COST ADVANTAGEANDDIFFERENTIATION ADVANTAGE

STRATEGIC POSITIONING SHOULD IMPROVE PROFITABILITY

2

Where managers of a company situate that company relative to it’s rivals along important competitive dimensions

To reduce the effects of rivalry and thereby improve profitability

A FIRM’S CHOICE OF POSITION DEPENDS ON TWO FACTORS

3

Firm’s resources and capabilities1

Industry structure2

A FIRM CAN GAIN ADVANTAGE OVER RIVALS IN TWO WAYS

4

No advantage overrivals

Advantage over rivals

Low-cost

Differentiation

Description

Produce an essentially equivalent product at a lower cost

Produce a differentiated product and charge suffici-ently higher prices to more than off-set the added costs of differentiation

THE STRATEGIC POSITIONING MODEL

5Adapted from poster, M.1980. Competitive strategy, 1980.

Low-cost Differentiation

Strategic advantage

Strategictarget

Narrow(i.e., particular segment only)

Broad(i.e., industry wide)

Broaddifferentiation

Focused costleadership

Focuseddifferentiation

Broad low-costleadership

LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET SHARE AND/OR PROFITS

6

Examples

Benefits

Low-cost leadership Differentiation

• 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)

• 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

STRATEGIC POSITIONING EXAMPLES

7

Low-cost Differentiation

Strategic advantage

Strategictarget

Narrow

Broad• Trek Bicycles

• Coca-cola

• Jet Blue• Montague

• Mercedes Benz (in US)

• Wal-Mart

• Gallo Wines

LOW-COST AND DIFFERENTIATION CAN GENERATE HIGH MARGINS

8

Hyundai Elantra

Honda Civic

Chevy Cavalier

Product cost Producer’s margin Buyer’s cost*

Hyundai has a cost advantage

Honda has a differentiation advantage

Price

Price

Price

* Including maintenance and other intangibles

RESULTS OF DIFFERENTIATED, LOW-COST, AND INTEGRATED POSITIONS

9

Successful differentiated competitor

Successful low-cost competitor

Industry average competitor

Competitor with both advantages (integrated)

Price

Cost

Industry average cost

Industry average price

KEY DRIVERS OF COST ADVANTAGE

10

• Economies of scale

• Learning

• Product technology

• Product design

• Location advantages for sourcing inputs

DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

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)

DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Some sourcesof economies

• R&D spend

• Advertising spend

• Specialization of specific production processes

• Superior inventory management

• Purchasing power

Some sourcesof diseconomies

• Bureaucracy

• High labor costs

• Inefficient operations

Economiesof scale

MINIMUM EFFICIENT SCALE (MES)

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Average cost

Scale of operations

Diseconomies of scale

Economiesof scale

Economiesof scale

Minimum efficient scale: The minimum scale needed to achieve

maximum cost savings (i.e., minimum costs)

LEARNING CURVE AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Costs decrease …

as the scale of operation increases during any given period of time

Economiesof scale

with the cumulative level of production since the production of the first unit

Learning curve

How Learning Differs from Scale

LEARNING CURVE (continued)

Economiesof scale

Economiesof scope

Productiontechnology

Productdesign

Location

Step 1: Measure

Step 2: CalibrateNo. of bikes produced

Hours spent on last bike

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.

Step 3: Project

Learning

10.00

15.00

20.00

25.00

30.00

35.00

0 24 48 72 96 120

144

168

192

216

240

264

288

312

336

Hou

rs

Number of Bikes Produced

East Side Bikes Learning Curve Hours per

bike

ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

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

PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

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)

PRODUCTION DESIGN AS A SOURCE OF COST ADVANTAGE

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

Product design can sometimes be altered to lower a firm’s production costs (e.g., Canon vs. Xerox)

LOCATION AS A SOURCE OF COST ADVANTAGE

19

Economiesof scale

Learning

Economiesof scope

Productiontechnology

Productdesign

Location

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)

KEY DRIVERS OF DIFFERENTIATION ADVANTAGES

20

• Premium brand image

• Customization

• Unique styling

• Speed

• More convenient access

• Unusually high-quality

To drive up customer’s willingness to pay and generate demand sufficient to

(1) Recoup added costs and

(2) Generate enough profits to make strategy worthwhile

Key Drivers Purpose

DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE

Low-cost

Differentiation

• Economies of scale

• Learning

• Economies of scope

• Superior technology

• Product design

• Location

Drivers Threats

• New technology

• Too low-quality

• Social, political, and economic risks of outsourcing

• 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

VALUE-CHAIN ACTIVITIES: OVERALL COST LEADERSHIP

McGraw-Hill/IrwinStrategic Management, 3/e Copyright © 2007 The McGraw-Hill Companies, Inc. All rights reserved.

Exhibit 5.3 Value-Chain Activities: Examples of Overall Cost LeadershipSource: Adapted with the permission of The Free Press, a division of Simon & Schuster, Inc., from Competitive Advantage: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985 by Michael E. Porter.

VALUE-CHAIN ACTIVITIES: DIFFERENTIATION

McGraw-Hill/IrwinStrategic Management, 3/e

TESTING THE QUALITY OF A STRATEGY

25

Key Evaluation Criteria Sub-questions

1. Does your strategy exploit your key resources?

• With your particular mix of resources, does this strategy give you an advantageous position relative to your competitors?

• Can you pursue this strategy more economically than competitors?• Do you have the capital and managerial talent to do all you envision? • Are you spread too thin?

2. Does your strategy fit with current industry conditions?

• Is there healthy profit potential where you're headed? • Are you aligned with the key success factors of your industry?

3. Will your differentiators be sustainable? • Will competitors have difficulty imitating you? • If imitation cannot be foreclosed, does your strategy include a ceaseless

regimen of innovation and opportunity creation to keep distance between you and the competition?

4. Are the elements of your strategy consistent and aligned with your strategic position?

• Have you made choices of arenas, vehicles, differentiators, and staging, and economic logic?

• Do they all fit and mutually reinforce each other?

6. Can your strategy be implemented? • Will your stakeholders allow you to pursue this strategy? • Do you have the proper complement of implementation levers in place?• Is the management team able and willing to lead the required changes?