MBA695 Unit 1 Week 1 Discussion 1 & 2

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Strategic Management

Jeff Dyer

Third Edition

Chapter 1

What is Business Strategy?

Professor’s Goals for this Lecture

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:

- the homework assignment involving calculating an experience curve in semiconductors

- Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)

- the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry

What does it mean to have a strategy?

What is the key to a successful strategy?

How can you evaluate a “good” or “bad” strategy?

Overview

So strategic management. I want to give you an overview. What does it mean? We’re going to discuss three questions. What does it mean to have a strategy? What is the key to a successful strategy? And how can you evaluate a good or bad strategy before the fact? Before you launch.

[Ask Students] So, what does it mean to have a strategy? When you hear the word “strategy,” what comes to mind?

[Student Classic Student Responses]

It’s a game plan, or knowledge about what types of goals you want to accomplish.

Accomplishing something, but recognizing that there will be responses from other people.

How you achieve competitive advantage.

From the chapter, a plan to achieve competitive advantage, right? A plan to achieve competitive advantage. So if we think about strategy, you’re trying to come up with a strategy to achieve competitive advantage, why? Well, the way we keep score in business is by generating shareholder value, by creating value in a company. And one of the reasons that you personally want to work for a company that has a good strategy and competitive advantage, is that research shows that the companies with competitive advantages, that deliver high shareholder value, they pay more money to people at all levels of the organization. Why? Because they can afford to. You only have to give enough to shareholders to keep them happy. If you’re doing a good job, of running the business and making a lot of money, then you get to keep more of it.

1. Markets: What markets (industries and geographic markets) the company will pursue in search of a high return on invested capital.

2. Unique Value (why we win with customers): What unique value to offer the customer in those markets (the firm’s value proposition : cost or differentiation).

3. Resources and Capabilities (how we deliver unique value): What resources (e.g., assets, brands, etc.) and capabilities (e.g., processes) will allow the firm to deliver a superior value proposition to customers.

4. Barriers to Imitation: How the company will prevent imitation of its strategy by competitors.

Strategy: Plan to Achieve Competitive Advantage

There four key strategic choices that you have to make with regard to a strategy. One is what markets are we going to pursue? How are we going to offer unique value in those particular markets? What resources and competencies, capabilities do we need to deliver that unique value better than the competition? And then how do we sustain it? How do we create barriers to imitation so that others can’t come in and do the same thing that we just did and do it better and steal the market from us? Okay. So that’s what it means to have a strategy.

Strategy

Competitive Advantage

Shareholder Value

Successful Strategies

Strategies are more likely to be successful when the plan explicitly takes into account four factors:

The goal of a strategic plan is to create competitive advantage.

The attractiveness of a market

How to offer unique value relative to the competition

What resources or capabilities are necessary to deliver that unique value

How to sustain a competitive advantage once it has been achieved.

What does it mean to have a strategy?

What is the key to a successful strategy?

Overview

We’re going to talk about the key to a successful strategy, and I want to give you a mini case.

Strategic Management Process

Strategic Management Process- The process by which organizations formulate a plan and allocate resources to achieve competitive advantage that involves making four strategic choices: (1) markets to compete in; (2) unique value the firm will offer in those markets; (3) the resources and capabilities required to offer that unique value better than competitors; and (4) ways to sustain the advantage by preventing imitation.

External Analysis- Examining the forces that influence industry attractiveness, including opportunities and threats that exist in the environment.

Internal Analysis- The analysis of a firm’s resources and capabilities, its strengths and weaknesses, to assess how effectively the firm is able to deliver the unique value (value proposition) that it hopes to provide to customers.

Good Strategies Have Barriers to Imitation

If competitors can quickly and easily imitate, then it raises

all rival’s costs without creating advantage.

It’s very important that good strategies have barriers to imitation. You’ve got to ask yourself, what’s the cost of the strategic initiative? How much is it going to cost us to do this, triple miles or whatever it might be? Then how long will it take for competitors to imitate it? Because they probably will try and imitate it if it provides value, unique value to the customers. And the key thing is, is there a barrier to imitation. If there is not a barrier to imitation, and this is the fourth of the four choices, there’s not a barrier to imitation, then you got to think carefully about whether or not you want to do it. Now in some industries, if you have a barrier to imitation, if you can do it, and they can’t do it for a month, you might take it. Hey we will take the advantage for a month, and we’ll look for something else during the next month to give us the advantage the next month, right?

So you got to think through sort of the cost benefit of any strategic initiative, but just please be aware, some things that often really look good on paper, if you haven’t thought about the competitor response, you can be in trouble. And that’s the issue of sustainable and barriers to imitation.

What is the cost of the strategic initiative?

How long will it take for competitors to imitate the strategic initiative?

Is there a Barrier to Imitation?

Additional Mini-Case

What is Your Market Entry Strategy?

Food Retailing

Macys

Acme

Safeway

Current Grocery Stores in a

High Growth City Market

Freeway

Exits

When I was working at Bain & Company, I was working for a client, a food and retail client, Finast, and we were developing a market entry strategy. This was a city in the Midwest, these are not the names of the grocery stores that were in this particular city, but I chose the names to just give you the idea that these were Harmon’s, Acme is a Philadelphia, northeast, sort of local grocery store chain. So there were two that were like local grocery stores, and one that was a national grocery store chain, like Safeway. There were three stores in the city. Now, our analysis had shown, basically, there was a freeway that went here, you came into the city from this side, or this side. This was the main street, and the Harmon’s and the Acme were the oldest stores in the city on the main street. Harmon’s was 50 years old. Acme was about 35 years old. Safeway had come in about 15 years earlier. This was the main part of the city, the growth had been out this direction in sort of the suburbs. Safeway had built a store out in that growth area. Now, we had to decide whether to enter that city with one store or maybe two stores, we had to have a market entry strategy. And we had to decide where to put the stores, or stores if we went into the market with more than one. This was a high growth market, there had not been an entry in 15 years. When we looked at the number of the population per store, and per square foot, our calculations showed that all of the stores were extremely profitable. So we knew that there was a lot of money that could be made by entering this particular market. So my question to you is, how would you think about entering this particular market in terms of location, number of stores, and what’s your logic? And you can ask if you have, if you want a little more data, you can ask me for a little more data. Yes?

Some info to give out if the students ask for it:

The first national stores is the client. They have stores in the northeast, in the Midwest, so they’re like a super-regional chain. They’re basically a middle-of-the-road Safeway kind of grocery store chain. In fact, all of these, so this is a basic Midwest town, none of these are really high end, they’re not like warehouse stores, they’re your basic grocery store.

So I can’t give you the specific population densities, but this represents 90 percent of the population of the city, the circle does. So 90 percent of the city’s population falls within that circle.

Right now we can’t see that there are any particular competitive advantages. Other than, you know, your location makes you more attractive for customers around you.

-- 70 percent of the people shop at the grocery store that’s closest to their home.

-- 30 percent will drive father but they have to have a reason to drive farther. Of the 30 percent that drive farther, on average, half of those will drive farther for lower price, and half will drive farther for better selection, better quality. But most people shop at the place closest to their home.

So how do our prices and quality compare? We are a Safeway-like grocery store chain. I mean, you can think about, how do the, you know, prices and quality compare for Smith’s and Macey’s or Harmon’s, you know. There are some subtle differences, but not huge.

If we had any different changing factors, like if we focused on organic foods or whole foods?

Professor: Nope. We’re basic, we are a meat and potatoes grocery store chain. Yes?

Student: I was going to ask, what are the barriers to entry?

Professor: There are no particular barriers to entry other than getting land for your store location and for the most part, that’s not a problem. And this particular market was growing rapidly because a couple of local businesses had been successful, export businesses, and so basically there was just a lot of growth for the market.

Additional Mini-Case

What is Your Market Entry Strategy?

Food Retailing

Finast

Strategic Intent: Avoid Rivalry

Unique Value: Convenience; but no sustainable cost or differentiation advantage

High Growth City Market

Freeway

Exits

Macys

Acme

Safeway

Some possible answers follow starting with this slide

This is some of an in class discussion transcript:

Student: I think it would be good to put it a little bit lower because if we put it exactly in the middle, you have to compete with the people…

Professor: If you put it here then they’re kind of going this way or this way or this way, so you want to be down in the territory more where there’s no competition.

Student: Yeah.

Professor: This is sort of the virgin territory. Yes?

Student: I agree, a little bit lower because I think that because Macy’s was first there’s going to be a lot more loyalty right up in that area. People are used to going to Macy’s, they know it, they know where the bread is, so I would put it slightly lower because you still get that big blank spot right there in the middle and some of the competition from the…

Professor: Okay, so, so one option is, and they were called Finast stores, so one option is let’s put it down here because, look, we’re going to avoid rivalry if we put it down there, and we’re going to provide, what’s our unique value? Well it’s convenience for these folks in this particular area. We’re going to be more convenient and therefore, we’re going to attract those folks. But we don’t really necessarily have a sustainable cost or differentiation advantage. What if, say for, what if you put a store right here and then Safeway puts a store right here, too? Next to you, or near you? Could they do that? If they do that, what does that do to your market entry strategy?

Student: They could do that, but then again it wouldn’t make sense for them to put it there because that creates rivalry, and I mean Safeway or Macy’s could just put a store next to yours

Professor: Do you want, yeah so the question is, I wouldn’t want to put it there because, you know, you’d say, “Look, you got a new store here, you got two new stores going against each other, that doesn’t make sense.” They won’t do it because it won’t look attractive to them is one option, is you say, “They won’t do it because there’s more rivalry.” Yes?

Additional Mini-Case

What is Your Market Entry Strategy?

Food Retailing

Finast

Strategic Intent: Offer Unique Value Proposition (e.g., Costco; Trader Joes)

Unique Value: Differentiation or low cost

High Growth City Market

Freeway

Exits

Macys

Acme

Safeway

Student: If we’re focus on the people that are already there, I would put the store smack dab in the center.

Professor: Okay. And what’s your logic for being in the center?

Student: Well I think that if there’s more people that are in that circle, then I think that’s, you’re going to get a lot of people that are close by there, and you’ll also attract a little of the community but maybe not as much as those that have to drive a little father.

Professor: So if you put it here you’re going to get all of maybe the folks out here that are closest to your store.

Additional Mini-Case

What is Your Market Entry Strategy?

Food Retailing

Finast

Strategic Intent:

Eliminate Rival(s)

Unique Value:

Low Cost; equal convenience

High Growth City Market

Freeway

Exits

Macys

Acme

Safeway

So another option would be, hey, let’s put in multiple stores. In fact, this was one of the recommendations that we made to our client, Finast. Three stores. And we wanted them all next to the existing stores. Why would we do that? What’s the logic for doing this?

We want to be able to get all of the customers, but let’s sort of think about what are we trying to have happen here? Yes?

Student: Well I think another advantage of having three stores in sort of the geography there is sort of the cost perspective. And transportation. You’re not just bringing one truck in for one store, you’re bringing one truck in for three stores.

Professor: And when you put an ad in the paper, you don’t have an ad in the paper for one store, right? It’s an ad for three stores. It just cuts your advertising costs in a third relative to the competition per store on a per store basis. It cuts your distribution costs on a per store basis. But for this to work, do you think these three stores can be profitable if these three other stores stay in business? No way. If you’re going in with this approach, you’re trying to kill some competitor stores. You are over-storing the market substantially. There isn’t room, you’re jumping in the water with your competitor, and you’re basically saying, “Let’s see who can hold each other’s head down longer.” And our goal here was to kill at least these two stores and be on this side to get the, so if we could kill these two stores then we would own here with a new store here and this with a new area, and can anyone come back in with a counter response and beat us on cost? Safeway could add another store perhaps. But once we have three stores, we have a market share advantage which gives us a cost advantage.

Now this approach was deemed a little too aggressive for our client. They did not choose this approach.

Additional Mini-Case

What is Your Market Entry Strategy?

Food Retailing

Finast

Strategic Intent: Eliminate Rival

Unique Value:

Low Cost

High Growth City Market

Freeway

Exits

Macys

Acme

Safeway

They chose this one instead. We looked at which of these stores was the weakest. Okay, so another strategy principle. This is the law of the jungle, the herd, you pick on the weak, the infirm, the easiest to kill. If you want market share, don’t go off the strongest player, you go out for the weakest players’ customers, right? So we went after the oldest store, which here is Macy’s, but this was the oldest store, we felt two stores would still cover the market. We looked at their finances and we felt that these would not be able to stay in the store. And what we wanted to do is put in a larger store so we could beat them on variety of product offered and because we had two stores we could beat them on price because we would have lower cost.

So let’s apply our framework here. Finast, why does Finast win with customers, and how do they deliver that unique value? We’ve already talked about this selective this market enter because it was high growth. So, they’ve chosen this market. Now, what’s the unique value that they’ve offered that customers will say, “I’m going to pick Finast stores instead of the competition.” Well if we go in with two stores or three, we’re going to be able to offer lower price, or at least advertise and at least price match or beat the competition on key items because we have lower costs because we have three stores or two stores versus one store. We’re going to build larger stores than the competition so that we can ensure that we can offer more variety, that’s also something that some customers want. And we’re going to be just as convenient as possible, at least the store we’re trying to kill, by being next door. How do we do it? Well, by having more stores than the competition we’re going to have lower local costs around advertising, training distribution and so on. We’re going to have larger stores that offer more variety, that’s not easy for them to knock out walls and expand their stores, possible but not easy. And we’re going to have greater brand awareness in that market because we have more stores than the competition. That brings more brand awareness.

So now we know why we win with customers and we know how we win. And we thought about barriers to imitation. The reason we want to go in with more than one store is we don’t want to put in one store and then have the competition be able to counter and put a store in there that would create a competitive advantage than the competitors.

Now, if I was Costco and I was going into this market, would I use the same approach? Why not? Yes?

Student: Because Costco’s strategy’s completely different. They are not your typical grocery store. Yeah, they sell bulk, but they sell a bunch of things that aren’t grocery items, and so the way that they look at those would be different than any of the competitors because we would want to look at Kmart’s or Walmart’s.

Professor: Yeah, and they’re trying to offer something that’s unique. In terms of low cost, high quality goods that’s at low cost. If you’re offering something that’s unique to this market, you probably just want to go with the highest traffic area. Wherever that is. And you put in one store. If it’s right in the middle if you think, you know, this sort of approach, if this is where it would be equally accessible to all customers that I’m doing something that’s totally unique, that’s probably where I’d put it, wherever I can get the most traffic. If I’m a high-end Whole Foods or Trader Joe’s and I’m trying to differentiate in some way, same thing. I’m not going to go in with three stores, I’m going to go in with one for the whole area, and I’m just going to go with the highest traffic area for my target customer segment. Does that make sense? But in this case because there were basically all the stores were offering a very similar value proposition in terms of products, that is the approach.

If you think about how, why a company wins with a set of customers in terms of unique value, this is the second decision. It’s usually low price, or product differentiation. In other words, I’ve got lower costs and therefore price below the competition, or I may have higher costs, but I provide enough product differentiation and people are willing to pay for it, this is the willingness to pay part of the equation, and therefore I can price at a premium. And I can succeed with either one of those approaches. But those are sort of two generic approaches to think about offering unique value in the market. So there’s low cost efficiency, it’s like E-Trade, like Walmart. Differentiation premium value, it’s like Apple or Merrill Lynch. And I’m going to offer a third that you don’t offer see in a lot of textbooks not even in chapter one of the one I gave you, and by the way a couple of you have given feedback, thank you very much. Yes?

The third one is, I think of as a value strategy. And it’s basically sort of an in between a pure differentiator and low costs. So think about Charles Schwab in the financial services. Charles Schwab at one time was the discount broker. Their strategy was low cost efficiency. You called in to do trades, they didn’t have many branches, then all of a sudden E-Trade comes in with a lower cost structure. It’s all electronic. They can no longer be the discount broker, they can’t beat low costs. So where have they moved? Do you know what their advertisements say? “Talk to Chuck.” Right? You can talk to somebody, but it’s not as expensive as Merrill Lynch if you were going for a broker or for branches, so it’s going for better value. It’s not the low end, it’s not the least expensive, it’s not the high end, but it’s this interesting mix of a combination of reasonable costs and reasonable differentiation.

Costco I think is really a value strategy. If you wanted to get the cheapest, the least expensive items, you go to Sam’s Club. It has cheaper items than Costco. Costco typically has higher quality products with higher prices than Sam’s Club. But for the price, for the quality of the items, people go to Costco, they think it’s a good value. Does that make sense? So you’ll sometimes hear out in, you know, companies they think we’re trying to offer the best value, that’s sort of what they’re talking about.

Finast Unique Value (Value Proposition)

Low Price

Better Selection

Just as Convenient

How Finast Delivers Unique Value

Lower “local” costs (advertising, training, distribution, etc.) due to more stores than competitors

Larger stores to offer more variety.

Greater brand awareness due to more stores/lower marketing costs

Additional Mini-Case Finast’s Strategy

Two Generic Strategies for Offering Unique Value: Cost and Differentiation

Cost Advantage- An advantage that a firm has over its competitors in the activities associated with producing a product or service, thereby allowing it to produce the same product at lower cost.

Differentiation Advantage- An advantage a firm has over its competitors by making a product more attractive by offering unique qualities in the form of features, reliability, and convenience that distinguishes it from competing products.

Costs

Margins

Industry

Average

Price

Low

Cost

Product

Differentiation

Sources of Advantage

Generic Firm-Level Strategies to Deliver Unique Value

Low Cost (Efficiency)

Providing similar product at lower cost

ETRADE, Walmart

Differentiation (Premium Value)

Providing unique product with attributes buyers will pay for

Merrill Lynch, Apple

Value (Best Value for the Price)

Providing a combination of features and price between low priced and premium value offerings

Charles Schwab, Costco

Example: Generic Firm-Level Strategies to Deliver Unique Value

The third one is, I think of as a value strategy. And it’s basically sort of an in between a pure differentiator and low costs. So think about Charles Schwab in the financial services. Charles Schwab at one time was the discount broker. Their strategy was low cost efficiency. You called in to do trades, they didn’t have many branches, then all of a sudden E-Trade comes in with a lower cost structure. It’s all electronic. They can no longer be the discount broker, they can’t beat low costs. So where have they moved? Do you know what their advertisements say? “Talk to Chuck.” Right? You can talk to somebody, but it’s not as expensive as Mara Lynch if you were going for a broker or for branches, so it’s going for better value. It’s not the low end, it’s not the least expensive, it’s not the high end, but it’s this interesting mix of a combination of reasonable costs and reasonable differentiation.

So here’s an interesting point. So can you beat low cost and differentiate at the same time? Okay, it’s hard to do in fact Mike Porter, one of the well-known strategy faculty at Harvard has often said companies that try to do that get stuck in the middle, they don’t do either well. But think about BYU. A lot of people come here because it’s low cost. A lot of people come here because of the different environment right? You actually, you’d pay more to come here, if you had to. So there are some cases where you might actually find that a lower cost player could also provide something that’s differentiated for a particular type of customer.

Now what we’re offering here doesn’t appeal to everybody in the US, or in the world, but it appeals to a certain segment of the market, okay?

“The essence of strategy is in the activities – choosing to perform activities differently or to perform different activities than rivals do.”

Michael Porter

Competitive Advantage

Doing Different Things

(skype)

Doing Similar Things Differently

(Southwest)

Example: Strategy Rests on Competencies (Activities) that Allow Firms to Deliver Unique Value

Alright, so strategy rests on competitive advantage and this advantage tends to come from the activities that you perform. So you got to do something different in order to be different. So let’s think about competitive advantage here, it means doing different things. Think about the way Skype places a phone call versus the way Verizon or AT&T or a land line company places a phone call. How is it different, the activities that they each perform? Anybody know? How does Skype place a phone call?

Professor: What kind of people work at Skype?

Student: Programmers.

Professor: Programmers. Software programmers. They write software you download it, they free ride on your investment and your computer, right? It’s actually pretty expensive to place that call once you look at the cost of the computer and your internet service. But they figure you’re going to have that anyway, so they kind of free ride on it. They don’t have to buy towers to sell calls, they don’t have to have switching equipment like AT&T. They have a very different way of placing a phone call.

So in fact once when I had a chance to talk to Niklas Zennstrom, the founder of Skype, I asked him how many people did you have working for your company when you sold to EBay for 2.6 billion? You know how many employees they had? 200. 200 employees, 2.6 billion value, you do the math. Okay? They all did very, very well in that acquisition. Because all they did was write software and you download and we’ll do a case later on Skype around what they did well to be successful doing voice-over IP. That’s a very different way of placing a phone call than building a set of cell phone towers, setting up stores, having cell phones, right there’s a whole different set of activities that you perform. They win because of cost, they are more efficient, and they do different things all together.

The other thing is that you do similar things differently. Southwest Airlines. We’ll do a case on them, but think about Southwest. How different are they really from Delta? They both have pilots, they have flight attendants, they have Bowing 737s, but Southwest makes money year after year and Delta hasn’t. We’ll look into it. They do similar things, but Southwest has done some few things differently enough that they are able to make money in a way that Delta, United, American, that others have not been able to do.

So competitive advantage, if we go back to the activities, this is around the resources and capabilities. That is really a key part of strategy is how do you deliver that unique value better than anybody else. Okay? And then you want to sustain it.

	Example Companies/Industries
Key activity or capability that confers advantage	Companies	Industries
Raw materials sourcing	DeBeers	Diamonds/Jewelry
Research and development	Genentech	Biotechnology
Design	Apple IDEO	Computers, MP3s, phones Anything
Large scale, low cost production capabilities (economies of scale)	Intel Boeing	Semiconductors Aircraft
Production technology	Toyota	Automobiles
Sales and marketing	P&G Virgin Group	Consumer products Airlines, cell phones, music
Store location and design skills	McDonalds Starbucks	Fast food Coffee
Servicing	Nordstrom	Clothing, accessories

Up-Stream

Down- Stream

Examples of Capabilities that Confer Advantage

Which brings us to some examples of competencies that confer advantage. So DeBeers, diamond company. Why do they win? Well because raw material sourcing for them historically has been a source of competitive advantage because they’ve owned the diamond mines. That gives them preferred access to diamonds that allows them to inflate the price, okay? And that’s not good for those of you who are recently married or wanting to get married you know diamonds aren’t cheap. And that’s part of the reason, so one of the keys to their competitive advantage has been their raw materials sourcing strategy.

Research and development, Sony historically, Genentech, pharmaceutical company, they win because of new products or have historically based on new research and development. Apple and IDEO win because of design. Intel and bowing because of their production, scale of production. Toyota because of their production technology, the Toyota Production System. EBay wins because of the product range and variety that you can get on the auction site and because of network effects which we will talk about later. Panasonic does well in their business because of application engineering, they’re really good at process and standardized quality. Sales and marketing, Procter & Gamble, Virgin Marketing Group, distribution retail network, Starbucks, McDonald, there are different ways that you can deliver your unique value better than the competition. And it could be at any of these different stages of the value chain where you beat the competition and you win.

What is the key to a successful strategy?

How can you evaluate a “good” or “bad” strategy?

Overview

Alright, so that gives you an idea of the key to a successful strategy, it’s offering unique value and delivering that unique value better than the competition. So how do you evaluate a good or a bad strategy before you launch it? That’s a challenge.

What Guides Strategy Formulation?

Mission- A company’s primary purpose that often specifies the business or businesses in which the firm intends to compete—or the customers it intends to serve.

SWOT Analysis- Strategic planning method used to evaluate the strengths, weaknesses, opportunities, and threats involved in a business.

External analysis involves: (1) an examination of the competition and the forces that shape industry competition and profitability; and (2) customer analysis to understand what customers really want.

Internal Analysis involves an analysis of the company’s set of resources and capabilities that can be deployed—or should be developed—to deliver unique value to customers.

In the mid 1980s Delta’s market researchers found that customers (particularly business customers) were strongly influenced to choose a particular airline by the airline’s frequent flyer program. Consequently, to motivate customers to choose Delta, they teamed up with American Express (an exclusive arrangement) to offer a special program: customers could receive triple miles if they would fly on Delta and purchase the tickets using the American Express card.

Additional Mini Case: Marketing Strategy at Delta

How would you evaluate Delta’s strategy? (Good or bad?)

The mid 1980’s, Delta teamed up with American Express to offer a special marketing program. If you bought a ticket on Delta and used the American Express card, you got triple miles. This is a way to try and build loyalty, to get people to use the card. One of the reasons they wanted to do it is that their average load factors were at 78 percent at the time. Meaning on average, their planes were 78 percent full. So what’s the cost of putting one more person on a plane that’s 78 percent full? Okay I think of it as peanuts. Literally, right? Maybe a Coke and peanuts. But the marginal cost is basically zero right? It’s basically zero. You don’t have to hire anybody else for that plane, you probably don’t need much more fuel. So it’s basically almost zero, so that means you get one more person to pay, it’s all profit. That’s what they’re trying to do. How do we fill the planes? We’re going to give you triple miles. This is the program, evaluate it. Is it a good idea, bad idea, why? And I will let you, you can ask if you want a little more data, once again, you can ask questions.

[Mini-case: We’ve included some of the transcripts from the teaching video for your benefit and to give you more of the data to effectively run this mini-case]

Professor: Okay, so one question that you’re raising is this depends on whether or not people will actually use the American Express card a fly more.

Professor: Or some people might switch from another airline though and fly use, right? So they don’t have to necessarily fly more, they could just switch from another airline to fly us, right?

Professor: So you’re giving away more to your existing customers.

Student: Yeah, so you might not get that 22 percent filled.

Professor: Okay, because some of it may be frequent flyers now using free tickets.

Professor: So what American Express does is they give Delta a slightly lower card rate, and they put up, they split the promotional expenses for this marketing program. So that’s what they have. Okay? Yes?

Professor: AmEx have a large market share in credit cards especially among the business travelers.

Professor: They probably have 65-70 percent share.

Student: Okay well then based on that alone, because I would doubt that Delta would have 65-70 percent of the airline share, so if you’re trying for 65-70 percent of credit card users, then you could attract a lot more customers. So on that basis.

The program will be at least six months. There’s not a clear end date at this point. They’re just right now they’re just offering it, triple miles if you fly Delta using the American Express card.

Professor: So if you were running United Airlines and Delta does this, you’re running Delta, you’ve said let’s do this, what are you going to do?

Student: Well, to me, if it looks like it is going to be a profitable strategy, then I would just copy it and keep my customers. Maybe I would team up with a different credit card company.

Professor: So what would you do?

Student: I would team up with Visa or not Visa, yeah Visa or MasterCard.

Professor: Okay. You take Visa. You’re running Northwest Airlines. What are you going to do?

Student: Grab MasterCard.

Professor: Okay, you’ve got United Airlines. Are you going to go for Discover’s card? Diner’s card? How many of you think, how many of you want to be in a battle where you’re going up there with a diner’s card, right? As your partner, and Delta’s got American Express which is the dominant card used by business travelers, and those are the travelers that you really want because those are the ones who typically pay the higher rates and have to fly during the week, don’t stay the weekends? Okay. So this is a challenge. If you don’t match them, people will move for triple miles. We know that people behave that way, they will move for triple miles. Yes?

Student: Well right now if Delta is teamed with American Express, Visa’s teamed with Southwest, and…

Professor: This actually led to creating cards that were co-branded, right? But this was the first step. Student: I don’t think it would necessarily attract more customers because the business people are the ones paying, they pay a yearly fee for the American Express. So the casual traveler isn’t going to pay the yearly fee just to get triple miles off the flight. So it’s attracting the same people who are already attracted to American Express and…

Professor: And Delta. Or American Express and another airline, right? Any airline. It’s more attractive, although some people might go out and American Express’ hopes are that people will go out and get an American Express card because now I can get triple miles when I fly on Delta or right? So they’re hoping that they’ll get more people to use it.

Additional Mini- Case: What Happened?

All competitors offer triple miles—regardless of how you paid

Customers that wanted to pay some other way than AmEx —flew another airline

Raised the costs of all airlines with no advantage

the customer only winner

No sustainable advantage for Delta

Now let me tell you what happened here. This happened in the mid 1980’s. This is when it ’86 or ’87 and I was working at Bain & Company. I was flying a lot, Delta launches triple miles. Within the week, every other major carrier announced that they would offer triple miles. And they didn’t care how you paid. American Express, Visa, there’s no time to develop a partnership, right, at that point? Can they do that? Sure they can offer triple miles. So now how does Delta respond? Do you go to quadruple miles? That seems silly now, doesn’t it? Because they can imitate you just like that.

The problems with this approach was that there was no barrier to imitation. When you do something, when you take a strategic action, you want to ask yourself, what’s the barrier to imitation? If there’s none, if they can imitate you tomorrow by dropping their price and make it easy and quick, and you have no cost advantage over time, for example, that’s a problem. Because what happened here is that everyone gave triple miles. Who won? The customer. I won. I love this! I’ve flown every airline and I get triple miles every time! This went on for about two years, they did these battles. And then finally the government says you know what? This looks like a pretty big liability that you’re building up. You need to estimate and calculate the liability and put it on your balance sheet. Ouch. They started to calculate the liability. It was big and so what they did was they changed their card programs. They grandfathered you on your old miles, they got rid of triple miles, they actually lowered, they actually increased the number of miles you needed to take a trip, they did a variety of things because what happened was this was a strategic move everybody felt they had to do, erased everybody’s costs but nobody was better off relative to anybody else. Delta, you could argue, was even a little worse off because they were teamed with American Express, and you had to use American Express. But they got the benefit of American Express put up promotional dollars to help fund this, so they also got some visibility. And that led to the partnership and relationship that they later created the co-branded card.

How Are Strategies Formulated?

Corporate Strategy- Decisions about what markets to compete in, made by executives at the corporate level of an organization.

Business Unit Strategy- Decisions about how to gain and sustain advantage, made at the manager level for each standalone business unit within a company.

Functional Strategy- Decisions about how to effectively implement the business unit strategy within functional areas like finance, product development, operations, information technology, sales and marketing, and customer service.

Strategy Vehicles- Activities and strategic choices—such as make versus buy, acquisitions, and strategic alliances—that influence a firm’s ability to enter particular markets, deliver unique value to customers, or create barriers to imitating its product.

Strategy Implementation

Strategy Implementation- The translation of a chosen strategy into organizational action so as to effectively implement the activities required to achieve strategic goals and objectives.

Effective implementation typically requires the following:

The functional strategies within the company—research and development, operations, sales and marketing, human resource management—are well aligned with delivering the unique value identified in the overall strategy. Implementation is generally more successful when a company can measure how effectively functional activities are being performed to support the overall strategy.

The organization’s structure, systems, staff , skills, style (culture), and shared values are designed to facilitate the execution of the strategy.

Who is Responsible for Business Strategy?

Strategic Leaders- Organizational leaders charged with formulating and implementing a strategy with the objective of ensuring the survival and success of an organization.

Deliberate Strategy- A plan or pattern of action that is formulated through a deliberate planning process that is then carried out to achieve the mission or goals of an organization.

Emergent Strategy- A plan or pattern of action that develops and emerges over time in an organization despite a mission or goals.

Who Benefits From a Good Business Strategy?

Stakeholders- Those who have a share or an interest in the activities and performance of an organization.

Organizations have four primary stakeholder groups:

Shareholders- Owners of a company.

Capital market stakeholders

Product market stakeholders

Organizational stakeholders

Community stakeholders

Four Strategic Questions

Where do we compete?

What unique value do we bring?

What resources and capabilities do we utilize?

How do we sustain our value?

So strategy is fundamentally on the formulation side is about making four strategic choices. One which markets are we going to compete in? That means which industries, which product markets, where can we make money? Two, how do we offer unique value in those markets? Why do we win with the customer? That means we’re going to be low cost, we’re going to be differentiated, or perhaps some sort of a value strategy. Third is, how are we going to deliver that unique value better than the competition. Why can we be low cost on a consistent basis relative to the competition? Why can we deliver better quality products on a consistent basis better than the competition? That goes back to the activities that you perform, the competencies you build. And then finally, and that’s related to the fourth, which is how do we create sustainable competitive advantage by building barriers to imitation?

That’s an initial framework that we’re going to use for the course for understanding strategy and the strategic choices made by the leaders of organizations.

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