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Creating Competitive Advantage

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Creating Competitive Advantage. Ghemawat, Chapter Three Notes. ROE-Ke Spread. 40%. Great Northern Iron. 30%. 20%. Worthington Inds. Nucor. Steel Technologies. 10%. Oregon Mills. Commercial Metals. 0%. Carpenter. British Steel PLC. Cleveland-Cliffs. Birmingham. Quanex. Lukens. - PowerPoint PPT Presentation
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Darral G. Clarke for BM 4 99 1 Creating Competitive Advantage Ghemawat, Chapter Three Notes
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Page 1: Creating Competitive Advantage

Darral G. Clarke for BM 499 1

Creating Competitive AdvantageGhemawat, Chapter Three Notes

Page 2: Creating Competitive Advantage

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

Page 3: Creating Competitive Advantage

Darral G. Clarke for BM 499 3

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

Page 4: Creating Competitive Advantage

Darral G. Clarke for BM 499 4

Industry

Positioning

Residual

Corporate

Calibrating Profit Drivers

Source: Richard P. Rumelt, “How Much Does Industry Matter?,” Strategic Management Journal, 1991; 12:167-185

Page 5: Creating Competitive Advantage

Darral G. Clarke for BM 499 5

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

Page 6: Creating Competitive Advantage

Darral G. Clarke for BM 499 6

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

Page 7: Creating Competitive Advantage

Darral G. Clarke for BM 499 7

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

Page 8: Creating Competitive Advantage

Darral G. Clarke for BM 499 8

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

Page 9: Creating Competitive Advantage

Darral G. Clarke for BM 499 9

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)

Page 10: Creating Competitive Advantage

Darral G. Clarke for BM 499 10

•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

Page 11: Creating Competitive Advantage

Darral G. Clarke for BM 499 11

STRATEGIC ADVANTAGE

Porter’s Generic Strategies

FOCUS

OVERALLCOST LEADERSHIPDIFFERENTIATION

Low Cost PositionUniqueness Perceived

by the Customer

Industry wide

ParticularSegment only

STRA

TEG

IC T

ARG

ET

Source: Michael Porter, Competitive Strategy, 1980

Stuck inThe middle

Page 12: Creating Competitive Advantage

Darral G. Clarke for BM 499 12

Small group exercise: Name the generic strategies in our cases

Coca ColaPepsiCoContinental CanCrown Cork and Seal

Page 13: Creating Competitive Advantage

Darral G. Clarke for BM 499 13

Interplay between Cost and Differentiation

$

Industryaverage

competitor

price

cost

1. 2. 3.

Page 14: Creating Competitive Advantage

Darral G. Clarke for BM 499 14

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

Page 15: Creating Competitive Advantage

Darral G. Clarke for BM 499 15

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

Page 16: Creating Competitive Advantage

Darral G. Clarke for BM 499 16

Cost Drivers

ScaleLearningPattern of capacity utilizationLinkagesInterrelationships

IntegrationTimingPoliciesLocationInstitutional factors

Source: Michael E. Porter, Competitive Advantage(New York: Free Press, 1985)

Page 17: Creating Competitive Advantage

Darral G. Clarke for BM 499 17

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

Page 18: Creating Competitive Advantage

Darral G. Clarke for BM 499 18

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

Page 19: Creating Competitive Advantage

Darral G. Clarke for BM 499 19

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

Page 20: Creating Competitive Advantage

Darral G. Clarke for BM 499 20

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

Page 21: Creating Competitive Advantage

Darral G. Clarke for BM 499 21

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

Page 22: Creating Competitive Advantage

Darral G. Clarke for BM 499 22

Stuck in the middleA 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”

Page 23: Creating Competitive Advantage

Darral G. Clarke for BM 499 23

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

Page 24: Creating Competitive Advantage

Darral G. Clarke for BM 499 24

LRAC Review

Experience advantages decline with volume,Scale advantages exhausted at optimal scale,If no change in technology, no advantage to volume

Cost

/uni

t

Volume

LRAC

Experience

Experience

Scale

New technology

Page 25: Creating Competitive Advantage

Darral G. Clarke for BM 499 25

Strategy and long-run average cost

Cost advantage from volume

Low High

Ability todifferentiateproduct

High

Low

FragmentedProfitable &Defensible

Stalemate Volume

Page 26: Creating Competitive Advantage

Darral G. Clarke for BM 499 26

Competitive Strategy and Long Run Cost/Differentiation I

Volume Industry Low cost leadership type markets There is an advantage in scale or

technologyStalemate Industry Can’t differentiate Economies of scale, experience common to

competitors No process innovation

Page 27: Creating Competitive Advantage

Darral G. Clarke for BM 499 27

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

advantagesProfitable 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

Page 28: Creating Competitive Advantage

Darral G. Clarke for BM 499 28

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

Page 29: Creating Competitive Advantage

Darral G. Clarke for BM 499 29

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

Page 30: Creating Competitive Advantage

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


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