Chapter Five
Crafting Business Strategy
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OBJECTIVES
Define generic strategies and show how they relate
1 to a firm’s strategic position
Describe the drivers of low-cost, differentiation,
2 and focus strategic positions
Identify and explain the risks associated with each
3 generic strategy position
Show how different positions fit with various stages
4 of the industry life cycle
5 Evaluate the quality of the firm’s strategy
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STRATEGIC POSITIONING SHOULD IMPROVE PROFITABILITY
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
2
A FIRM’S CHOICE OF POSITION DEPENDS ON TWO FACTORS
1 Firm’s resources and capabilities
2 Industry structure
3
A FIRM CAN GAIN ADVANTAGE OVER RIVALS IN TWO WAYS
No advantage over
rivals
Description
Advantage over rivals
Differentiation
Produce a differentiated
product and charge sufficiently higher prices to more
than off-set the added
costs of differentiation
Low-cost
Produce an essentially
equivalent product at a
lower cost
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THE STRATEGIC POSITIONING MODEL
Broad
(i.e., industry
wide)
Broad low-cost
leadership
Broad
differentiation
Narrow
(i.e., particular
segment only)
Focused cost
leadership
Focused
differentiation
Low-cost
Differentiation
Strategic advantage
Adapted from poster, M.1980. Competitive strategy, 1980.
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LOW-COST LEADERSHIP AND DIFFERENTIATION OFFER GREATER MARKET
SHARE AND/OR PROFITS
Low-cost leadership
Differentiation
• Capture market share by
• Capture market share by
offering lower-price or
• Earn higher by maintaining
Benefits
price parity
offering higher quality
at same price or
• Earn higher margins by
raising prices over
competitors
Examples
• 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)
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STRATEGIC POSITIONING EXAMPLES
Broad
Narrow
• Wal-Mart
• Gallo Wines
• Trek Bicycles
• Coca-cola
• Jet Blue
• Montague
• Mercedes
Benz (in US)
Low-cost
Differentiation
Strategic advantage
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LOW-COST AND DIFFERENTIATION CAN GENERATE HIGH MARGINS
Price
Hyundai Elantra
Price
Chevy Cavalier
Price
Honda Civic
* Including maintenance and other intangibles
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RESULTS OF DIFFERENTIATED, LOW-COST, AND INTEGRATED POSITIONS
Industry
average
competitor
Successful
Successful
differentiated low-cost
competitor
competitor
Competitor
with both
advantages
(integrated)
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KEY DRIVERS OF COST ADVANTAGE
• Economies of scale
• Learning
• Product technology
• Product design
• Location advantages for
sourcing inputs
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ECONOMIES OF SCALE
Economies
of scale
• Economies of scale exist during a period of time if the average
Learning
Economies
of scope
Production
technology
Product
design
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)
Location
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DISECONOMIES OF SCALE – SIZE DOES NOT ENSURE ECONOMIES OF SCALE
Economies
of scale
Learning
Economies
of scope
Production
technology
Product
design
Some sources
of economies
Some sources
of diseconomies
• R&D spend
• Advertising spend
• Bureaucracy
• High labor costs
• Specialization of specific
• Inefficient operations
production processes
• Superior inventory
management
• Purchasing power
Location
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MINIMUM EFFICIENT SCALE (MES)
Economies
of scale
Learning
Average cost
Minimum efficient scale:
The minimum scale
needed to achieve
maximum cost savings
(i.e., minimum costs)
Economies
of scope
Production
technology
Product
design
Scale of
operations
Location
Economies
of scale
Diseconomies
of scale
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LEARNING CURVE AS A SOURCE OF COST ADVANTAGE
Economies
of scale
How Learning Differs from Scale
Learning
Costs decrease …
Economies
of scope
Production
technology
Economies
of 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
Product
design
Location
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LEARNING CURVE (continued)
Economies
of scale
Learning
Economies
of scope
Step 1: Measure
No. of bikes
produced
Step 2: Calibrate
Hours spent
on last bike
1
30.00 actual
2
27.00 actual
4
24.30 actual
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21.87 est.
y = ax-b
East Side Bikes Learning Curve
Product
design
19.68 est.
Hours per bike
35.00
32
17.71 est.
30.00
64
15.92 est.
25.00
128
14.34 est.
Hours
Production
technology
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20.00
15.00
281
261
241
221
201
181
161
141
121
81
61
41
1
Step 3: Project
101
Location
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10.00
Number of Bikes Produced
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ECONOMIES OF SCOPE AS A SOURCE OF COST ADVANTAGE
Economies
of scale
Learning
Economies
of scope
Production
technology
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
Product
design
Location
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PRODUCTION TECHNOLOGY AS A SOURCE OF COST ADVANTAGE
Economies
of scale
Learning
Economies
of scope
Production
technology
Product
design
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)
Location
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PRODUCTION DESIGN AS A SOURCE OF COST ADVANTAGE
Economies
of scale
Learning
Economies
of scope
Product design can sometimes
be altered to lower a firm’s
production costs (e.g., Canon
vs. Xerox)
Production
technology
Product
design
Location
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LOCATION AS A SOURCE OF COST ADVANTAGE
Economies
of scale
Learning
Economies
of scope
Production
technology
Product
design
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)
Location
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KEY DRIVERS OF DIFFERENTIATION ADVANTAGES
Key Drivers
• Premium brand image
• Customization
• Unique styling
• Speed
• More convenient access
• Unusually high-quality
Purpose
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
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DRIVERS AND THREATS TO DIFFERENTIATION AND LOW-COST ADVANTAGE
Drivers
Low-cost
• Economies of scale
• Learning
• Economies of scope
• Superior technology
• Product design
• Location
Threats
• New technology
• Too low-quality
• Social, political, and
economic risks of
outsourcing
• Premium brand image • Failure to increase
buyer’s willingness
• Customization
to pay higher prices
• Unique styling
• Under estimating
Differentiation • Speed
cost of differentiation
• Convenient access
• Over fulfillment of
• Unusually high-quality
buyer’s needs
• Lower cost imitation
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STRATEGIES FOR DIFFERENT PHASES OF THE INDUSTRY LIFE CYCLE
Phases of industry life cycle
Embryonic
Growth
Mature
Decline
Arenas
Local
Vehicles
Internal
development
Alliances to secure
missing inputs or
distribution access
Alliances for
cooperation
Acquisitions in
targeted markets
Differentiators
Staging
Target basic needs, Tactics to gain
minimal
early footholds
differentiation
Economic Logic
Prices tend to be high.
Costs are also high
Focus is on securing
additional capital to
fund growth phase.
Penetration into
Increased efforts
Integrated
Margins can improve
adjacent markets
toward
positions require rapidly because of
differentiation
choice of
experience and scale
Low cost leaders
focusing first on Price premiums accrue
emerge through
cost or
to successful
gaining experience differentiation
differentiators
advantages and
scale
Globalization
Mergers and
More stable
Choosing
Consolidation results
Diversification
acquisitions result positions emerge
international
in fewer competitors
in consolidation
across competitors markets and new (favoring higher
industry
margins) but declining
diversification; growth demands cost
need rational
containment and
sequencing
rationalization of
operations.
Some arenas may be Acquisitions for
Rationalizing cost
abandoned if decline diversifying moves
is severe
Divestitures to exit
Focus on segments for some
which provide most competitors
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profitability
TESTING THE QUALITY OF A STRATEGY
Key Evaluation Criteria
Sub-questions
• 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 • Is there healthy profit potential where you're headed?
industry conditions?
• Are you aligned with the key success factors of your industry?
3. Will your differentiators be
• Will competitors have difficulty imitating you?
sustainable?
• 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
• Have you made choices of arenas, vehicles, differentiators, and
consistent and aligned with your
staging, and economic logic?
strategic position?
• 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?
1. Does your strategy exploit your key
resources?
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SUMMARY
1 Define generic strategies and show how
they relate to a firm’s strategic position
2 Describe the drivers of low-cost, differentiation, 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
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