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ECP 6701Competitive Strategies in Expanding Markets

Strategic Positioning for Competitive Advantage

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Readings

BDSS Chapter 11

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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

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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

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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

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Framework for Competitive Advantage

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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

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Industry and Business Unit Effects in Profitability

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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

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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

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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

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The Value Map

PriceP,

q, quality

Product A

Product B

indifference curve

Lower consumer surplusProduct D

Higher consumer surplus

Product C

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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

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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

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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.

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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

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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

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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

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Michael Porter’s Value Chain

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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

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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

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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

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Strategic Positioning

Two broad approaches to strategic positioning– Cost leadership– Benefit leadership

Alternative is to use a narrow focus strategy

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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

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The Strategic Logic of Cost Leadership

Price, unit costP, C,

q, quality

PE

PF

qEqF

CE

CF

C

E

F

q

indifference curve

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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 marginCE – CF > PE – PF PF – CF > PE – CE

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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

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The Strategic Logic of Benefit Leadership

Price, unit costP, C,

q, quality

PE

PF

qE qF

CE

CF C

E

F

q

indifference curve

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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 marginPF – PE > CF – CE PF – CF > PE – CE

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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

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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

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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

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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

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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

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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)

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“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

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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

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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

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Strategic Positioning

Two questions are important– How will the firm create value? [Benefit, cost]– Where will the firm do it? [Broad or narrow

segments]

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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

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Segmenting an Industry

Differences in segments arise due to– Customer preferences– Supply conditions– Segment size

Customers within a group should have common features

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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

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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