ECP 6701 Competitive Strategies in Expanding Markets

1. ECP 6701 Competitive Strategies in Expanding Markets Strategic Positioning for Competitive Advantage

2. Readings • BDSS Chapter 11

3. Strategic Positioning • Firms within the same industry can position themselves in different ways • Not all positions will be equally profitable or lead to the same odds of survival • A firm’s ability to create value and enjoy a competitive advantage over other firms depends on how it positions itself within its industry

4. Competitive Advantage and Value Creation • A firm is said to have a competitive advantage in a market if it earns a higher rate of economic profit compared to the average economic profit in the industry • Economic profit earned by a firm depends on the market conditions as well as the economic value created by the firm

5. Competitive Advantage and Value Creation • A firm can achieve competitive advantage only if it can create more economic value than its competitors • A firm’s ability to create value depends on its cost position as well as its benefit position relative to its competitors

6. Framework for Competitive Advantage

7. Competitive Advantage and Profitability: Evidence • Research on the variation in profitability across firms by Anita McGahan and Michael Porter shows that • 19% of the variation is due to industry effects • 32% is due to competitive advantage of firms • 43% of the variation is random • 4% of the variation is attributable to the corporate parent and about 2% is the year effect

8. Industry and Business Unit Effects in Profitability

9. Value Creation and Profitability • Value created = consumer surplus + producer’s profit • Consumer surplus is the difference between the maximum the consumer is willing to pay (monetary value of the perceived benefit) and the price

10. Components of Consumer Surplus • A firm can increase consumer surplus by increasing the perceived benefit or by selling at a lower price • The firm can also increase consumer surplus by reducing the cost of using the product and the transactions costs that the consumer incurs

11. Competition in Price-Quality Continuum • When products differ in quality, competing firms can be viewed as submitting consumer surplus bids with their quality-price combinations • When a firm fails to offer as much consumer surplus as its rivals, its sales will decline

12. P, Price Lower consumer surplus indifference curve Product D Product A Product C Product B Higher consumer surplus q, quality The Value Map

13. Value Map: An Illustration • Points on the indifference curve represent price-quality with the same consumer surplus • The steepness of the indifference curve reflects the tradeoff between price and quality that the consumers are willing to make

14. Value Map: An Illustration • Products A and B exhibit consumer surplus parity • Product C has a higher consumer surplus than A and B • Product D has a lower consumer surplus

15. Value Created and Economic Profits Value created = Consumer surplus + Producer surplus = (B - P) + (P - C) = B - C If (B-C) is not positive the product will not be viable.

16. Value Created and Competitive Advantage • To achieve competitive advantage, a firm must produce more value than its rivals • Consumers will demand the same consumer surplus from the firm as from its rivals • With superior value creation, the firm can offer as much consumer surplus as the rivals and still make an economic profit

17. Consonance Analysis of Value Creation • Consonance analysis looks at a firm’s prospects for continuing to create value • Ability to create value will be affected by • changes in market demand • changes in technology and • threats from other firms in the industry and from other industries

18. The Value Chain • The value chain or the vertical chain is the representation of the firm as a set of value creating activities • Activities in the value chain include primary activities like production and marketing as well as support activities such as human resource management and finance

19. Michael Porter’s Value Chain

20. Value Chain • Each activity in the value chain can potentially add to perceived benefits • Each activity also adds to costs • In practice it is difficult to isolate the incremental perceived benefit and the incremental cost of each activity

21. Value Creation and Resources and Capabilities • Two ways in which a firm can create more economic value than its competitors • Configure its value chain differently from competitors • Perform the activities more effectively than the rivals • If the firm’s value chain is similar to its rivals’ the firm needs resources and capabilities that the rivals do not have to create superior value

22. Value Creation and Resources and Capabilities • Capabilities have some of the following characteristics • They are typically valuable across multiple markets and products • They are embedded in organizational routines that survive when individuals are replaced • They represent tacit knowledge in the organization

23. Strategic Positioning • Two broad approaches to strategic positioning • Cost leadership • Benefit leadership • Alternative is to use a narrow focus strategy

24. The Strategic Logic of Cost Leadership • A cost leader can create more value than its competitors by • offering the same benefits as the competitors do (benefit parity) • offering a slightly lower benefit (benefit proximity) • offering a qualitatively different product

25. P, C, Price, unit cost indifference curve E PE F PF CE DC Dq CF q, quality qF qE The Strategic Logic of Cost Leadership

26. The Strategic Logic of Cost Leadership • Firm F offers lower quality than the rest of the industry (E) and has much lower costs than the rest of the industry • If the cost leader attains consumer surplus parity with the rest of the firms in the industry it earns a higher profit margin CE – CF > PE – PF PF – CF > PE – CE

27. The Strategic Logic of Benefit Leadership • A benefit leader firm can create superior values by offering • cost parity • cost proximity • substantially higher benefit and higher cost

28. P, C, Price, unit cost indifference curve F PF E PE CF DC CE Dq q, quality qF qE The Strategic Logic of Benefit Leadership

29. The Strategic Logic of Benefit Leadership • Firm F offers higher benefit than the rest of the industry (E) at a slightly higher cost • If the benefit leader attains consumer surplus parity with the rest of the firms in the industry it earns a higher profit margin PF – PE> CF – CE PF – CF> PE– CE

30. Extracting Profits From Cost and Benefit Advantage • When the products are not differentiated, the firm that has a cost (or benefit) advantage over others can capture the entire market • With product differentiation, this extreme result does not hold since firms face downward sloping demand curves • With differentiated products, customers do not switch easily

31. Exploiting a Competitive Advantage Through Pricing • When the product differentiation is weak the firm should follow a market share strategy • With a cost advantage, the firm should underprice its rivals and build share • With a benefit advantage, the firm should maintain price parity and let the benefit build the share

32. Exploiting a Competitive Advantage Through Pricing • When the product differentiation is strong the firm should follow a profit margin strategy • With a cost advantage, the firm should maintain price parity with its rivals • With a benefit advantage, the firm should charge a price premium over the competitors

33. Conditions Suitable for Seeking a Cost Advantage Cost advantage should be sought • when the nature of the product does not allow benefit enhancement • when consumers relatively price sensitive and • when the product is a search good rather than an experience good

34. Conditions Suitable for Seeking a Benefit Advantage Benefit advantage should be sought • when consumers are willing to pay a premium for benefit enhancements • when economies of scale and learning have been already exploited and differentiation is the best route to value creation and • when the product is an experience good

35. Diversity of Strategies • Firms need to deliver a distinct bundle of economic value through their strategy choices • When consumers differ in their willingness to pay for product attributes, different strategies can coexist (Example: Walmart and Target)

36. “Stuck in the Middle” • It can be argued that firms should either pursue a cost advantage or a benefit advantage but not both • Firms that pursue both could, according to this argument, get stuck in the middle and have neither advantage • In reality, successful firms appear to have both types of advantages simultaneously

37. Cost and Benefit Leadership • There could be other explanations why cost advantage and benefit advantage appear together • Firms that offer high quality products may expand market share and enjoy cost advantages due to economies of scale and learning

38. Cost and Benefit Leadership • Learning economies may be more important for high quality production than for low quality production • The high quality producers may also be more efficient producers than low quality producers

39. Strategic Positioning • Two questions are important • How will the firm create value? [Benefit, cost] • Where will the firm do it? [Broad or narrow segments]

40. Segmenting an Industry • An industry can be represented in two dimensions • Product varieties • Customer groups • A potential segment is the intersection of a particular product group with a particular customer group

41. Segmenting an Industry • Differences in segments arise due to • Customer preferences • Supply conditions • Segment size • Customers within a group should have common features

42. Broad Coverage Strategies • Offer a full line of products to serve a range of customer groups • Economies of scope can arise from • Production • Distribution • Marketing

43. Focus Strategies • Customer specialization: A wide range of products to a narrow customer group • Product specialization: Limited product variety for a wide range of customers • Geographic specialization: Exploit the unique conditions of the region