Transcript Economics of Strategy - Florida Gulf Coast University

Economics of Strategy
Strategic Positioning for
Competitive Advantage
Competitive Advantage
• Traditional Management Definition
– “the ability of the firm to favorably distinguish
itself from its competitors in the the eyes of
consumers”
Competitive Advantage
• Economists Definition
– “a firm has a competitive advantage when it
outperforms competitors who sell in the same
market (i.e., earns higher rates of profitability
than)”
• Traditional definition focused on sales (i.e.,
demand factors)
• This definition is much broader
– includes stake-holders beyond consumers
– explicitly addressed costs
Competitive Advantage
• Depends upon two major factors
– creating firm value through the cost side
– creating firm value through the demand or
product differentiation side
• both are in relative terms compared to peer
competitors who sell in the same market
• Profitability depends upon both the industry
you are in and your relative performance
within that industry
– see figure 12.1, p. 442
Analysis of Competitive
Advantage
• Consumer Surplus
– the difference between what the consumer pays
for a product and the perceived benefits by the
consumer
– treat the demand curve as a marginal benefit
curve
• consumers buy products which maximize
their consumer surplus
Perceived Gross Benefits
to the consumer
• Start with product attributes
• subtract out user costs
• subtract out the transactions costs
Perceived Attributes
•
•
•
•
•
•
•
performance
reliability
durability
convenience
aesthetics
image
resale value
User Costs
•
•
•
•
•
installation costs
learning costs
operations costs
maintenance costs
disposal costs
Transactions Costs
• the costs of organizing and transacting an
exchange
Price
The Value Map
Indifference Curve 1
Indifference Curve 2
Preference direction
“higher consumer surplus”
Quality
Value Creation
• Value is created as the product moves
through the vertical chain from raw
materials to finished product
• B as the perceived benefit to the final
consumer
• C as the costs of inputs
– all economic inputs including opportunity costs
• Value Created = B - C
• Value created is split into consumer surplus
+ producer surplus
Value-Creation and Competitive
Advantage
• To achieve competitive advantage the firm
– must create value AND
– it must create more value than its competitors in
the industry
• competition among firms is a process of
bidding for both the dollar votes of
consumers and the dollar votes of investors
Value-Creation and Competitive
Advantage
• Why do customer’s choose your product over the
other choices they have?
• How do production, distribution, and sales
technology affect your firm?
• What is the underlying cost structure of your firm?
– Are there economies of scale or scope?
– How do non-production costs affect your overall cost
structure? (Production, distribution, sales?)
– How do costs change with experience?
Value-Creation and the Value
Chain
• The value chain identifies processes within
the firm that create value
• Each stage can potentially add or reduce B
and/or C
• To have competitive advantage the firm
must create more value (the spread between
B and C) than its competitors
• This requires resources and capabilities
Resources
• firm-specific assets that cannot be easily
duplicated or acquired by your competitors
–
–
–
–
–
–
patents, copyrights, trademarks
brand recognition
organizational culture
good relationships with work force
protected access to channels of distribution
monopoly power through legislation
Capabilities
• clusters of activities that your firm performs
well relative to competitor firms
– developed expertise
•
•
•
•
Disney in cartoons
American Airlines in yield management
Employee relationships at Saturn
Honda and small internal combustion engines and
power trains
• Harley Davidson and The American Mystique
• Bausch and Lomb in optics
Capabilities - Common
Characteristics
• They are typically valuable across multiple
markets or products
• They are typically embedded in
organizational routines
– well-honed patterns of performing activities
inside the organization
• They are difficult to quantify or reduce to
simple algorithms or procedure lists
Key Success Factors
• Skills and assets a firm must possess to
achieve profitability in the industry
• these are necessary but not sufficient
– necessary - they are required to be in the game
(join the industry)
– sufficient - they are not what creates
competitive advantage (within the industry)
among your peer competitors
Creating Value vs. Redistributing
Value
• Competition for the former is fierce
– dependent upon bargaining skill
– usually one-time gain
• The former is less likely to be replicable
– usually ongoing gain
Retained Value for the Firm
• The firm wants to be able retain the valuecreated
• Industry structure affects their ability to do
so
• Position in the vertical chain affects their
ability to do so
– lower levels on the vertical chain are often
more commodity-like, hence more competitive
Cost Advantage and
Differentiation Advantage
• Cost Advantage - creating value on the cost
side relative to peer competitors
• Differentiation Advantage - creating value
on the demand side relative to your
competitors
Cost Advantage
• Create value by lowering your costs relative
to your peer competitors
Benefit Parity
• You could offer the same benefits to
consumers as your peer firms but
– obtain competitive advantage by reducing your
cost structures
• e.g., Lexus, Accra, Infinity vs. Mercedes Benz
Benefit Proximity
• You could offer slightly lower benefits than
your peer firms
– obtain your competitive advantage by reducing
cost structures
– cost structures themselves may be lower due to
reductions in quality which consumers value
• e.g., oil filters - Fram vs. MotorCraft
Produce a qualitatively different
product
• Redefine the product in ways that allow for
substantial differences in benefits or costs
relative to traditional product definitions
– compete on much lower costs and quality
• McDonalds, Timex watches, Bic pens and lighters
– compete on much higher costs and quality
• Hatteras Yachts, Rolex, pork rinds ;-)
Differentiation Advantage
• You can offer a higher perceived benefit to
consumers
– where the percentage increase in perceived
benefits exceed the percentage increase in costs
Extracting Profits
• Vertical Differentiation
– sellers seek competitive advantage by providing
increased perceived benefits to all consumers
– more likely where the product is more
homogeneous
– more likely in competitive markets
Extracting Profits
• Horizontal Differentiation
– sellers seek competitive advantage by providing
increased perceived benefits to some consumers
but decreased perceived benefits to other
consumers
• carving up market niche based upon quality
• more likely with numerous product attributes
– e.g., automobiles, boats, breakfast cereals, cigars
– More likely outside of the pure competition
model (product differentiation)
Extracting Profits - Horizontal
Differentiation
• Ed becomes very important
– The more elastic the demand, the more
important volume becomes
• consumers are very price-sensitive
– The more inelastic the demand, the more
important margins become
• consumers are not very price sensitive
Pursue Cost Strategies
– when economies of scale and learning
economies are potentially significant but no
firm in the market seems to be exploiting them
– when opportunities for enhancing the product’s
perceived benefits are limited by the nature of
the product
– when customers are relatively price sensitive
and unwilling to pay for quality, performance,
or image
– when the products attributes are easily
observable at the time of purchase (a search
good)
Pursue Differentiation Strategies
– when consumers are willing to pay for
increased perceived benefits
– when economies of scale and learning
economies are significant and being fully
exploited
– when the products attributes supply increased
perceived value and are difficult to replicate (an
experience good)
Implications for Functional Areas
• See Table 12.2, p. 474
“Stuck in the Middle”
• Michael Porter has argued that firms have
great difficulty pursuing both cost and
differentiation strategies simultaneously
because product differentiation costs
• Mixed empirical results on this thesis
Countering the “Stuck in the
Middle” Theory
– A firm that offers high-quality products
increases its market share, which may result in
economies of scale or learning curve effects
• figure 12.10, p.477
– The rate at which accumulated experience
reduces costs is greater for higher-quality
products than for lower-quality products
– Inefficiencies muddy the relationship between
cost position and differentiation position
Segmenting the Market
• How can we segment out consumers into
relatively homogeneous groups so that we
can price to each group accordingly?
Why Segment?
• To extract consumer surplus
• Airline example
Targeting the Market
• Which segments do we go after?
– Focus strategies
– Broad-coverage strategies
Broad Coverage Strategies
• offer a full line of related products
– economic logic can be found in economies of
scope across the related products
•
•
•
•
Frito Lay (production and distribution facilities)
Statistical Software - SPSS Modules
Television Cable Services
Victoria's Secret (women’s lingerie and clothing)
Broad Coverage Strategies
• “one-size-fits-all” approach
• a common product line is marketed to a
variety of different market segments
• economic logic for a one-size fits all can be
found in economies of scale
• Software Office Suites
• Programming packages (C+)
• Toothbrushes
Focus Strategies
• offer a single product or target a single
market
–
–
–
–
product specialization
geographic specialization
customer specialization
niche specialization
Focus Strategies
• Economic logic
– deep economies of scale by focusing on one
product and/or one market
– learning effects come more quickly
– establish market power within the niche
– choose niches where customers are less price
sensitive
Targeting a segment and pricing
• Targeting is connected to pricing
• see figure 12.12
Segmentation and Competition
• Different segments of the market face
varying competitive environments
Strategic Groups
• a collection of firms within an industry that
are similar to one another and sufficiently
different from other collections of firms
firms in the industry in one or more key
strategic dimensions
Identification by Strategic
Dimension
• Organization Characteristics
– scale and scope, distribution channels, vertical
integration, diversification, relationship to
government
• Marketing and Product Characteristics
– price, quality, image, service, technology
• Financial Characteristics
– costs, debt position
Strategic Maps
• Identify to critical strategic dimensions
• Classify firms according to these
dimensions
• Map onto a Cartesian plane
• Group the clusters to determine strategic
competitors
Strategic Groups
• compete with one another
• competitive advantage cannot be
maintained without barriers to entry
– patent, trademark, copyright
– unique location
– scale or scope economies