Honda

1. Honda James Oldroyd Kellogg Graduate School of Management Northwestern University J-oldroyd@northwestern.edu 801-422-7888 650 TNRB

2. Honda’s New Plant 1958 30,000 Units a Month 360,000 Units a Year Present Demand About 450,000 in 1959 in Japan 247 Competitors with 3 Strong Competitors: Suzuki, Yamaha, and Kawasaki How big was the US market?

3. Honda’s Entry (Customer?) “You meet the Nicest People on a Honda” Deliberate Strategy Enter the Motorcycle Market in North America Honda switched to the new, untested, recreational off-road market. • Most NA Dealers were unwilling to accept an untested product line. • Of the units sold in NA, it became apparent the vehicle was not designed for highway use. Repairs on warrantied bikes significantly drained the company. Realized Strategy Unrealized Strategy Emergent Strategy The Honda employees began to “dirt-bike” to vent their frustrations in the hills of Los Angeles. Their neighbors thought it looked fun and began requesting “dirt-bikes”

4. Figure A: The Value of Experience 1959-1974 Price in Yen (1,000s) 51-125 cc Class 60,000 X 10 Million = 600 Trillion/280(280 yen to the dollar) = $2.1 Billion 100 80 60 40 20 Volume in Millions 1 10

5. The Honda Advantage 450 to 350 Cost Drop = 100 Per Bike X 2.1 Million Bike Produced = 210 Billion Yen / 280 Yen to the Dollar = $750 Million Dollars Cost Advantage Employees are 4x productive as US employees 20% Price Premium (Ability to discount significantly and still remain profitable)

6. The Relationship between Price and CostEXPERIENCE CURVES COMPANY PROFITABILITY) Cost/Unit (Constant Dollars) Industry Price A B C Cost Accumulated Experience (units of experience) • Different companies within an industry will have similar prices but will have accumulated different amounts of experience Predictable Unit Cost Differences Predictable Profitability Differences

7. Which is more beneficial to a firm? Cost (Steep Curve) Cost (Flat Curve) Cost Per/Unit Industry Price Profit Points Number of Units With a Steep Curve the initial costs are higher and there is greater risk.

8. Profitability vs. Market Share

9. Strategic Implications of the Experience Curve • First movers in a fast growing market will secure a widening cost advantage. Firm’s must grow as fast, or faster, than rivals or be at a cost disadvantage. Cost (Firm A) Cost (Firm B) Cost Per Unit Industry Price Cost Disadvantage For Firm B Profit Points Number of Units

10. More Often the Disadvantage Looks Like: Cost (Firm A) Time Advantage for Firm A Cost (Firm B) Cost Per Unit Industry Price Cost Disadvantage For Firm B Number of Units Firm A Has First Mover Advantage and Crosses into Profitability First.

11. Advantages Continued…. • Understanding the behavior of costs allows for more sophisticated pricing strategies. The experience curve can be used: • As a basis for pricing a production run or contract • As a basis for market share based pricing strategy • As a basis for planning future prices

12. Continued… Experience curves can be plotted for a company and its competitors to assess how well each company is managing its costs. Companies with the greatest cumulative experience should have the lowest costs (if business is properly defined). Product life cycles influence how you use the experience curve for pricing. Products with a short product life cycle (rapid development of new models) need to be priced to make money more quickly because they can’t count on a long learning curve and long productions runs.

13. Southwest James Oldroyd Kellogg Graduate School of Management Northwestern University J-oldroyd@northwestern.edu 801-422-7888 650 TNRB

14. American’s Volume Advantage? Costs American Time Advantage for American Cost Southwest Cost Per Unit Industry Price Cost Disadvantage For Southwest Number of Units American Has First Mover Advantage and Crosses into Profitability First.

15. Why don’t we see the results we expect? How does Southwest do it?

16. What does your chart look like? Profits Market Share

17. Measuring Success Airline Profitability Profitability = [yield X load factor] - cost In order to survive and profit in this tough environment, airlines attempt to manipulate three main variables: Cost, calculated as total operating expenses divided by available seat miles (ASM) Yield, calculated as total operating revenues divided by the number of revenue passenger miles (RPM) Load Factor, calculated as the ratio between RPMs and ASMs, which measures capacity utilization.

18. Southwest Airline’s Focus • CEO Herb Kelleher, a Connecticut attorney turned Texan, had the best labor relations in the industry and an excellent company culture. • Company vision was to provide low cost airline service to an increasingly larger number of people. • Lowest cost structure in the industry. • Objective to minimize reservation costs.

19. Wal-mart’s Distribution Model A key to their success Airlines use the same model. Does this make sense?

20. Point to Point Vs. Hub and Spoke Southwest The National Carriers VS. • Commuter airline that concentrates on city pairs. (Average flight is 400 miles or less and takes less than one hour)

21. COST ADVANTAGE AT SOUTHWEST “Airlines don’t have revenue problems, they have cost problems.” Southwest. Conventional Strategy: Meals, pre-assigned seats, membership in airline reservation system, travel agents, and hub & spoke system are key to success. Southwest Strategy: Lowest cost operations and lowest prices. Human Resource Mgmt. Sales/Marketing Operations • Fly only Boeing 737s (smallest, most fuel efficient craft) • Train pilots & mechanics only on 737s • Fly to cheaper, less congested airports (i.e. Love Field Dallas; Midway, Chicago) • Don’t transfer baggage to other airlines • Fast turnaround of aircraft (20 minutes vs. 50 minutes for industry) • Initially non-union, now partially union labor • Cross training, flexible workforce • Employees receive same pay per job hour regardless of location (low turnover overall but accept high turnover in high cost areas; i.e. Calif.) • Offer direct flights to busy cities of less than 500 miles • No pre-assigned seats • Little reliance on travel agents (saves 5-10%) • Snacks rather than meals • Prices 20-50% lower than the competition

22. COST ADVANTAGE AT SOUTHWEST CONTINUED… • Airfares in Southwest markets are roughly 25 percent lower than in non-Southwest markets. • Southwest has an average 65 percent marketshare compared with less than 40 percent for other airlines in their top 100 markets. • Unit costs of other airlines are 50-60 percent higher than Southwest’s, except for America West with unit costs that are 20 percent higher. • Southwest has been the most profitable U.S. airline from 1980-1995. Source: U.S. Dept. of Transportation

23. Target’s Differentiation Strategy James Oldroyd Kellogg Graduate School of Management Northwestern University J-oldroyd@northwestern.edu 801-422-7888 650 TNRB

24. Differentiation Low Cost Mom and Pop Store K-mart Wal-mart Goldman Sachs Merrill Lynch To Date Dual Advantage Willingness to Pay Supplier opportunity cost Burger King McDonald’s

25. Dimensions of Value Top Line Value Product Differentiation Service Value Price Willingness to Pay Value Captured by Customer Bottom Line Value Price Value Captured by Firm Cost Value Captured by Supplier Supplier Opportunity Costs

26. Achieving Differentiation Advantage • How one goes about obtaining a differentiation advantage depends upon the nature of the product/service: • Observable Goods: the buyer can easily form accurate judgements about the quality of a product. • Experience Goods: the buyer finds it difficult and/or costly to determine the quality of the product prior to purchase and use. • Communication/Network Goods: the value to the buyer rises as the number of buyers and users increases. • And it embraces the whole relationship between supplier and customer

27. Total Cost of Use to Buyer Buyer’s Costs Search Learning Switching Risk/loss Performance Service Differentiating Observable Goods By differentiating an observable good the producer acts to reduce the total cost of use to the buyer. Very often this requires an increase in product price. But in successful differentiation the price increase is more than offset by a reduction in the costs experienced by the buyer. The aim is not be the low cost producer but TO BE THE LOW COST PROVIDER. Product Price Manufacturer's Value Added Raw Materials Engineering Labor Marketing Distribution Administration

28. Differentiation-Based Strategy Utility Software User’s Total Cost of New Software Product Price Risk Search Learning Adaptation Evaluation Resources

29. Value Chains for Cost Advantage and Differentiation Advantage Price Firm A has a cost advantage Firm A: Firm B: Price Price Firm C has a differentiation advantage Firm C: Price Firm B: Total cost to buyer Producer’s cost Producer’s margin Buyer’s cost

30. Strategic Positioning • The essence of strategic positioning is to make choices that are different from those of rivals • Strategy is not a race to one ideal position --- it is the creation of a different position • Differences in positioning are necessary but not sufficient for sustainable competitive advantage • Sustainable advantage depends on barriers to imitation • Advantage is magnified by mutual reinforcement across activities

31. Vertical and Horizontal Alliances James Oldroyd Kellogg Graduate School of Management Northwestern University j-oldroyd@northwestern.edu 801-422-7888 650 TNRB

32. Alliances-How far have we come? • “Alliances are mere transitional devices and because of this they are destined to fail” • Michael Porter • “Many so-called alliances between Western companies and their Asian rivals are little more than sophisticated outsourcing arrangements -- the traffic is almost entirely one way” • Hamel, Doz, and Prahalad • “Avoid alliances like the plague.” • Reich and Mankin

33. Alliances Growing as a Source of Revenue Alliances as a Percentage of Revenue for Top 1,000 U.S. Public Corporations Source: Columbia University, European Trade Commission, Studies by BA&H, AC.1983-1987, 1988-1993, 1994-1996, 1999

34. Total business conducted through alliances 50% 40% 40% 30% 30% 20% 20% 10% 3-5% 0% 2000 2005 2010 1990 Source: EIU Global Executive Survey Andersen Consulting, Warren Company

35. Alliances-How far have we come? • “If you think you can go it alone in today’s global economy, you are highly mistaken”(Jack Welch, CEO of GE) • “Microsoft can’t make it alone, but together anything is possible.”(Bill Gates, Chairman of Microsoft) • “Our approach is to develop long term relationships with companies that offer a unique advantage with General Motors. The Alliance Strategy is our major thrust.”(John F. Smith, Jr., Chairman & CE of General Motors)

36. Alliances vs. Acquisitions: Stock Market Response to Announcements Average Stock Market Gains(Average over 10 day window following announcement) .84 percent Percent Stock Market Gains Following Announcements (in percentages) 0 percent Alliances* Acquisitions** (Acquirers) * Source: Dyer, Kale & Singh, 2001 ** Source: Bradley, Desai, & Kim, 1988

37. Benefits: Speed (vs. acquisition or greenfield) Access to key complementary assets Removal of potential competitor Maintain incentives for partner management Drawbacks: Lack of control; must share decision making Potential spillover of knowledge and capabilities Organizational clashes may impede ability to collaborate Strategic Alliances

38. HISTORICAL VISION PARTNERSHIP VISION TOTAL SYSTEM ECONOMICS • INTERNAL FOCUS 100% 80% CUSTOMER 50% ECONOMICS 60% MY 20% MY ECONOMICS 40% ECONOMICS SUPPLIER 20% 30% ECONOMICS 0%

39. EXPANDING THE PIE • Leverage the full resources of suppliers to create value for the end customer • Develop partnerships with key suppliers to optimize the system (lower total systems costs)

40. Toyota Engineering (7,000 Engineers) LEVERAGING THE RESOURCES OF PARTNERS Remaining 250 Tier I Suppliers (10-15,000 Engineers Top 35 Affiliated Suppliers (5-6,000 Engineers) Toyota can leverage its value creation resources by 5-15x by involving suppliers in the Extended Enterprise

41. THE VALUE OF A NETWORK CHANGES AS MEMBERSHIP INCREASES Single Firm 3-Firm Network 6-Firm Network Connections: 0 3 15 Directions: 0 6 30 As the number of nodes in a network increases arithmetically, the value of the network increases exponentially (n2 growth). Small improvement efforts that ripple through the network can dramatically increase the value for all members.

42. Toyota’s Supplier – Customer Interface Surface Contact vs. Multiple-Point Contact (Correct) Top Execu- tives R & D R & D Top Execu- tives Manufacturing Manufacturing Quality Assurance Quality Control Quality Assurance Quality Control Sales Purchasing Point Contact (Wrong) Customer Supplier

43. CREATING EFFECTIVE PARTNERSHIPS • Build supplier trust • Use new processes of supplier selection and evaluation • Create multiple functional interfaces to facilitate system learning • Make dedicated/customized investments

44. THE FUTURE…. • Supply chain management will become increasingly important for competitive advantage • Teams of companies will increasingly compete with other teams (extended enterprise); lean teams will win • Leveraging the full resources of the extended team will be critical • Leading companies will increasingly use partnerships--though not with all suppliers

45. Horizontal Alliances

46. The Scope of Inter-corporate Linkages Contractual AgreementsEquity Arrangements Traditional Nontraditional No New Firm Creation of Entity Dissolution Contracts Contracts of Entity Arm’s-length Joint Research Minority Nonsubsidiary JV Mergers and Buy/Sell Equity JVs Subsidiaries Acquisitions Contracts Investments of MNCs Franchising Joint Product Equity Fifty-fifty Development Swaps Joint Ventures Licensing Long-term Unequal Sourcing Equity Agreements Joint Ventures Cross- Joint Manufacturing licensing Joint Marketing Shared Distribution/ Service Standard Setting/ Research Consortia Strategic Alliances Based on: Yoshino and Rangan, 1995

47. Reduce Risks Size or Uncertainty Associated with Project Preempt Competitors Flexibility/Option Value Gain Efficiency Economies of Scale and/or Scope Speed to Market Access Complementary Skills New market entry; synergy-sensitive skills Learning Acquire New Skills Gain Market Knowledge and Experience Monitor Competition Politics Sensitive Industries Regulations Market Access Why Seek a Partner? 1 4 2 5 3

48. Challenges for Horizontal Alliances • Leveraging each partner’s resources while protecting proprietary know-how; many horizontal alliances are inherently learning races. • Building trust with potential competitors; simultaneously cooperating and competing (Co-opetition) • Less ability to “control” partner decisions (relative to supplier alliances). 1 2 3

49. Favorable Conditions for Horizontal Alliances • The partner’s strategic goals converge while their competitive goals diverge. • (e.g., Philips and Du Pont collaborate to mfg. compact disks; neither invades the other’s market) • The size, market power, and skills/resources of partners is modest compared with industry leaders; an attempt to catch up. • (e.g., Japanese chipmakers collaborate to develop chips; U.S. automakers collaborate on autobody and battery technology). • Each partner believes it can learn from the other and at the same time limit access to proprietary skills • (e.g., Xerox and Fuji alliance; Xerox gets access to Japanese market and technology in Japan; Fuji participates in copier business; Fuji believes it can protect film business while Xerox believes it can protect worldwide copier business)

50. The Logic for Joint Ventures • Alliance objective is characterized by a high degree of uncertainty, such as R&D alliances (need incentives to bring best technology) • Desire to create a “new culture” (resources, processes, values) that fit the new opportunity. • Desire to limit liability of parent companies. • Superior way to measure alliance performance (separate P&L)