Economics of Strategy
Fifth Edition
Besanko, Dranove, Shanley, and Schaefer
Chapter 9
Strategic Positioning for
Competitive Advantage
Copyright  2013 John Wiley  Sons, Inc.
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.
Competitive Advantage & Value Creation
 A firms is said to have a competitive
advantage in a market if it earns a higher
rate of economic profit compared to the
average firm in the industry.
 Economic profit earned by a firm depends
on the economic attractiveness of its market
as well as the economic value created by the
firm.
Competitive Advantage & Value Creation
 A firm is said to have a 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
Framework for Competitive Advantage
Maximum Willingness to Pay
and Consumer Surplus
 Maximum willingness to pay - Price at which the
consumer is indifferent between buying the
product and not buying
 Consumer surplus is the difference between the
maximum the consumer is willing to pay
(monetary value of the perceived benefit) and the
prevailing market price
Consumer Surplus and Competition
 Consumer surplus needs to be positive for the
purchase to occur.
 If there is a choice between two or more products
consumer will choose the one with the largest
consumer surplus.
 To compete successfully firms need to deliver
consumer surplus.
Competition in Price-Quality Continuum
 A firm can increase consumer surplus by
increasing the perceived benefit or by lowering the
price
 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
Value Map
 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
The Value Map
Value Map
 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
Indifference Curves & the Tradeoff
between Price & Quality
Value Creation
 B = Maximum willingness to pay
 P = Price of the product
 C = Cost of making the product
 Value created = B – C = (B - P) + (P - C)
 Value created = Consumer surplus + Producer
surplus
 If B - C (the value created) is not positive the
product will not be viable.
 If B - C is positive, all parties are better off because
the product was made and sold
Value Creation and Market Segments
 Value creation occurs with respect to particular
customers.
 A firm may be successful in creating positive B – C
in one segment while it takes another firm to do
the same in another segment.
Value Created and Economic Profit
 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.
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

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.
Value Chain
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.
Value Added Analysis
 Value added analysis is a tool to identify
where the value creation occurs along the
value chain.
 To estimate the incremental value for the
parts of the value chain we need market
prices of semi finished and finished goods.
Value Creation
Firms can create more economic value than
its competitors by
 either
configuring its value chain differently
from competitors or
 performing the activities more effectively than
the rivals
Value Creation, Resources, and Capabilities
 To perform activities more effectively than the
rivals firms need resources and capabilities that
the rivals do not have.
 Resources are specialized assets (patents,
established brand name etc.)
 Capabilities are activities a firm can perform better
than its rivals do.
Value Creation, 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

Strategic Positioning
 A firm’s generic strategy describes how it
positions itself (Porter).
 Two broad approaches to strategic positioning are
cost leadership and
 benefit leadership

 Alternatively a firm can use a narrow focus
strategy.
Porter’s Generic Strategies
The Strategic Logic of Cost Leadership
 A cost leader creates a larger B – C than its
rivals by achieving a lower C than its rivals
 The cost leader can
 price
its product below the rivals and sell more or
 match rivals’ price and achieve better price-cost
margins
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) or
 offering a qualitatively different product.
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
The Strategic Logic of Benefit Leadership
 A benefit leader creates a larger B – C than
its rivals by achieving a higher B than its
rivals
 A benefit leader firm can create superior
values by offering
 cost
parity
 cost proximity
 substantially higher benefit and higher cost
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
Extracting Profits From Cost & 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, many firms can
coexist since firms face downward sloping demand
curves.
 With differentiated products, customers do not
switch easily when a firm cuts prices.
Exploiting Competitive Advantages 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.
Exploiting Competitive Advantages 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.
Exploiting a Competitive Advantage through Pricing
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
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.

“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.
Stuck in the Middle?
 In reality, however, successful firms appear to have
both types of advantages.
Firms that offer high quality products expand market
share and enjoy cost advantages due to economies of
scale and learning
 Learning economies may be more important for high
quality production than for low quality production
 High quality producers may also be more efficient
producers

“Stuck in the Middle”
 Trying to attain excellence in all dimensions often
leads to unfocussed decision making.
 Trying to achieve cost advantage and benefit
advantage may lead to uninspired imitation of
“best practices.”
Strategic Positioning
Two questions are important
 How
will the firm create value? [Benefit, cost]
 Where will the firm do it? [Broad or narrow
segments]
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
Industry Segmentation Matrix
Segmenting an Industry
 Structural attractiveness of segments vary
due to
 Buyer
economics
 Supply conditions
 Segment size
 Buyers in each class have similar tastes,
needs and marketing responses.
Industry Segmentation Matrix
for the Injection Molding Equipment Industry
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
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
Common Focus Strategies
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