Part 2 Strategy Formulation6*

LO 6-1 Define business-level strategy and describe how it determines a firms strategic position.LO 6-2 Examine the relationship between value drivers and differentiation strategy.LO 6-3Examine the relationship between cost drivers and cost-leadership strategy.LO 6-4Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.LO 6-5Explain why it is difficult to succeed at an integration strategy.LO 6-6Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.LO 6-7Describe and evaluate the dynamics of competitive positioning.

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Chapter Case 6 Trimming Fat at Whole Foods MarketWhole FoodsBusiness Strategy RevitalizationStarted as small natural-foods store 1980Became market leader; differentiation through organics and quality Competitive advantage through 2008CEO John Mackey: Refocused Mission, Reduced Costs 6*

Business Strategy and Competitive AdvantageA business-level strategy is an integrated and coordinated set of commitments and actions designed to provide value to customers and gain a competitive advantage by utilizing core competencies in specific individual product markets.6*

Business-Level Strategy: How to Compete for Advantage?Answer the Who, What, Why, and How Who - which customer segments to serve?What needs, wishes, desires will we satisfy?Why do we want to satisfy them?How will we satisfy customers needs?Details actions managers take in quest for competitive advantageSingle product or group of similar products6*

Abells Framework for Defining the Business

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EXHIBIT 6.1 Industry and Firm Effects Jointly Determine Competitive Advantage6*

Business Strategy and Competitive AdvantageTwo fundamental questions:

How do you generate advantage?How do you sustain advantage?

Key idea for sustainability is barriers to imitation.

How long will it be before the first rival imitates the first mover?How fast does new imitation occur once it starts?

These two factors determine appropriability.6*

Business Strategy and Competitive AdvantageDoes market share generate competitive advantage?

The computer industry is an excellent example of the lack of correspondence between market share and profit rates. IBM was a clear market leader in terms of market share but had only mediocre economic performance relative to its rivals. High market share is no guarantee of high rates of profitability.

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Business Strategy and Competitive AdvantageDoes market share generate competitive advantage?

Perhaps high market share causes high profit rates.

But it could equally well be that there is a third factor (e.g., good service capabilities at Caterpillar), unobserved by us, that causes both high profitability and high market share.

In this case, we would see a correlation between profitability and market share but no causal explanation.

Business Strategy and Competitive Advantage When can market share work to generate and sustain an advantage?

Scale economies combined with high exit costs may make market share a defensible advantage.6*

Sustainable Competitive Advantage Costly Duplication due to:

Historical Conditions;

Uncertainty;

Social Complexity; and

Property Rights Protection.6*

Business Strategy and Competitive AdvantageAn organizations knowledge or expertise can lead to sustainable advantage if:The knowledge is tacit rather than articulable;Tacit Knowledge: We know more than we can tell.Tacit Skills: Riding a bike, swimming, learning by doing, which is critical for maintaining a manufacturing base The knowledge is not observable in use; The knowledge is (socially) complex, rather than simple. 6*

Strategic PositionDetermined by Firms Business-Level StrategyTwo primary competitive levers:Value (V)Cost (C)Economic Value Created: (V-C)The greater (V-C) = Competitive Advantage

Strategic Position Based on:Value creation Cost

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Forms of Competitive AdvantageSimilar Product At Lower CostPrice Premium From Unique Product6*

EXHIBIT 6.2Strategic Position and Competitive Scope: Generic Business Strategies6*

LO 6-1 Define business-level strategy and describe how it determines a firms strategic position.LO 6-2 Examine the relationship between value drivers and differentiation strategy.LO 6-3Examine the relationship between cost drivers and cost-leadership strategy.LO 6-4Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.LO 6-5Explain why it is difficult to succeed at an integration strategy.

LO 6-6Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.LO 6-7Describe and evaluate the dynamics of competitive positioning.

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Building Competitive Advantage

Resources and Capabilities Competitive Positioning Defending

Value drivers Cost drivers Isolating mechanisms

Retain customers & Prevent imitation

Superior Contribution Sustainable PositionCompetitive Advantage

Southern Methodist University

Competitive Positioning With Customers

Economic contributionThe value customers receives less the cost to the firm

Buyer surplus

Suppliers profit

Economic contribution produced by supplier

Product value

Market price

Product cost

Southern Methodist University

Types of Competitive Advantage

Buyer value generated (willingness to pay)

Costs incurred (including opportunity cost of capital)

Industry average competitor

Successful differentiated competitor

Successful low-cost competitor

Competitor with dual advantage

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Value Created

Start with a simple mathematical identityPlot here a couple of items in terms of dollars per dollar of capital deployed. When you deploy capital and run a business, you do two things: you generate a product for which customers are willing to pay, something that is valued. And you incur costs. You hope that the first outweighs the second. To have competitive advantage, you need a wider gap that the average player in your industry. Only a few ways to do this:Differentiate: command a price premium. In doing so, generate more willingness to pay than you incur costs. Example? Goldman SachsLow-cost: generate less buyer value but incur fewer costssacrificing less in WTP than you gain in cost savings. Example? Enterprise Rent-a-CarDual competitive advantage: manage to do both at once. Example? Toyota?

Differentiation Advantage

Differentiation Advantage, a concept developed by economist Joan Robinson, occurs when a firm is able to obtain from its differentiation a price premium in the market which exceeds the cost of providing differentiation.6*

EXHIBIT 6.3Value Drivers: DifferentiationDifferentiation:Product features, customer service, customization, and complementsCompetitive advantage = economic value created (V-C) > competitorsMarriott line of Hotels

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1*STRATEGY HIGHLIGHT 6.1Toyota: From Perfect Recall to Recall NightmareToyotas strategic challenges.Launched Lexus 1989Luxury car segment dominated by Mercedes-Benz, BMW, CadillacLS400 line required recall a little over a year after launchTurned threat into opportunity to establish reputation for superior customer service

Two years after launch Lexus ranked first on quality and customer satisfaction by J.D. Powers2010 Toyota has largest recall in automotive historyNeeded to exhibit superior customer responsiveness again8 million vehicles recalled was much more challenging6*

EXHIBIT 6.4Cost Drivers: Cost-LeadershipCost Leadership:Cost of input factors, economies of scale, and learning-curve and experience-curve effectsCompetitive advantage = economic value created (V-C) > competitorsWalmart vs. KmartDell vs. Compaq, Gateway, & HP

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1*STRATEGY HIGHLIGHT 6.2Ryanair: Lower Cost than the Low-Cost Leader!The Southwest Airlines of EuropeLowest-cost airline in the worldNo window shades on older planes, seats dont recline, etc.Fares as low as $8Numerous fees and surcharges: pillows, blankets, check-in, etc.20+% of revenues flow from ancillary services

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Ryanair Sample Revenue Calculation 6*

Drivers of Cost Advantage

PRODUCTION TECHNIQUES

PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

MANAGERIAL/ ORGANIZATIONALEFFICIENCY

ECONOMIES OF LEARNING

ECONOMIES OF SCALE

Organizational slack

Ratio of fixed to variable costs Costs of installing and closing capacity

Location advantages Ownership of low-cost inputs Bargaining power Supplier cooperation

Design for automation Designs to economize on materials

Mechanization and automation Efficient utilization of materials Increased precision

Increased dexterity Improved coordination/ organization

Indivisibli\ties Specialization and division of labor

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EXHIBIT 6.5Economies of Scale and Diseconomies of Scale

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Economies of Scale: The Long-Run Cost Curve for a Plant

Units of outputper period

MinimumEfficientPlant Size

Cost perunit ofoutput

Sources of scale economies:- technical input/output relationships- indivisibilities- specialization

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"Big Box" Retailers' Advantage Cube-Square Rule: Each dimension increases 50% (2 goes to 3) BUTEach volume increases 237.5% (8 goes to 27) !! 6*

Learning Curve: Sources of GainNeed less time to instruct workersWorkers become more skillful in their movementsDevelop better operation sequences Machines and tooling are continually improvedRejections and rework decreaseManagement controls improvedEngineering changes become less frequentCost-effective improvements in product designEnriched knowhow in managing and operating businessMore efficient inventory handling and distribution methods

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Limits of Learning Curve Advantages

Copying and reverse engineering of products;

Hiring a competitors employees;

Purchasing the know-how from consultants;

Obtaining the know-how from customers;

Experience advantages are often nullified by product obsolences and innovations.6*

Learning CurveThe following discussion and applications focus on direct labor hours per unit, although we could as easily have used costs. In developing a learning curve, we make these assumptions:

Direct labor requirements will decrease at a declining rate as cumulative production increases. The reduction in time will follow an exponential curve. In other words, the production time per unit is reduced by a fixed percentage each time production is doubled. We can use a logarithmic model to draw a learning curve. The direct labor required for the nth unit, kn, is

kn = k1 nb where k1 = direct labor hours for the first unit n = cumulative number of units produced b = log r/log 2 r = learning rate

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Learning CurveExample: The Bellweather Company has a contract for 60 portable electric generators. The labor-hour requirement for manufacturing the first unit is 100. With that as given, Bellweather planners develop an aggregate capacity plan using learning-curve calculations. They use a 90 percent learning curve, based on previous experience with generator contracts.

The labor requirement for the second generator is: k2 = k1 nb = 100 (2)log 0.9/log 2 = 100 (2)-.152 = 100 (.9) = 90 hours

This result for the second unit, 90, is expected, since for a 90% learning curve there is a 10% percent learning between doubled quantities.

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Learning CurveExample: The Bellweather Company

For the 8th unit,

= 100 (8)-.152 = 100 (0.729) = 72.9 hours

This result is also obtained by 100 (.9) (.9) (.9) = 72.9 hours.

Learning curves can be used for:

Bid Preparation

Financial Planning

Production Scheduling

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The Learning CurveAircraft Assembly (1925-57): 80%Calculator (1975-78): 74%

EXHIBIT 6.6Gaining Competitive Advantage Through Learning and Experience Curves6*

LO 6-1 Define business-level strategy and describe how it determines a firms strategic position.LO 6-2 Examine the relationship between value drivers and differentiation strategy.LO 6-3Examine the relationship between cost drivers and cost-leadership strategy.LO 6-4Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.LO 6-5Explain why it is difficult to succeed at an integration strategy.LO 6-6Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.LO 6-7Describe and evaluate the dynamics of competitive positioning.

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EXHIBIT 6.7Competitive Positioning and the Five Forces6*

LO 6-1 Define business-level strategy and describe how it determines a firms strategic position.LO 6-2 Examine the relationship between value drivers and differentiation strategy.LO 6-3Examine the relationship between cost drivers and cost-leadership strategy.LO 6-4Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.LO 6-5Explain why it is difficult to succeed at an integration strategy.LO 6-6Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.LO 6-7Describe and evaluate the dynamics of competitive positioning.

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EXHIBIT 6.8Avon Pursuing an Integration Strategy6*

EXHIBIT 6.9Value and Cost Drivers6*

Integration Strategy Corporate LevelConglomerates can coordinate above the SBU levelTata Group from India

2008 bought Jaguar & Land RoverPrestigious differentiated products

2009 Tata Motors creates a Nano carLowest-priced car in the world!Zero to 60 mph in 30 secondsNo radio or glove boxTargets bicyclists to move to cars6*

LO 6-1 Define business-level strategy and describe how it determines a firms strategic position.LO 6-2 Examine the relationship between value drivers and differentiation strategy.LO 6-3Examine the relationship between cost drivers and cost-leadership strategy.LO 6-4Assess the benefits and risks of cost-leadership and differentiation business strategies vis--vis the five forces that shape competition.LO 6-5Explain why it is difficult to succeed at an integration strategy.LO 6-6Evaluate value and cost drivers that may allow a firm to pursue an integration strategy.LO 6-7Describe and evaluate the dynamics of competitive positioning.

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The Dynamics of Competitive PositioningStrategic Positions need to change over timeeBay withdrew from selling new goods & sold SkypeProductivity FrontierValue-cost relationshipCaptures the best practices at a point in timeMobile Devices2005 Apple differentiator, Dell cost leader2010 Apple still differentiator, HP moving to successful integrator, Dell shifting toward integrator6*

EXHIBIT 6.10The Dynamics of Competitive Positioning: Apple, HP, and Dell6-47

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Differentiation vs. Cost Leadership as a Basis for Competitive Advantage

Highest return on equity among top 200 US companies, 2002 (%) (%)Colgate Palmolive367.8Gillette53.8Caremark Rx303.2H.J. Heinz48.5American Standard161.4Pfizer45.7Yum Brands 98.1Dell Computer43.0Kellogg 80.5TJX41.3Anheuser-Busch 63.4Oracle36.4Nextel Communications 58.3PepsiCo35.6Sara Lee 58.03M32.9Altria Group 57.0Eli Lilly32.7Wyeth 54.5Sysco31.9

QUESTION: Which is the primary basis for competitive advantage in the above companies: cost or differentiation?

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**INSTRUCTOR: Slide 37 covers the consider this case extension for Whole Foods. In this slide is an embedded video link of an interview with John Mackey. You may want to consider using this video closer to the opening of the chapter material. ****

INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text. **INSTRUCTOR: An Interactive video activity is available online through McGraw-Hill Connect on this section of the text.

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*INSTRUCTOR: For a story (with a short video) on the increasing use of airline fees in the U.S. using data from 2010, please see the ABC news link below.

http://abcnews.go.com/Travel/airlines-made-57-billion-profits-2010-fees/story?id=13832011

*INSTRUCTOR: This is an additional graphic to complement Strategy Highlight 6.2 on Ryanair. It is not in the textbook. *

*INSTRUCTOR: This graphic is additional material that is not in the textbook. The instructors manual has additional teaching tips if you wish to explore this learning objective on cost drivers further.*INSTRUCTOR: This graphic is additional material that is not in the textbook. The instructors manual has additional teaching tips if you wish to explore this learning objective on cost drivers further.*

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*INSTRUCTOR: An Interactive activity is available online through McGraw-Hill Connect on this section of the text. Learning Objective 6-6.

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