Chapter Five Crafting Business Strategy

1. Chapter Five • Crafting Business Strategy

2. OBJECTIVES • Define generic strategies and show how they relate to a firm’s strategic position 1 • Describe the drivers of low-cost, differentiation, and focus strategic positions 2 • Identify and explain the risks associated with each generic strategy position 3 • Show how different positions fit with various stages of the industry life cycle 4 5 • Evaluate the quality of the firm’s strategy

3. STRATEGIC POSITIONING SHOULD IMPROVE PROFITABILITY Definition • Where managers of a company situate that company relative to it’s rivals along important competitive dimensions Purpose • To reduce the effects of rivalry and thereby improve profitability

4. 1 • Firm’s resources and capabilities 2 • Industry structure A FIRM’S CHOICE OF POSITION DEPENDS ON TWO FACTORS

5. A FIRM CAN GAIN ADVANTAGE OVER RIVALS IN TWO WAYS • Description • No advantage overrivals • Advantage over rivals • Produce a differentiated product and charge suffici-ently higher prices to more than off-set the added costs of differentiation • Differentiation • Produce an essentially equivalent product at a lower cost • Low-cost

6. THE STRATEGIC POSITIONING MODEL • Broad(i.e., industry wide) • Broad low-costleadership • Broaddifferentiation • Strategictarget • Narrow(i.e., particular segment only) • Focused costleadership • Focuseddifferentiation • Low-cost • Differentiation • Strategic advantage • Adapted from poster, M.1980. Competitive strategy, 1980.

7. Low-cost leadership • Differentiation • Capture market share by offering lower-price or • Earn higher by maintaining price parity • Capture market share by offering higher quality at same price or • Earn higher margins by raising prices over competitors • Benefits • Pacific Cycle • Gallo Wines • Wal-Mart • Southwest Airlines • Home Depot • Trek Bicycles • Coca-Cola and Pepsi • Mercedez Benz • Honda, Yamaha, and Suzuki motorcycles • Stouffers (frozen foods) • Examples LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET SHARE AND/OR PROFITS

8. STRATEGIC POSITIONING EXAMPLES • Wal-Mart • Gallo Wines • Trek Bicycles • Coca-cola • Broad • Strategictarget • Montague • Mercedes Benz (in US) • Narrow • Jet Blue • Low-cost • Differentiation • Strategic advantage

9. 2 • Product cost • Producer’s margin • Buyer’s cost* LOW-COST AND DIFFERENTIATION CAN GENERATE HIGH MARGINS Price • Hyundai Elantra • Hyundai has a cost advantage Price • Chevy Cavalier Price • Honda has a differentiation advantage • Honda Civic * Including maintenance and other intangibles

10. 40 RESULTS OF DIFFERENTIATED, LOW-COST, AND INTEGRATED POSITIONS Price Cost Industry average price Industry average cost • Industry average competitor • Successful differentiated competitor • Successful low-cost competitor • Competitor with both advantages (integrated)

11. KEY DRIVERS OF COST ADVANTAGE • Economies of scale • Learning • Product technology • Product design • Location advantages for sourcing inputs

12. ECONOMIES OF SCALE • Economiesof scale • Economies of scale exist during a period of time if the average total cost for a unit of production is lower at higher levels of output • You must review cost to assess whether economies of scale exist: • Fixed costs remain the same for different levels of production • Variable costs are the costs of variable inputs (such as raw materials and labor) and vary directly with output • Marginal cost is the cost of the last unit of production • Total cost is the sum of all production costs and always increases as output goes up • Average cost is the mean cost of total production during a given period (say, a year) • Learning • Economiesof scope • Productiontechnology • Productdesign • Location

13. Some sourcesof economies • Some sourcesof diseconomies • R&D spend • Advertising spend • Specialization of specific production processes • Superior inventory management • Purchasing power • Bureaucracy • High labor costs • Inefficient operations DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE • Economiesof scale • Learning • Economiesof scope • Productiontechnology • Productdesign • Location

14. MINIMUM EFFICIENT SCALE (MES) • Average cost • Economiesof scale • Minimum efficient scale: The minimum scale needed to achieve maximum cost savings (i.e., minimum costs) • Learning • Economiesof scope • Productiontechnology • Productdesign • Scale of operations • Location • Economiesof scale • Diseconomies of scale

15. Costs decrease … • Economiesof scale • as the scale of operation increases during any given period of time • Learning curve • with the cumulative level of production since the production of the first unit LEARNING CURVE AS A SOURCE OF COST ADVANTAGE • Economiesof scale How Learning Differs from Scale • Learning • Economiesof scope • Productiontechnology • Productdesign • Location

16. LEARNING CURVE (continued) • Step 1: Measure • Economiesof scale • Step 2: Calibrate • No. of bikes produced • Hours spent on last bike • y = ax-b • 1 • 2 • 4 • 8 • 16 • 32 • 64 • 128 • 30.00 actual • 27.00 actual • 24.30 actual • 21.87 est. • 19.68 est. • 17.71 est. • 15.92 est. • 14.34 est. • Learning • Economiesof scope • Productiontechnology • Productdesign • Step 3: Project • Location

17. ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE • Economiesof scale • If a firm produces two or more products and can share resources among two or more of these (e.g., share manufacturing machines) – thereby lowering the costs of each product – it benefits from economies of scope • Learning • Economiesof scope • Productiontechnology • Productdesign • Location

18. PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE • Economiesof scale • Often, a new entrant who wants to compete against industry incumbents with significant scale and experience advantages, tries to match or beat incumbents’ costs by introducing a production technology that is subject to different economics (e.g., Jet Blue, Nucor Steel) • Learning • Economiesof scope • Productiontechnology • Productdesign • Location

19. PRODUCTION DESIGN AS A SOURCE OF COST ADVANTAGE • Economiesof scale • Learning • Product design can sometimes be altered to lower a firm’s production costs (e.g., Canon vs. Xerox) • Economiesof scope • Productiontechnology • Productdesign • Location

20. LOCATION AS A SOURCE OF COST ADVANTAGE • Economiesof scale • Sometimes firms try to attain lower production costs by locating their operations in cheaper labor markets (e.g., Pacific Cycle manufactures in China and Taiwan to achieve lower costs than Trek who manufactures in the US) • Learning • Economiesof scope • Productiontechnology • Productdesign • Location

21. To drive up customer’s willingness to pay and generate demand sufficient to • Premium brand image • Customization • Unique styling • Speed • More convenient access • Unusually high-quality • Recoup added costs and • Generate enough profits to make strategy worthwhile KEY DRIVERS OF DIFFERENTIATION ADVANTAGES Key Drivers Purpose

22. Drivers • Threats • Economies of scale • Learning • Economies of scope • Superior technology • Product design • Location • New technology • Too low-quality • Social, political, and economic risks of outsourcing • Low-cost • Premium brand image • Customization • Unique styling • Speed • Convenient access • Unusually high-quality • Failure to increase buyer’s willingness to pay higher prices • Under estimating cost of differentiation • Over fulfillment of buyer’s needs • Lower cost imitation • Differentiation DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE

23. STRATEGIES FOR DIFFERENT PHASES OF THE INDUSTRY LIFE CYCLE • Phases of in-dustry life cycle • Embryonic • Growth • Mature • Decline

24. TESTING THE QUALITY OF A STRATEGY

25. 1 • Define generic strategies and show how they relate to a firm’s strategic position 2 • Describe the drivers of low-cost, differen-tiation, and focus strategic positions 3 • Identify and explain the risks associated with each generic strategy position 4 • Show how different positions fit with various stages of the industry life cycle 5 • Evaluate the quality of the firm’s strategy SUMMARY

26. Class Exercise • Find a strategy concept for a new Las Vegas restaurant • Use concepts from this chapter to show how it will make money

27. Competitive Positioning: Game Theory • Companies are players that are simultaneously making choices • The potential profitability varies depending on the strategy one company selects and the strategies that its rivals select • Sequential move and simultaneous move games • Look forward and reason back

28. A Decision Tree for UPS’s Pricing Strategy

29. A Payoff Matrix for GM and Ford

30. Extension • IPDEO • Australian auction