darral g. clarke for bm 4991 creating competitive advantage ghemawat, chapter three notes
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Darral G. Clarke for BM 499 2
Source: Compustat, Value Line, Marakon Associates Analysis
ROE-Ke Spread
(30%)
(20%)
(10%)
0%
10%
20%
30%
40%
$0 $1 $2 $3 $4 $5 $6 $7 $8 $9 $10 $11 $12 $13 $14 $15
Great Northern Iron
Worthington IndsNucor
Steel TechnologiesOregon Mills
Commercial Metals
CarpenterBirmingham
British Steel PLCCleveland-Cliffs
QuanexLukens
ACME MetalsAmpco
USX-US Steel
Inland Steel
ArmcoWHX BethlehemAverage Invested Equity ($B)
Average Economic Profits in the Steel Industry, 1978 -1996
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Source: Compustat, Value Line, Marakon Associates Analysis
ROE-Ke Spread
(80%)
(60%)
(40%)
(20%)
0%
20%
40%
60%
$0 $5 $10 $15 $20 $25 $30
SmithKline
Glaxo
AmericanHomeProducts
Amgen
Merck
Schering PloughWatson
BristolMyers
Rhone-PoulencMylan LabsWarner Lambert
Eli Lilly Pfizer
PerrigoPharmacia & Upjohn
Forest LabsAlza
ICNScherer
IvaxGenetech
BiogenRobertsGenzyme
DuraChiron
CephalonGensiaCygnus
ImmunexAverage Invested Equity ($B)
Average Economic Profits in the Drug Industry, 1978 -1996
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Industry
Positioning
Residual
Corporate
Calibrating Profit Drivers
Source: Richard P. Rumelt, “How Much Does Industry Matter?,” Strategic Management Journal, 1991; 12:167-185
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Added value = total industry value created with the firm in the game- total value created without the firm in the game
OR EQUIVALENTLYthe value that would be lost to the industry if the firm disappeared
Added Value
Under unrestricted bargaining, a firm cannot capture more than its added value
If you (in your relationships with customers and suppliers) create no value, you can capture no value
More generally, if a firm (in its relationships) creates no new value, it had better have some clever way of claiming value
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Value Creation•Value is created by a business operating together with its customers and its suppliers
– A firm does not create value in isolation
•Willingness to pay = the most that a customer will pay for a firm’s product
•Supplier opportunity cost = willingness to receive = the least that a supplier will accept for the resources required to make a product
•The value created by a transaction is the difference between the customer’s willingness to pay and the opportunity cost of the resources
Customer
Firm
Supplier
Willingness to pay
Supplier opportunity cost
Total value created
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Value Division
Customer
Firm
Supplier
Willingness to pay
Supplier opportunity cost
Price
Cost
Value captured by customer
Value captured by firm
Value captured by supplier
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Activity Analysis of Competitive Advantage
Added value => goal is to drive a wedge between willingness to pay and (supplier opportunity) cost Indeed, a wider wedge than competitors achieve
Problem: a firm must often incur higher costs to deliver a better product or service
Partial solution: use activity analysis to spot opportunities to widen the wedge
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Technology
DesignDevelopment
Manufacturing
ProcurementAssembly
Distribution
TransportInventory
Marketing
RetailingAdvertising
Service
PartsLabor
McKinsey’s Business System
Source: Carter F. Bales, P.C. Chatterjee, Donald J. Gogel, and Anapam P. Puri, “Competitive Cost Analysis,” McKinsey & Co. Staff Paper (January 1980)
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•Inbound shipment of top titles
•Warehousing
•Server operations
•Billing
•Collections
•Picking and shipment of top titles from warehouse
•Shipment of other titles from third- party distributors
•Pricing
•Promotions
•Advertising
•Product information and reviews
•Affiliations with other websites
•Returned items
•Customer feedback
•CDs•Shipping
•Computers•Telecom lines
•Shipping services
•Media
•Inventory system
•Site software •Pick & pack procedures
•Site look & feel
•Customer research
•Return procedures
•Financing, legal support, accounting
•Recruiting, training, incentive system, employee feedback
Procurement
TechnologyDevelopment
Human Resources
FirmInfrastructure
•Primary•activities
SupportActivities
InboundLogistics
Operations OutboundLogistics
Marketing& Sales
After-Sales Service
Primary Activities
Value Chain for an Internet Start-Up
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STRATEGIC ADVANTAGE
Porter’s Generic Strategies
FOCUS
OVERALLCOST LEADERSHIP
DIFFERENTIATION
Low Cost PositionUniqueness Perceived
by the Customer
Industry wide
ParticularSegment only
STR
ATEG
IC T
AR
GET
Source: Michael Porter, Competitive Strategy, 1980
Stuck inThe middle
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Small group exercise: Name the generic strategies in our cases
Coca ColaPepsiCoContinental CanCrown Cork and Seal
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Interplay between Cost and Differentiation
$
Industryaverage
competitor
price
cost
1. 2. 3.
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Porter’s Generic Strategies
Cc
Low cost leadership Differentiation
Di
Dc
Di
Ci Ci
Cc
Focus: Low cost or differentiation in a market segment.
Cc
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Cost Leadership StrategyDeliver a GOOD product or service at the lowest possible costOpen a significant and sustainable cost gap over all competitorsCreate advantage through superior management of key cost driversTranslates into above-average profits with industry-average prices
BUTCost leaders must maintain product parity or proximity in satisfying buyer needsCost leadership often requires making trade-offs with differentiation
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Cost Drivers
ScaleLearningPattern of capacity utilizationLinkagesInterrelationships
IntegrationTimingPoliciesLocationInstitutional factors
Source: Michael E. Porter, Competitive Advantage(New York: Free Press, 1985)
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Common Pitfalls in Cost Leadership
Misunderstanding of actual costsFalse perception of cost driversFocus on manufacturingFailure to exploit linkagesInadequate proximity to differentiatorsIgnoring competitor behaviorPoor implementationActing incrementallyNo cost management program
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The Differentiation StrategySelect one or more needs that are valued by buyerAchieve and sustain superior performance by meeting these needs uniquelySelectively add costs if necessary to do soSuccessful differentiation leads to premium prices
Differentiators must pick cost-effective forms of differentiation
Differentiation leads to above-average profitability provided the firm maintains cost parity or proximity to competitors
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Common Pitfalls in Differentiation
Creating differentiation that buyers do not valueOver-fulfilling buyer needsLooking too narrowly at the sources of differentiationCharging an excessive price premiumFailing to understand costs of differentiationIgnoring signals of valueFailing to recognize buyer segmentsCreating differentiation that competitors can emulate quickly or cheaply
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Focus Strategy
Exploits the same fundamental types of competitive advantageSelects narrow target segment(s) with unusual needsCreates optimal strategy for the target
Narrowing of scope creates cost ordifferentiation advantage
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Can business do more than one?
Overall Cost
Leadership+
Differentiation
FocusSometimes
consistentBut requires defense against a competitor achieving one or the other
Can have multiply-focused entities in one company
OR
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Stuck in the middle
A company can be stuck in the middle if A differentiator attempts to cut costs that are
essential to its differentiation A low cost leader incurs costs, above those which are
essential to its low cost position, which do not differentiate the product
A focus company attempts to broaden its strategic target beyond the segments in which it has an advantage
In other words, by incurring costs, or by cutting costs, or by pursuing markets that reduce the “wedge”
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An Expanded Version of Generic Strategies
Extend BCG framework to include a broader set of cost structuresExtend Porter’s five forces to recognize a more diverse set of competitive environmentsApply the economic theory of long run average cost
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LRAC Review
Experience advantages decline with volume,Scale advantages exhausted at optimal scale,If no change in technology, no advantage to volume
Cost/
un
it
Volume
LRAC
Experience
Experience
Scale
New technology
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Strategy and long-run average cost
Cost advantage from volume
Low High
Ability todifferentiateproduct
High
Low
FragmentedProfitable &Defensible
Stalemate Volume
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Competitive Strategy and Long Run Cost/Differentiation I
Volume Industry Low cost leadership type markets There is an advantage in scale or
technology
Stalemate Industry Can’t differentiate Economies of scale, experience common to
competitors No process innovation
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Competitive Strategy and Long Run Cost/Differentiation II Fragmented Industry
Differentiation is key competitive factor Niche strategy Volume in niches inadequate to achieve volume cost
advantages
Profitable and defensible industry Differentiated product Customer preference Low cost producer of differentiated product
Transitory industry Cost advantage based on labor Cost advantage based on any other temporary
advantage
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Small group exercise: Provide an example of a cost leadership strategy in one of our cases (identify the company and provide some detail)
Cola wars and beverage industryCoors and brewing industryCrown Cork and SealDeBeers and the diamond industry
Egghead and the retail industryBarnes and Noble, Amazon and the retail book industry
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Small group exercise: Provide an example of a differentiation strategy in one of our cases (identify the company and provide some detail)
Cola wars and beverage industryCoors and brewing industryCrown Cork and SealDeBeers and the diamond industry
Egghead and the retail industryBarnes and Noble, Amazon and the retail book industry
Darral G. Clarke for BM 499 30
Small group exercise: Provide an example of a focus strategy (either cost or differentiation) strategy in one of our cases (identify the company and provide some detail)
Cola wars and beverage industryCoors and brewing industryCrown Cork and SealDeBeers and the diamond industry
Egghead and the retail industryBarnes and Noble, Amazon and the retail book industry