Chapter 11: Sustaining Competitive Advantage

Monday, November 10

AEC 422 Fall 2014 Unit 5: Building and Sustaining Competitive Advantage – see Ch 11

Reminder: Competitive Advantage and Value Creation

   A firm has a

competitive advantage

in a market if it earns a higher rate of economic profit than the average firm in the same industry Profitability is determined by

market effects

(Porter’s five forces) and

positioning effects

(ability to create economic value through

cost or benefit leadership

)

Consonance analysis

projects the firm’s prospects for creating value in the future, as a function of changes in demand, technical progress, threats from other firms in the industry and from other industries

Static vs. Dynamic Economies

 Preferences (trends, income, demography, knowledge)  Scientific discoveries, technical change, capital and knowledge accumulation  Natural resources discovery and attrition  Institutions and government regulation (the “rules of the game”)  General business conditions (business cycle, interest rate, exchange rate, globalization)  Low-probability extreme events (Katrina/Sandy, drought)

Sustaining Competitive Advantage: Examples

 Mondavi vs the “old world” wine model – brand and domestic experience vs use expertise and limited supply to limit barriers to entry for the premium wine segment  Nest Fresh Eggs –  Diamond Foods –

Sustaining Competitive Advantage: Examples

   Mondavi vs the “old world” wine model – brand and domestic experience vs use expertise and limited supply to limit barriers to entry for the premium wine segment Nest Fresh Eggs – build on unique production knowledge – trying to integrate cause clarification into marketing, production contracts Diamond Foods –

Sustaining Competitive Advantage: Examples

 Mondavi vs the “old world” wine model – brand and domestic experience vs use expertise and limited supply to limit barriers to entry for the premium wine segment  Nest Fresh Eggs – build on unique production knowledge – trying to integrate cause clarification into marketing, production contracts  Diamond Foods – lower cost through scale/scope efficiencies (R&D, mgmt) but pursue product extensions and food segmentation expertise through branding, packaging, vertical relationships

Sustaining Competitive Advantage: Examples

 Monforte Dairy- Artisanal focus, CSA market relationships, tourism spillover – experience emphasis connected with products. Build-your own strategy with the cheese school.

Sustaining Competitive Advantage: Examples

 Whole Foods -

Sustaining Competitive Advantage: Examples

 Whole Foods –  Pursue benefit leadership through superior local sourcing (that other retailers can’t source)  Build loyalty (core) by integrating social awareness into full range of products  First mover advantage and “authentic” connection to true “core”  Design store “experience” to support values-chain marketing; superior HR program  Pursue scale economies (such as they are) through mergers to build natural foods market share

 2007 acquisition of Wild Oats – sold off in 2009  FTC and market power

Sustaining Competitive Advantage: Examples

 All of these firms are moving toward profitable positions that, through different strategies, they can maintain (at least for awhile).

 Looking for paths that are difficult for others to follow.

Monsanto – science, patents Viburnam Farms (artisnal)

Threats to Profit Sustainability – Perfectly Competitive Markets

   Producers have the same production function, produce the same good, and face equal input prices – few sources of cost or differentiation advantage Profit opportunities may arise exist in the short run due to favorable market conditions In the long-run, entry induces an increase in industry output, which drives the price down to the point where (economic) profits are zero

Threats to Profit Sustainability – Monopolistic Competition

  Horizontal product differentiation Mark-up pricing (P > MC)  profit margin positive operating  The entry of firms with new differentiated products entails market share and profit losses by incumbents, up to the point where operating profits just cover fixed costs  Solution to profit sustainability: entry deterrence

Threats to Profit Sustainability in General – remember 5 forces

 Supplier and buyer power can erode the profits of top firms within an industry  When suppliers/buyers have market power, they can extract profits during good (or bad) times  Emergence of low-cost substitutes Cheap And Tasty - Trader Joe's Top Picks 2014 Wines 7, 8, 9 & 10

Firm-Level Competitive Advantage vs. Industry-Level Performance

    Picking industries (emphasis on dynamics of 5 – forces) vs picking firms (competitive position within an industry) Market forces are a threat to profits, but only up to a point. Other forces appear to protect profitable firms Industry conditions that determine industry-wide profitability are distinct from forces that sustain a firm’s competitive advantage A firm may have a persistent edge over its rival despite strong internal rivalry and weak entry barriers

Sustaining competitive advantage

 Competitive advantage is sustainable if it persists despite competitors’ efforts to duplicate it or neutralize it  Sustainability can be attributed to two main factors:  Firms exhibit differences in their

resources capabilities

and endowment, which persist over time 

Isolating mechanisms

advantage of firms protect the competitive

The Resource-Based Theory of the Firm

 A firm’s ability to create superior value depends on its resources and capabilities  Resources: physical capital, human capital, creative individuals, knowledge/technology, intermediate inputs, intangible assets such as brand reputation, customer base, established distribution channels, networks  Capabilities: abilities to perform some activities better than competitors – product development process

The Resource-Based Theory of the Firm

 The uneven distribution of resources and capabilities across firms explains observable differences in performance within an industry  For competitive advantage to be sustainable, it must rest on resources and capabilities that are scarce and imperfectly mobile between firms

Building on capabilities

 Amazonfresh – would people really shop this way for fresh food?

 What is the Amazon advantage?

The Resource-Based Theory of the Firm

 Why are some resources/capabilities imperfectly mobile across firms?

 Non-tradable inputs/location-specific inputs (Customer base; KY Bourbon, Napa Valley wine, Roquefort, Comte, Cantal cheese, etc.)  Relationship-specific inputs  Co-specialized inputs  Proprietary processes

Isolating Mechanisms

 Isolating mechanisms are to a firm what an entry barrier is to an industry  Isolating mechanisms prevent other firms from acquiring the resources and developing the capabilities that would allow them to duplicate or neutralize the competitive advantage of a firm 

Impediments to imitation



Early-mover advantages

Impediments to Imitation

 Legal restrictions  Imitation is limited by legal restrictions protecting intellectual property: patents, copyrights, and trademarks  Government regulatory policies controlling entry into markets: licensing, quotas on operating rights (ex. Tobacco quotas), and certification  Acquiring a patent or an operating right in the open market will not lead to economic profits unless the firm can deploy the asset in superior ways (through superior capabilities or complementary resources)

Impediments to Imitation

 Superior access to inputs or customers  Firms often achieve favorable access to inputs by controlling the sources of supply through ownership or long-term exclusive contracts  Firms can prevent rivals from accessing retail distribution channels through the use of exclusive dealing clauses  Again, securing access to inputs or customers may not lead to competitive advantage as the price of locations or contracts that give the firm control of scarce inputs or distribution channels would be bid up until extra profits are captured by their original owners

Impediments to Imitation

 Market size and scale economies  Imitation (by existing firms and entrants) may be deterred when the minimum efficient scale is large relative to the market demand and one firm has secured a large share of the market  Examples in the bio-tech industries: equine drugs, pesticides for minor-use crops (avocados, tangerines), GMO crops for developing countries

Impediments to Imitation

 Intangible barriers to imitation  The basis of the firm’s advantage lies in distinctive organizational capabilities 

Causal ambiguity

 Dependence on

historical circumstances



Social complexity

Early-Mover Advantage

 Learning curve  A firm that has produced more output than its competitors in earlier periods has moved farther down the learning curve and is able to produce at a lower unit cost  Dynamic effect: lower unit cost   greater cumulative output  … lower price  Example: bio-tech industries

Can JBS afford not to pursue the Chinese market opportunity?

Pig production (1961-2011) 600 500 400 300 200 100 0 Source: FAO, 2013 China • Huge market potential U.S.

Emerging Markets: How to pursue and manage?

• Competitor’s early move Source: http://www.cargill.com.cn/en/locations/index.jsp

Early-Mover Advantage

 Reputation and buyer uncertainty  In the case of experience goods, consumers who have had a positive experience with a firm’s brand will be reluctant to switch to competing brands if there is a chance that their products fail to satisfy them  early mover advantage (ex.: Maker’s Mark, Mondavi)  Pioneering brands can influence the formation of consumers’ preferences, and consumers may consider the attributes of a pioneer brand the ideal for a certain type of product  early mover advantage  Technology, marketing/advertising and other factors can narrow the effective and/or perceived quality gap between early-mover brands and later-comer brands (private labels for instance)

Early-Mover Advantage

 Buyer switching costs  Switching costs can confer a substantial advantage to an early mover  But a firm that has created switching costs for established customers may be at a disadvantage competing for new customers because if it cuts prices to attract them, the profit margin on sales to its loyal customers also declines

Early-Mover Advantage

 Network effects  A product exhibits network effects when its value to consumers increases with the number of consumers using it (social media, cell phones, wikipedia)  Actual networks/virtual networks and the role of complementary products  The first firm that can establish a large installed base of customers in a market with network effects obtains a sustainable competitive advantage (ex.: Chicago agricultural futures and options markets)

Remarks

 Business opportunities don’t last forever  Sometimes success cannot be imitated easily because it is due to luck or trivial circumstances  Sure is good to know what keeps you ahead of your competition

Preview of the Monsanto Case

     Shift in strategic positioning, from an agricultural chemical products based business (Roundup) to a biological products based firm (GMO) Superior value creation: plant-made pharmaceutical molecules, feed and processing use value enhancement, Roundup incremental improvement Capabilities expansion through strategic alliances with seed companies and other agribusinesses Early mover in the plant biotechnology industry and the use of molecular breeding to create new commercial varieties Learning and scope economies in R&D intensive activities, patenting  high barriers to imitation by rivals

Preview of the Monsanto Case

   Historical circumstances: profits from the agricultural chemical business unit allowed Monsanto to invest heavily in biotech R&D Network effect – scope of GM technology adoption Response to changes in energy markets’ fundamentals