft can p rovide in in areas like pri vacy, secu- rity, and data hand ling . Microsoft's message is clear - it still believes that Office is the superio r product offering , differentiated by features, function s, p rivacy, data hand- ing, and security. Whether Office 365 will keep Google Apps in check, however, remains to b e seen .

Sources: Author intervi ews at Microsoft a nd Google; 0 . Hardy, "Goog le Apps Moving onto Microsoft's Busi ness Tu rf, " New York Tim es, December 26, 20 12; A. R. Hickey, "Google Apps: A $ 1-Billion Business?" CRN, February 3, 2012, www.crn .com; M. Foley, "Microsoft now has $1 20 million business users for Office 365," ZDN et, October 26, 20 17 .

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C hapter 5 Business-Level Strategy l 5 9

BUSINESS-LEVEL STRATEGY, INDUSTRY, AND COMPETITIVE ADVANTAGE

Properly executed, a well-chosen, well-crafted business-level strategy can give a com- pany a competitive advantage over actual a nd potential rivals. More precisely, it can put the company in an advantageous position relative to each of the competitive forces that we discussed in Chapter 2- specifically, the threat of entrants, the power of buy- ers and suppliers, the threat posed by substitute goods or services, and the intensity of rivalry between companies in the industry.

Consider first the low-cost company; by defin ition, the low-cost enterprise can make profits at price points that its rivals cannot profitably match. This ma kes it very hard for rivals to enter its market. In ot her words, the low-cost company can build a n entry barrier into its market; it can, in effect, erect an economic moat around its business that thwarts higher-cost rivals. Amazon has done this in the online retail business. Through economies of scale and other operating efficien- cies, Amazon has attained a very-low-cost structure that effectively constitutes a high entry barrier into this business. Rivals with less volume and fewer economies of scale than Amazon cannot match it on price without losing money- not a very appealing proposition.

A low-cost position and the ability to charge low prices and still make profits also protect a company against substitute goods or services. Low costs can help a company absorb cost increases that may be passed on downstream by powerful suppliers. Low costs can also enable the company to respond to demands for deep price discounts from powerful buyers and still make money. The low-cost company is often best posi- tioned to survive price rivalry in its industry. Indeed, a low-cost company may delib- erately initiate a price war in order to grow volume and drive its weaker rivals out of the industry. Dell did this during its glory days in the early 2000s, when it repeatedly cut prices for PCs to drive up sales volume and force marginal competitors out of the business. This strategy enabled Dell to become the largest computer company in the world by the mid-2000s.

Now let us consider the differentiated compa ny. The successful differentiator is also protected against each of the competitive forces we discussed in Chapter 2. The brand loyalty associated with differentiation can constitute an importa nt entry bar- rier, protecting the company's market from potential competitors. The brand loyalty enjoyed by Apple in the smartphone business has set a very high hurdle for any new entrant to match, and effectively acts as a deterrent to entry. Because the successful differentiator sells on non-price factors such as design or customer service, it is also less exposed to pricing pressure from powerful buyers. Indeed, the opposite may be the case- the successful differentiator may be able to implement price increases without encountering much, if any, resistance from buyers. The differentiated company can also fairly easily absorb price increases from powerful suppliers and pass them on downstream in the form of higher prices for its offerings, without suffering much, if a ny, loss in market share. The brand loyalty enjoyed by the differentiated company also protects it from substitute goods and service.

The differentiated company is protected from intense price rivalry within its in- dustry by its brand loyalty, and by the fact that non-price factors are important to its customer set. At the same time, the differentiated company often does have to invest

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l 60 Part 3 Strategies

significant effort and resources in non-price rivalry, such as brand building through marketing campaigns or expensive product development efforts, but to the extent that it is successful, it can reap the benefits of these investments in the form of stable or higher prices.

This being said, it is important to note that focused companies often have an advan- tage over their broad market rivals in the segment or niche in which they compete in. For example, although Wal-Mart and Costco are both low-cost companies, Costco has a cost advantage over Wal-Mart in the segment that it serves. This primarily is due to the fact that Costco carries far fewer SK Us, and those it does are sold in bulk. However, if Costco tried to match Wal-Mart and serve the broader market, the need to carry a wider product selection (Wal-Mart has over 140,000 SKUs) means that its cost advantage would be lost.

The same can be true for a differentiated company. By focusing on a niche, a nd customizing the offering to that segment, a differentiated company can often outsell dif- ferentiated rivals that target a broader market. Thus, Porsche can outsell broad market companies like Toyota or GM in the high-end sports car niche of the market, in part because the company does not sell outside of its core niche. Porsche creates an image of exclusivity that appeals to its customer base. Were Porsche to start moving down market, it would lose this exclusive appeal and become just another broad market differentiator.

5-6 IMPLEMENTING BUSINESS- LEVEL STRATEGY

As we have already suggested in this chapter, for a company's business-level strategy to translate into a competitive advantage, it must be well implemented. This means that actions taken at the functional level should support the business-level strategy, as should the organizational a rrangements of the enterprise. There must, in other words, be alignment or fit between business-level strategy, functional strategy, and organization (see Figure 5.5). We have disc ussed functional strategy in Chapter 4; detailed discussion of organizational arrangements is postponed until Chapter 12.

Figure 5.5 Strategy Is Implemented Through Function and Organization

Functio nal Strategy

t Organizational Arrangements

Source: Charles W .L. Hill © Copyright 2013 .

Alignment Business-level

strategy

t

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C hapter 5 Business-Level Strategy l 6 l

Notwithstanding, we will make some basic observations about the functional strate- gies and organizational arrangements required to implement the business-level strate- gies of low cost and differentiation.

5-6a Lowering Costs Through Functional Strategy and Organization

Companies achieve a low-cost position primarily by pursuing functional-level strate- gies that result in superior efficiency and superior product reliability, which we discussed in detail in Chapter 4 when we looked at functional-level strategy and the building blocks of competitive advantage. As you will recall from Chapter 4, the following are clearly important:

• Achieving economies of scale and learning effects. • Adopting lean production and flexible manufacturing technologies. • Implementing quality improvement methodologies to ensure that the goods or ser-

vices the company produces are reliable, so that time, materials, and effort are not wasted producing and delivering poor-quality products that have to be scrapped, reworked, or reproduced from scratch

• Streamlining processes to take out unnecessary steps • Using information systems and technology to automate business process • Implementing just-in-time inventory control systems • Designing products that can be produced and delivered at as low a cost as

possible • Taking steps to increase customer retention and reduce customer churn

In addition, to lower costs the firm must be organized in such a way that the struc- ture, control systems, incentive system s, and culture of the company all emphasize and reward employee behaviors and actions that are consistent with, or lead to, higher pro- ductivity and greater efficiency. As will be explained in detail in Chapter 12, the kinds of organizational arrangements that are favored in such circumstances include a flat structure with very few levels in the ma nagement hierarchy, clear lines of accountabil- ity and control, measurement and control systems that focus on productivity and cost containment; incentive systems that encourage employees to work in as productive a manner as possible, a nd that empower them to suggest and pursue initiatives that are consistent with productivity improvements; and a frugal culture that emphasizes the need to control costs. Companies that operate with these organizational arrangements include Amazon and Wal-Mart.

5-6b Differentiation Through Functional-Level Strategy and Organization

As with low costs, to successfully differentiate itself a company must pursue the right actions at the functional level and organize itself appropriately. Pursuing functional-level strategies that enable the company to achieve superior quality in terms of both reliability and excellence are important, as is an emphasis upon innovation in the product offering, a nd high levels of customer responsiveness. You will recall from Chapters 3 and 4 that superior quality, innovation, and customer responsiveness are three of the four building blocks of competitive advantage, the other being efficiency . Remember, too, that the dif- ferentiated firm cannot ignore efficiency; by virtue of its strategic choice, the differentiated

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162 Part 3 Strategies

company is likely to have a higher cost structure than the low-cost player in its industry. Specific functio nal-level strategies designed to improve differentiation include:

• Customization of the product offering and marketing mix to different market segments

• Designing product offerings that have high perceived quality in terms of their funct ions, features, and performance, in addition to being reliable

• A well-developed customer-care function for quickly handling and responding to customer inquiries and problems

• Marketing efforts focused on brand building and perceived differentiation from rivals • Hiring and employee development strategies designed to ensure that employees act

in a manner that is consistent with the image that the company is trying to project to the world

For example, Apple has an excellent customer care function, as demonstrated by its in-store " Genius Bars," where well-trained employees are available to help customers with inquiries and problems, and provide tutorials to help them get the best value out of their purchases. Apple has also been very successful at building a brand that differentiates it from rivals such as Microsoft (for example, the long-running TV advertisements that fea- tured "Mac," a very hip guy, and "PC," a short, overweight man in a shabby gray suit).

As regards organization, creating the right structure, controls, incentives, and cul- ture can all help a company differentiate itself. In a differentiated enterprise, one key issue is to make sure that marketing, product design, customer service, and customer care functions all play a key role. Again, consider Apple; following his return to the company in 1997, Steve Jobs reorganized to give the industrial design group the lead on all new product-development efforts. Under this arrangement, industrial design, headed by Johnny Ive, reported directly to Jobs, and engineering reported to indus- trial design for purposes of product development. This meant that designers rather than engineers specified the look and feel of a new product, and engineers then had to design according to the parameters imposed by the design group. This is in contrast to almost all other companies in the computer and smartphone business, where engineer- ing typically takes the lead on product development. Jobs felt that this organizational arrangement was necessary to ensure that Apple produced beautiful products that not only worked well, but also looked and felt elegant. Because Apple under Jobs was dif- ferentiating by design, design was given a pivotal position in the organization. 7

Making sure that control systems, incentive systems, and culture are aligned with the strategic thrust is also extremely important for differentiated companies. We will return to and expand upon these themes in Chapter 12.

COMPETING DIFFERENTLY: BLUE OCEAN STRATEGY

We have already suggested in this chapter that sometimes companies can fund amen- tally shift the game in their industry by figuring out ways to offer more value through differentiation at a lower cost than their rivals. We referred to this as value innovation, a term first coined by Chan Kim and Renee Ma uborgne. 8 Kim and M auborgne de- veloped their ideas further in the bestselling book Blue Ocean Stra tegy .9 Their basic proposition is that many successful companies have built their competitive advantage

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C hapter 5 Business-Level Strategy l 63

by redefining their product offering through value innovation and, in essence, creating a new market space. They describe the process of thinking through value innovation as searching for the blue ocean- which they characterize as a wide-open market space where a company can chart its own course.

One of their examples of a company that found its blue ocean is Southwest Airlines. From its conception, Southwest competed differently than other companies in the U.S. airline industry. Most important, Southwest saw its main competitors not as other air- lines but as people who would typically drive or take a bus to travel. For Southwest, the focus was to reduce travel time for its customer set and do so in a way that was cheap, reliable, and convenient, so that they would prefer to fly rather than drive.

The first route that Southwest operated was between Houston and Dallas. To re- duce total travel time, it decided to fly into the small, downtown airports in both cities, Hobby in Houston and Love Field in Dallas, rather than the large, intercontinental ai rports located an hour's drive outside of both cities. The goal was to reduce total travel time by eliminating the need to drive to reach a major airport outside the city before even beginning one's journey. Southwest put as many flights a day on the route as possible to make it convenient, and did everything possible to drive down operating costs so that it could charge low prices and still make a profit.

As the company grew and opened more routes, it followed the same basic strategy. Southwest always flew point to point, never routing passengers through hubs. Changing planes in a hub adds to total travel time and can hurt reliability, measured by on-time de- partures and arrivals, if connections are slow arriving or departing a hub due to adverse events such as bad weather delaying traffic somewhere in an airline's network. Southwest also dispensed with inflight meals, only offers coach-class seating, does not have lounges in airports for business-class passengers, and has standardized on one type of aircraft, the Boeing 737, which helps to raise reliability. The net result is that Southwest delivers more value to its customer set and does so at a lower cost than its rivals, enabling it to price lower than them and still make a profit. Southwest is a value innovator.

Kim and Mauborgne use the concept of a strategy canvas to map out how value innovators differ from their rivals. The strategy canvas for Southwest shown in F igure 5.6, shows that Southwest charges a low price and does not provide meals or lounges in airports, business-class seating, or connections through hubs (it flies point to point), but does provide friend ly, quick , convenient, reliable low-cost service, which is exactly what its customer set values.

The whole point of the Southwest example, and other business case histories Kim and Mauborgne review, is to illustrate how many successful enterprises compete differ- ently than their less successful rivals: T hey carve out a unique market space for them- selves through value innovation. When thinking about how a company might redefine its market and craft a new business-level strategy, Kim and M auborgne suggest that managers ask themselves the fo llowing questions:

1. Eliminate: Which factors that rivals take for granted in our industry can be elimi- nated, thereby reducing costs?

2. Reduce: Which factors should be reduced well below the standard in our industry, thereby lowering costs?

3. Raise: Which factors should be raised above the standard in our industry, thereby increasing value?

4. Create: What factors can we create that rivals do not offer, thereby increasing value?

Southwest eliminated lo un ges, business seating, and meals in fli ght; it reduced in- flight refreshment to be well below industry standard s; and by flying point-to-point it

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l 64 Part 3 Strategies

Figure 5.6 A Strategy Canvas for Southwest Airlines

High

en

·= :i 0

Low

Trad itional Airli ne

Meals Price

Business Friend ly Seati ng service

Lounges Connections (Hubs)

Southwest

Conve nient Speed (Frequent Reliability

Departures/ Downtown Airports)

raised speed (reducing travel time), convenience, and reliability. Southwest also created value by flyi ng between smaller, downtown airports whenever possiblef- something that other airlines did not typically do.

This is a useful framework, and it directs managerial attention to the need to think differently than rivals in order to create an offering and strategic position that are unique. If such efforts are successful, they can help a company build a sustainable advantage.

One great advantage of successful value innovation is that it can catch r ivals off guard and make it difficult for them to catch up. For example, when D ell Computer started to sell direct to customers via the Internet, it was very difficult for rivals to re- spond because they had already invested in a different way of doing business- selling though a physical retail channel. Dell's rivals could not easily adopt the D ell model without alienating their channel, which would have resulted in lost sales. The prior strategic investment of Dell's rivals in distribution channels- which, at the time they were made, seemed reasonable- became a source of inertia that limited their ability to rapid ly respond to Dell's innovations. The same holds true in the airline industry, where the prior strategic investments of traditional airlines have made it very difficult for them to respond to the threat posed by Southwest.

In sum, value innovation, because it shifts the basis of competition, ca n result in a sustained competitive advantage for the innovating company due to the relative iner- tia of rivals a nd their inability to respond in a timely manner without breaking prior strategic commitments.

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P"KEY TERMS

business-level strategy 146

value innovation 151 market segmentation 153 standardization

strategy 154

segmentation strategy 154

focus strategy 154 generic business-level

strategy 156

C hapter 5 Business-Level Strategy l 65

broad low-cost strategy 156

broad differentiation strategy 156

focus low-cost strategy 156

focus differentiation strategy 156

P"TAKEAWAYS FOR STRATEGIC MANAGERS

l . Business-level strategy refers to the overarch- ing competitive theme of a company in a given market.

2. At the most basic level, a company has a com- petitive advantage if it can lower costs relative to rivals and/ or differentiate its product offering from those of rivals.

3. A low-cost position enables a company to make money at price points where its rivals are losing money.

4. A differentiated company can charge a higher price for its offering, and/ or it can use superior value to generate growth in demand.

5. There are often multiple viable market positions along the differentiation-low-cost conti nuum .

6. Value innovation occurs when a company devel- ops new products, processes, or strategies that enable it to offer more value through differentia- tion at a lower cost than its rivals.

7. Formulating business-level strategy starts with de- ciding who the company is going to serve, what

DISCUSSION QUESTIONS

l. What are the main differences between a low- cost strategy and a differentiation strategy?

2. Why is market segmentation such an important step in the process of formulating a business- level strategy?

3. How can a business-level strategy of (a) low cost and (b) differentiation offer some protection against competitive forces in a company's industry?

needs or desires it is trying to satisfy, and how it is going to satisfy those needs and desires.

8 . Market segmentation is the process of subdivid- ing a market into clearly identifiable groups of customers that have similar needs, desires, and demand characteristics.

9 . A company's approach to market segmentation is an important aspect of its business-level strategy.

l 0 . There are four generic business-level strategies: broad low cost, broad differentiation, focus low cost, and focus differentiation.

11 _ Business-level strategy is executed through ac- tions taken at the functional level and through organizational arrangements.

12. Many successful companies have built their com- petitive advantage by redefining their product offering through value innovation and creating a new market space. The process of thinking through value innovation has been described as searching for a " blue ocean" -a wide-open market space where a company can chart its own course.

4. What is required to transform a business-level strategy from a concept to a reality?

5. What is meant by the term value innovation? Can you identify a company not discussed in the text that has establ ished a strong competitive position through value innovation?

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l 66 Port 3 Strategies

CLOSING

Virgin America

Prior to its 2016 acqms1t10n by Alaska Airlines, Virgin America was consistently rated as one of the top U.S. airline s. Founded in 2004, the a irline served 20 destinations out of its main hub in San Francisco. Virgin America was known for its leather seats, cocktail-lounge-style lighting, onboard W i- Fi, in-seat power outlets for electronic devices, full- service meals, and that most scarce of all assets in coach class, legroom. The airline has earned a host of awards since its launch in 2007, including being named t he " Best U.S. Airline" in the Conde Nast Traveler Readers' Choice Awards every year from 2008-2014; and " Best Domestic Airline" in the Travel + Leisure World's Best Awards for 7 years in a row. Furthermore, Consumer Reports named Virgin America the " Best U. S. Airline" in 20 13 and 2014. Industry statistics supported these accolades. In 2014, Virgin was #1 in on-time arrivals in the U nited States, with 83.5% of aircraft arriving on time. Virgin America also had the lowest level of denied boardings (0.07 per 1,000 passengers), and mishandled baggage (0.87 per 1,000 passengers), and the fewest customer complaints (1.50 per 1,000 passengers).

Virgin Ame rica was an offshoot of the Vir- gin Group, the enterprise started by British bil- lionaire Richard Branson . Branson got his start in t he mus ic business with Virgin Records stores (established in 1971) and the Virgin Record record label (established in 1973). In 1984, he leveraged the Virgin brand to enter an entirely new indus- try, airlines, with Virgin Atlantic. Virgin Atla ntic became a major competitor to British Airways on a number of long-haul routes out of London, win- ning market sh are t hrough superior customer ser- vice, inn ovative perks for premium travelers, and competitive pricing. Branson has also licensed the right to use the Virgin brand name across a wide

CASE

array of businesses, including Virgin Media (a ma- jor U.K. cable operator), Virgin Money (a U.K. financial services company), and Virgin Mobile (a wireless brand that exists in many countries). This strategy has made Virgin one of the most recog- nizable brands in the world. Interestingly, Branson makes money from royalty payments irrespective of whether companies licensing the Virgin brand a re profitable or not. Branson himself describes the Virgin brand as representing, "innovation, quality, and a sense of fun. "

For all of its accolades and the power of the Virgin brand, Virgin America has had a hard time making money. One problem is that, as a small airline, Virgin only has a few flights a d ay on many routes and is unable to offer consum- ers the choice of multiple departure times, some- thing that many travelers value. For example, on the popular ro u te for tech workers between San Francisco and Austin, Texas, United offers six flights a day and Jet Blue offers two, compared with just one for Virgin America.

Another serious problem is that providing all of the extra frills necessary to de liver a high- quali ty experience costs money. In its first 5 yea rs of operation, Virgin America accumulated $440 mil- lion in losses before registering a small profit of $67 million on revenues of $ 1.4 billion in 20 13. In 2014, Virgin America went public and managed to post a respectable $ 150 million in net profits on revenues of close to $ 1.5 billion. The company was helped by a n improving economy, strong d emand, and lower j et fuel cos ts.

The key competitive iss ue the company faced was t hat it was a niche player in a much larger in- dustry where low-cost carriers such as Southwest Airlines and Jet Blue put constant pressure on prices and crowded out routes with multiple flights

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daily. Virgin America charged prices that were 10 to 20% above those of its no-frills rivals, but it could not raise prices too far without losing customers and flying with empty seats, which is a recipe for failure in an industry where mar- gins are slim . On the route between New York's Kennedy Airport and Los Angeles during late 2012, for example, Virgin passengers were pay- ing an average of $305 a ticket compared to an industry average of $263. Virgin's passenger-load factor on that route was 96% of the industry average during the same period. Virgin CEO David Cush, however, was adamant that the air- line " ... won't get into a fare war. Our product is good; we've got good loyalty. People will be

CASE DISCUSSION QUESTIONS 1. What was Virgin America's segmentation

strategy? Who did it serve? 2. With regard to its core segment, what did

Virgin America offer its customers? 3. Using the Porter model, which generic

bus iness-level strategy was Vi rgin America pursuing?

C hapter 5 Business-Level Strategy l 67

willing to pay $20 or $30 more." Was he correct? We will never know. In 2016, Virgin was acquired by West Coast rival Alaska Airlines, reportedly because Alaska wanted Virgin's landing slots in San Francisco hub. Although Virgin continued to operate as a division of Alaska for a while, in April 2018 it was fully merged into Alaska's oper- ating structure, and the brand disappeared.

Sources: M. Richtel, "At Virgin America , a fine line between pizazz and p rofit," Neiv Yo rk T imes, September 7, 201 3; B. Tutt le, " Why a n a irline that travelers love is failing," Time, Octo ber 25, 20 12; T. Hudd lesto n, " Virgin America goes public," Fortune, N ovember 13, 2014; A. Levine-Weinberg, " How Richa rd Branson built a $5-billio n fortune from scratch ," M otley Fool, October 19, 2014, www. fo o l.com .

4. What actions taken at the functiona l level enabled Virgin America to imp lement its strategy?

5. Do you th ink Virgin America wou ld have been able to survive had it rema ined inde- pendent? (The company was acquired by A laska Airlines in 2016.)

1D. F. Abell, Defining the Busi- ness: Th e Starting Point of Strate- gic Planning (Englewood Cliffs, NJ:

Framework," A cademy of Manage- m ent R eview 13 (1988): 401 -412.

6Porter, Competitive Advantage and Competitive S trategy.

Prentice-Hall, 1980). 2M. E. Porter, Competitive Advan-

tage (New York: Free Press, 1985); M. E. Porter, Competitive Strategy (New York, Free Press, 1980).

3C. W L. Hill, " Differentiation Versus Low Cost or Differentia - tion and Low Cost: A Contingency

4M. E. Porter, " What Is Strat- egy?" Harvard Business R eview, On-point Enhanced Edition Ar- ticle, February 1, 2000.

5W C. Kim and R. M auborgne, " Va lue Innovation: The Strategic Logic of High Growth," Harvard Business R eview (January- February 1997).

7The story was related to author Charles Hill by an executive at Apple.

8Kim and M a uborgne, " Value Innovation: The Strategic Logic of High Growth. "

9W C. Kim and R. M auborgne, Blue Ocean Strategy (Boston, Mass: H arvard Business School Press, 2005).

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