Sustainable Competitive Advantage ,

Porter’s Generic Strategy

2

What is Competitive advantage?

“When two or more firms compete within the same market, one firms possesses a competitive advantage over its rivals when it earns a persistently higher rate of profit (or has the potential to earn a persistently higher rate of profit)”

R. M. Grant, 2000

Competitive Advantage - Definition

• A competitive advantage is an advantage over competitors gained by offering consumers greater value, either by means of lower prices or by providing greater benefits and service that justifies higher prices.

• An advantage that a firm has over its competitors, allowing it to generate greater sales or margins and/or retain more customers than its competition.

•  There can be many types of competitive advantages including the firm's cost structure, product offerings, distribution network and customer support.

Competitive Advantage

• Competitive advantage comes from erforming better than competitors

• Sustainable competitive advantage comes from performing better than competitors for a long time

Competitive Advantage Examples (cont)

• Focus on a narrow market niche– eBay – Online auctions

– McAfee – Virus protection auctions

• Develop expertise, resource strengths, andcapabilities not easily imitated by rivals– FedEx – Next-day delivery of small packages

– Walt Disney – Theme park management and family entertainment

– Toyota – Sophisticated production system

Competitive Advantage Examples

• Strive to be the industry’s low-cost provider– Wal-Mart

• Outcompete rivals on a key differentiating feature– Johnson & Johnson – Reliability in baby products

– Harley-Davidson – King-of-the-road styling

– Rolex – Top-of-the-line prestige

– Mercedes-Benz – Engineering design and performance

– Amazon.com – Wide selection and convenience

7

Cost advantageCost advantage

Differentiation advantageDifferentiation advantage

Competitiveadvantage

Competitiveadvantage

Similar product

at lower cost

Higher pricefor unique product

The Main Types of Competitive Advantage

There are two main types of competitive advantages:• Comparative advantage and • Differential advantage. • Comparative advantage, or cost advantage, is a firm's

ability to produce a good or service at a lower cost than its competitors, which gives the firm the ability sell its goods or services at a lower price than its competition or to generate a larger margin on sales.

• A differential advantage is created when a firm's products or services differ from its competitors and are seen as better than a competitor's products by customers

What do you mean by “Sustainable”

• Sustainable is not measured in calendar time.• Sustainable does not mean the advantage will

last forever.• Sustainable suggests the advantage lasts long

enough that competitors stop trying to duplicate the strategy that makes the advantage sustained.

Where are we?

Assets Capabilities Competencies Competitive Advantage

• Competitive advantage.– A competitive advantage is simply an advantage you have over

your competitors.– A competency will produce competitive advantage provided:

• it produces value for the organization, and• it does this in a way that cannot easily be pursued by competitors.

Sustainable Competitive Advantage

• However, we said the primary objective of business-level strategy was to create sources of sustainable competitive advantage (SCA).

• How do we know SCA when we see it? What is it? When is it considered “sustainable”?

• To produce SCA, the capability must:1. Produce value2. Be rare3. Imperfectly imitable, i.e. not be easily imitated or substituted4. Be exploitable by the organization

Sustainable Competitive Advantage1. The Question of Value:

– Capabilities are valuable when they enable a firm to conceive of or implement strategies that improve efficiency and effectiveness.

– Value is dependent on type of strategy:• Low cost strategy: lower costs (Timex)• Differentiator: add enhancing features (Rolex)

– To be valuable, the capability must either• Increase efficiency (outputs / inputs)

– Information system reduces customer service agents required, or increases the number of calls the same number of agents can answer

• Increase effectiveness (enable some new capability not previously held)– Opening a new regional campus enables outreach to a new market of

students

Sustainable Competitive Advantage2. The Question of Rareness:

– Valuable resources or capabilities that are shared by large numbers of firms in an industry are therefore not rare, and cannot be a source of SCA.

– Given the following, which are rare?• A web server• An MIS instructor• A state-of-the-art stamping press

– None of these are rare. Some researchers think only organizational assets or resources are rare (such as culture). What do you think?

Sustainable Competitive Advantage

3. The Question of Imitability– Valuable, rare resources can only be sources of SCA if firms that do

not possess them cannot obtain them. They must be “imperfectly imitable”, i.e. impossible to perfectly imitate them.

– Ways imitation can be avoided:• Unique Historical Conditions (Caterpillar, e.g.)• Causal Ambiguity (why resources create SCA is not understood,

even by the firm owning them)– Imitating firms cannot duplicate the strategy since they do not

understand why it is successful in the first place.• Social Complexity (trust, teamwork, informal relationships, causal

ambiguity where cause of effectiveness is uncertain)– E.g. A competitor steals all the scientists in an R&D lab and relocates

them to a new facility. But, the “dynamics”, “culture” and “atmosphere” are not the same.

Sustainable Competitive Advantage

4. The Question of Substitutability– There must be no equivalent resources that can be

exploited to implement the same strategies.– Forms of substitutability:

• Duplication: Although no two management teams are the same, they can be strategically equivalent, produce the same results.

• Substitution: Very different resources can be substitutes, e.g. – A charismatic leader with a clear vision vs. a strategic planning dept.– A superior marketing strategy for a recognized brand name.– A superior technical support group for an intelligent diagnostic

software package

Sustainable Competitive Advantage

• An asset is anything the firm owns or controls. – Loosely, “Asset” is to Accounting as “Resource” is to

Management.

• Types of assets:– Physical: plant equipment, location, access to raw materials– Human: training, experience, judgment, decision-making skills,

intelligence, relationships, knowledge– Organizational: Culture, formal reporting structures, control systems,

coordinating systems, informal relationships

Sustainable Competitive Advantage

• A capability is usually considered a “bundle” of assets or resources to perform a business process (which is composed of individual activities)

– E.g. The product development process involves conceptualization, product design, pilot testing, new product launch in production, process debugging, etc.

• All firms have capabilities. However, a firm will usually focus on certain capabilities consistent with its strategy.

– For example, a firm pursuing a differentiation strategy would focus on new product development. A firm focusing on a low cost strategy would focus on improving manufacturing process efficiency.

• The firm’s most important capabilities are called competencies.

Competencies vs. Core Competencies vs. Distinctive Competencies

• A competency is an internal capability that a company performs better than other internal capabilities.

• A core competency is a well-performed internal capability that is central, not peripheral, to a company’s strategy, competitiveness, and profitability.

• A distinctive competence is a competitively valuable capability that a company performs better than its rivals.

Examples: Distinctive Competencies

• Toyota, Honda, Nissan– Low-cost, high-quality manufacturing capability and short design-

to-market cycles

• Intel– Ability to design and manufacture ever more powerful

microprocessors for PCs

• Motorola– Defect-free manufacture (six-sigma quality) of cell phones

Creating Advantage - Synergy and Vision versus Opportunism

PPT 8-20

Sustainable Competitive Advantage

• SCA is an element (or combination of elements) of the business strategy that provides a meaningful advantage over both existing and future competitors.

• An SCA needs to be meaningful, sustainable and substantial.

• An SCA needs to be supported and enhanced over time.• The assets and competencies of an organization

represent the most sustainable element of a business strategy, because these are usually difficult to copy or counter.

Creating Advantage - Synergy and Vision versus Opportunism

PPT 8-21

Sustainable Competitive Advantage

• An SCA should be visible to customers and provide or enhance a value proposition.

• The key is to link an SCA with the positioning of a business.

• A solid value proposition can fail if a key ingredient is missing (e.g., Pringles).

Sustainable Competitive Advantages vs Key Success Factors

• A KSF is an asset or competence needed to compete, whereas, an SCA is an asset or competence that is the basis for a continuing advantage.

• An SCA is analogous to a Point of Differentiation (POD), whereas a KSF can be analogous to either a Point of Parity (POP) or a POD.

Frameworks for Sustainable Competitive Advantage

• Knowledge-based strategy• Generic strategy• Hybrid strategy• Core competence/distinctive

capability/resource based strategy

Knowledge-based Strategy

Superior Knowledge(compared to competitors)

Core Competences

Competitive Advantage

Knowledge (2 Types)

• Explicit knowledge – knowledge whose meaning is clearly stated, the details of which can be recorded and stored– Examples: human resource audit, financial

analysis, market research

• Tacit knowledge – unstated, based on individual knowledge and experience, and is difficult to record and store (but is also difficult to imitate)

Knowledge and Core Competence

• Core competences can come from – Knowledge of customers and their needs– Knowledge of technology and how to use it

distinctively– Knowledge of products and processes– Knowledge of the business environment– Knowledge of competitors– Knowledge of countries and culture

Porter’s Generic Strategy Framework

• Porter’s generic strategy is based on answering 2 questions:– Should strategy be differentiation or cost

leadership?– Should the scope of strategy be broad or narrow?

Generic Strategy

• According to Porter, competitive advantage, and thus higher profits will result either from:

• Differentiation of products and selling them at a premium price, OR

• Producing products at a lower price than competitors

Generic Strategy (cont.)

• In association with choosing differentiation or cost leadership, the organization must decide between:

• Targeting the whole market with the chosen strategy, OR

• Targeting a specific segment of the market

Prof.Sushil\IITD\Session-VI 30

PORTER’S GENERIC STRATEGIES

1. Cost Leadership

2. Differentiation

3 A. Cost Focus 3 B. Differentiation FocusNarrow

Target

Broad Target

DifferentiationLower Cost

Competitive Advantage

Competitive Score

Generic Strategy: Cost Leadership Strategy

• Strategy focus: organize value adding activities to be the lowest cost producer of a product in an industry

Strategy - Cost Leadership

• With this strategy, the objective is to become the lowest-cost producer in the industry. Many (perhaps all) market segments in the industry are supplied with the emphasis placed minimizing costs. If the achieved selling price can at least equal (or near)the average for the market, then the lowest-cost producer will (in theory) enjoy the best profits.

• This strategy is usually associated with large-scale businesses offering "standard" products with relatively little differentiation that are perfectly acceptable to the majority of customers.

• Occasionally, a low-cost leader will also discount its product to maximize sales, particularly if it has a significant cost advantage over the competition and, in doing so, it can further increase its market share.

• Examples of Cost Leadership: Dell Computers & Wal-Mart

Cost Leadership Strategy: Advantages

• Higher profits resulting from charging prices below that of competitors, because unit costs are lower

• Increase market share and sales by reducing the price below that charged by competitors (assuming price elasticity of demand)

• Ability to enter new markets by charging lower prices• Is a barrier to entry for competitors trying to enter the

industry

Cost Leadership and the Value Chain

• Analysis of the value chain identifies where cost savings can be made in the various parts and links

Cost Leadership and the Value Chain

• With a cost leadership strategy, the value chain must be organized to:– Reduce per unit costs by copying, rather than original

design, using cheaper resources, producing basic products, reducing labor costs and increasing labor productivity

– Achieve economies of scale by high-volume sales– Using high-volume purchasing to get discounts– Locating where costs are low

Cost Leadership and Price Elasticity of Demand

• Cost leadership strategy is best used in a market or segment when demand is price elastic, OR

• When charging a similar price to competitors at the same time increasing advertising to increase sales

Generic Strategy: Differentiation Strategy

• Differentiation strategy focuses on changing customer perception about a product, i.e., that the product is superior to other products

• Based on actual superiority (superior features) or perceived superiority

Generic Strategy Framework

Cost leadership Differentiation

Cost focus Differentiation focus

Strategic Scope

Broad

Narrow

Low cost Differentiation

NOTE: If 2 or more competitors choose the same box, competition will increase

Differentiation Strategy: Advantages

• Products will get a premium price• Demand for products is less price elastic than

that for competitor’s products• It is an additional barrier to entry for

competitors to enter the industry

Differentiation Strategy and the Value Chain

• With differentiation strategy, the value chain must be organized to:

• Create products that are superior to competitors’ products in design, technology, performance, etc.

• Offer superior after-sales service• Have superior distribution channels• Create a strong brand name• Create distinctive or superior packaging

Differentiation Strategy and Price Elasticity of Demand

• Differentiation strategy, properly used, can:• reduce price elasticity of demand for the product• lead to the ability to charge higher prices than

competitors, without reducing sales volume• lead to above average profits compared to sales

Generic Strategy: Focus Strategy

• Focus strategy – targets a segment of the product market, rather than the whole market or many markets

• Segment is determined by the bases for segmentation, i.e., geographic, psychographic, demographic, behavioral characteristics

• Within the segment, either cost leadership or differentiation strategy is used

Strategy - Differentiation Focus

• In the differentiation focus strategy, a business aims to differentiate within just one or a small number of target market segments.

• The special customer needs of the segment mean that there are opportunities to provide products that are clearly different from competitors who may be targeting a broader group of customers.

• The important issue for any business adopting this strategy is to ensure that customers really do have different needs and wants - in other words that there is a valid basis for differentiation - and that existing competitor products are not meeting those needs and wants.

• Examples of Differentiation Focus: any successful niche retailers.

Strategy - Cost Focus

• Here a business seeks a lower-cost advantage in just on or a small number of market segments. The product will be basic - perhaps a similar product to the higher-priced and featured market leader, but acceptable to sufficient consumers. Such products are often called "me-too's".

• Examples of Cost Focus: Many smaller retailers featuring own-label or discounted label products.

Generic Strategy Framework

Cost leadership

Differentiation

Cost focus Differentiation focus

Strategic Scope

Broad

Narro

w

Low cost Differentiation

NOTE: If 2 or more competitors choose the same box, competition will increase

Focus Strategy: Advantages

• Lower investment costs required compared to a strategy aimed at the entire market or many markets

• It allows for specialization and greater knowledge

• It makes entry into a new market more simple

Focus Strategy: Advantages

• Lower investment costs required compared to a strategy aimed at the entire market or many markets

• It allows for specialization and greater knowledge

• It makes entry into a new market more simple

Criticisms of Porter’s Generic Strategy

• A hybrid strategy may be successful, although Porter argues that either differentiation or cost leadership must be used (a mix of the two leads to being “stuck in the middle”)

• Cost leadership alone does not lead to sales of products• Differentiation strategies may be used to increase sales

volume, rather than charging a premium price• Price may be used to differentiate• Generic strategy doesn’t create competitive advantage,

rather it is a model to help an organization in analysis• The resource based framework may be more accepted

now

Economic Performance

Valuable?

Rare?

Costly to Imitate?

Exploited by the Organization?

Competitive Implications

Economic Performance

No -- -- -- Competitive Disadvantage

Below Normal

Yes No -- -- Competitive Parity

Normal

Yes Yes No -- Temporary Competitive Advantage

Above Normal

Yes Yes Yes Yes Sustained Competitive Advantage

Above Normal