strategy and sustaining competitive advantage -- february 18, 2006 dr. theodore h. k. clark...
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Strategy and Sustaining Competitive Advantage --
February 18, 2006
Dr. Theodore H. K. ClarkAssociate Professor, Deputy Head (IS), and Academic Director of
MSc in IS Management and MSc in E-Commerce Management ProgramsDepartment of Information & Systems Management
The Hong Kong University of Science & Technologyand Adjunct Associate Professor of Operations & Information Management
(Information Economics and Strategy Group) 1998 - 2001
The Wharton School of the University of Pennsylvania
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What is Strategy? Strategy versus Tactics
Strategy is when you have time to plan Time is a luxury many firms may not have Planning helps firms avoid failures or inefficiency
Doing the right things, not just solving the urgent crisis
Goal of Strategy is to Gain Advantage Faster growth, higher margins, or both
Alternative is More Work, Resources, or Luck But, a good strategy can beat superior forces
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What is Competitive Advantage? Comparable Advantage - Something you are
better at than almost everyone else Circular slide rule example Swedish language example
Competitive Advantage - A comparable advantage that MATTERS in your market Circular slide rule skills irrelevant; use calculator! Swedish MIGHT matter in some environments Would Cantonese be a competitive advantage?
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Porter’s Five Competitive Forces that Drive Industry Profitability
Potentialnew entrants
Industrycompetitors
Threats of substituteproducts or services
Bargaining powerof suppliers
Bargaining powerof buyers
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Why is Industry Structure Important for Strategy? Implications of new investments or changes
in environment can affect all firms Decisions on entry or exit of an industry Decisions on investments in new capabilities Understanding how technology affects firms
Useful tool to examine how these forces act differently upon different firms in an industry
Benchmark for understanding expected profits in an industry given these forces
HKUST Business School
Lessons from Five Forces Industry structure has a strong influence on
profitability Firms position in industry is endogenous (chosen) We used to believe industry structure was exogenous
(given)... now we’re not really sure “Excessive” profits threatened by new entrants and
substitute products and competitive actions Retention of value determined by relative
bargaining power of suppliers and customers Market imperfections determine ability to keep
value that is created
HKUST Business School
Three generic strategies
Overall CostLeadership
Differentiation
Focus
StrategicTarget
Industry
SegmentOnly
Strategic Advantage
Uniqueness Low cost position
“Determining the cost/value tradeoff you wish to offer consumers is themost critical decision” - Porter
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Porter’s Generic Strategy # 1: Leadership Based on Lower Cost Become low-cost producer in the industry
Lowest total cost, not just low variable cost Often driven by economies of scale Must have parity quality or have lowest cost
AFTER adjusting for quality differences Leveraging scale is common source of
advantage in many industries Information goods may have difficulties with
this strategy as costs of duplication are low
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Porter’s Generic Strategy # 2: Differentiation and Segmentation Differentiation means to make your product
unique and (hopefully) more valuable Becoming hard to copy is critically important Avoid commodity competition based on price
Differentiation must be worth more to customers than it costs to create
Horizontal differentiation (segmentation) versus vertical differentiation (quality) Less competition with horizontal differentiation
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Porter’s Generic Strategy # 3: Focus or Niche Target Market Can be based on cost, differentiation or both
By targeting a narrow market segment, you may be able to provide targeted products and services to that segment that are both low-cost and differentiated relative to less targeted firms
Strategy is by design differentiated based on segment, as target market segment needs must be unique for focus strategy to work
May be only option open for new entrants
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Rethinking and Updating Porter’s Generic Strategies Today Cost leadership and differentiation are
often hard to separate or clearly distinguish Cost leadership adjusted for quality differences Differentiation relative to differentiation costs Market leaders generally achieve BOTH
Information goods total cost leadership means highest volumes (or copying) Differentiation critical to achieving scale Pricing not uniform, so a new key variable
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Attackers’ Advantage Large Business Operations Focus on
Meeting the Needs of Traditional Customers New Products and Services Offer Small
Revenues Cost of Redesigning Existing Processes is High
New Entrants can Focus on Niche Markets Fast Growing Niche / New Customer Segments New Products with Higher Initial Cost and Value Rapid Growth Replaces Traditional Markets
Ignoring New Markets can be VERY Costly!
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Sustainable Advantage: Part 1 Economies of Scale and Network Externalities
Economies of scale important for E-commerce (e.g., advertising, software development, etc.)
However, network externalities can be even more powerful forces in online business (Metcalf’s Law)
Value of network of relationships increases as a function of the number of people or systems in the network
Fax machines, Telephones, VCRs, VCD, E-mail, Internet Learning effects of scale can also be hard to copy
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Achieving and Sustaining Competitive Advantage Firms need a COMPETITIVE ADVANTAGE to
be able to PROFIT from this REVOLUTION Sustaining an Online Advantage can be Difficult
Key Challenge is Becoming Hard to Copy Economies of scale and network externalities Access to key skills, resources, or suppliers Customer switching costs and brand preference Government policy (patents, antitrust, etc.)
Fast (not First) Mover Advantage also Matters
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Sustainable Advantage versus Competitive Necessity Information goods have relatively low costs
of reproduction and distribution Lower distribution costs are good, but Lower reproduction costs can be a problem
It is frequently one-third less expensive to copy an innovation (even without violating patent rights) and takes one-third less time
IT innovations often become competitive necessities instead of strategic advantages
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Competitive Necessity Today: Challenge for the Future The more we spend on IT, the more we lose
Why don’t we all just stop investing in systems? Why don’t you start first and show us how well
it works for you, and then we will follow? No firm can afford NOT to have advanced
IT-based trading systems in market today How long is long enough for sustainable
advantage in our fast paced world? Long enough to keep a venture capitalist happy
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Copying Innovations and Competitive Necessity Many new IT enabled innovations are easy to
copy or can not be maintained by one firm Bank ATMs - only HSBC has sufficient market
share to go it alone, so others collaborate Competitive advantage initially, then copied Unsustainable advantage may become necessity
An innovation is a competitive necessity if: Must do it to be competitive in the market Easy to copy and many firms doing it Not clear benefits as “stand-alone” investment
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Innovations, Investments, and Competitive Necessity An investment should only be justified as
competitive necessity as a LAST RESORT Many investments are just smart business, like
investing in factory automation to reduce costs Competitive necessity LOOKS like a bad
investment versus STATUS QUO, but is essential A competitive necessity must be valued by
customers MORE than the cost of investment Some market innovations are not worth copying Alternative strategies could enable differentiation
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Economies of Scale versus Economies of Networks Economies of scale resulted in larger firms
winning, limited by minimum efficient scale Any firm with efficient scale could survive Minimum scale sufficient for moderate success Stability achieved by declining returns to scale
Economies of networks result in single firm or at least standard becoming dominant
Value increases based on number of users Positive feedback leads to single firm dominance Sometimes referred to as a “natural” monopoly
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Lower Cost Distribution: Scale Advantages from Technology Giving away samples to increase sales
Mrs. Fields cookies and new food products Free newspapers for high-class hotels Free “samples” of information online
Information products are EXPERIENCE goods Need to try it to know if it worth buying later
Free samples as “Infomercials” (free version) Need attractive upgrade path for customers Create component based products online
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Strategy, Technology, Timing, and Competitive Advantage Technology changes so fast, that strategy is
highly dependent on implementation timing Good strategy, wrong timing leads to failure
Many new technologies failed to achieve market success at first, and many eventual successes require multiple failed attempts for learning
Failure of a strategy may be error in timing Banking ATMs, disposable diapers, ziplock bags,
PC banking, and many more examples
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Sustainable Advantage: Part 2 Access to Resources as Source of Advantage
Access to either suppliers or channels of distribution can be a sustainable advantage
Customer switching costs can provide a first mover advantage and can favor established firms
Part of IBM’s continuing advantage is due to cost of software conversion which makes switching difficult
Brand can be viewed as a form of switching cost, but may be overcome with intensive promotion
Scarce expertise may provide lasting advantage
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Targeting the New Battleground Pricing and Versioning can create NEW
strategic options that can enable firms to overcome SIZE advantages of dominant firms
Alternative to “Winner Takes All” is smartest firm using customer information most effectively gains competitive advantage.
How can firm with higher operating costs (due to lower scale) WIN with lower prices?
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Competitive Strategy and Information Goods Pricing Pricing of information goods is complex, as
there is no clear cost basis for comparison Most traditional products have some cost based
component in the pricing of products Information goods pricing can be very different
from comparable physical goods Encyclopedia for $1600 USD or $89.99 USD? Costly to produce, but cheap to reproduce
Generic competition means all firms lose
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Critical Role of Information Differentiation in E-Commerce For any online business, ask yourself if this
product or service can easily be copied? If yes, then it is a commodity and competition will
drive prices (and profits) towards zero over time If no, business MAY generate sustainable profits
Cost of copying: barrier to entry CD-based US telephone books example FREE information online (marginal cost = zero)
Advertising and “free” services - challenges
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Sustainable Market Structures for Information Goods Dominant firm model: Winner Take All
Microsoft example - cost leadership via scale What is the cost per copy for competitors?
10 million to develop and 10 customers 10 million to develop and 10 million customers
Not the best product, but size and scale win Differentiated product market
Needs differ by segment, so focus wins Publishing (low cost author?), TV, Movies
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Even if Dominant, Pricing Important for Maximizing Value Customer willingness to pay different for
different groups of customers (segments) DON’T BE GREEDY - limit incentives for entry PLAY TOUGH - Attack entrants aggressively
Not optimal in each case individually, but powerful signal to the market that entry is not profitable
Personalized products and pricing strategies Use information to determine pricing Value-based pricing by segment
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Maximizing Value: Creative Product Pricing Strategies Personalized pricing: Sell unique product to
each customer at a different price Consulting or legal services Grocery products: coupons and electronic
rewards Value of information in services and pricing
Versioning: Portfolio of products and prices Discussed in depth in Session #7
Group pricing: Price sensitivity (students), Network effect, Lock-in, and Sharing
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Power of Profitability Gradient New Entrants Exploit Profitability Gradient
Profitability of all customers is not the same Historical pricing is not adequately
differentiated Information advantage can yield high profits
Percentageof TotalCustomers
Percentage of Total Profits-20 0 20 40 60 80 100
10
0
80
60
40
20
0
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Datamining: A Powerful Segmentation Tool, But … Datamining can only tell you about possible
correlation, not drivers of behavior Driven by past data; future might be different Correlation not same as causality (coincidence)
Need to look for plausible justification for findings from datamining processes For example, datamining shows that CEOs are
bad customers for credit card companies - WHY?
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Information-Based Pricing Strategy: Summary Information about customers behavior,
preferences, cost-to-serve, and ability to pay can be extremely valuable for ALL products
Datamining is ONE powerful tool that can be used to understand potential opportunities Correlation but not causality
Data collection in online businesses can be much lower cost than for traditional firms
Valuable and unused data as free byproducts
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Sustainable Advantage: Part 3 Government, Politics, and Options Advantages
Patents, copyright, and trademarks are Government granted Monopoly rights (potentially hard to copy)
Franchises and Licenses, granted by Governments or by Large and Successful Firm, can be hard to copy
Value of owning McDonald’s franchise right can be high Right to operate Star Ferry may valuable and hard to copy
Government policies on antitrust or prohibitions of monopoly can be source of advantage or disadvantage
Government “grants” may be source of advantage
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Information Alliances, Outsourcing, and Strategy Information outsourcing is becoming
increasingly common and popular Information alliances are becoming essential
for competitive advantage, especially for network goods to achieve scale for success
Vertical integration initially projected for the new economy is becoming virtual integration No firm can afford to own all elements of the
value chain in today’s complex, global economy Virtual integration is both efficient and flexible
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Information Based Organizational Transformation Implementation Implementing Transformation Strategy
Objective are often unclear or evolving over time Industry transformation is hard to do top down Risks and failures can be costly for innovators
Radical Goals, Incremental Change Process Harvard study of successful Reengineering P&G channel transformation success case study
Process R&D and Process Prototyping Needed Infrastructure more than systems; need skills too.
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Risks and Benefits of Sharing Information Sharing information even once can result in
power shifts that last for years in a relationship (proceed with caution)
However, successful partnerships based on shared information can yield strong mutual benefits and reduce channel inefficiencies P&G now selling more than 50% of volume
using channel information sharing processes Intel and customers both benefit from shared
information to improve efficiency and service
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Developing Relationships of Trust Establishing inter-organizational
relationships based on trust requires management time and attention
But, management time is one of the most scare assets any firm possesses, especially for senior management
Thus, any firm has a limit on the number of close relationships based on trust which can be sustained
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Evolution of Trust and Consolidation of Relationships Limited number of relationships at a high
level of trust results consolidation of vendor and customer relationships
Tight partnerships for critical jointly interdependent activities (e.g., JIT) GM and other firms reducing suppliers Strategic supply networks and alliances
Leaders in developing trust can gain sustainable competitive advantage
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Reengineering: What is it and Why is it Needed Anyway? Business as usual won’t work
Legacy of past failures - creeping inefficient and tolerance for under-performance.
Does BPR work? Sometimes ... As many as 70% of BPR projects failed. But there are many dramatic successes as well.
Ford - Accounts payable department reduced by 75%. Bell Atlantic - Cycle time reduced from 15 to 3 days. IBM Credit - Loan application turn-around time
reduced from 6 days to 4 hours with 100 times (not 100%) increase in volume using same staff!
HKUST Business School
Value Chain - Activities
InboundLogistics
Operations OutboundLogistics
Marketing &Sales
Service
Organization
Human resources
Technology
Purchasing
SupportActivities
PrimaryActivities
Idea: Break firm down into manageable pieces for analysis
From: Porter & Miller, 1985
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Value System
Identify where value is created outside the firm Can a firm use IT to appropriate this value? Are there additional opportunities to create gains
from trade?
Supplier Firm Channel Buyer
From: Porter & Miller, 1985
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Continuous Replenishment: A Continuous Channel Process
Timely, accurate, paperless information flow
Smooth, continual product flow matched to consumption
Supplier Distributor Retail Store
Supplier receives daily demand information and ships based on actual sales demand from distributor warehouse to retail store
Supplier Distributor Retail Store
Traditional Grocery Channel Product and Information Flows using EDI
Weekly or less frequent order received based on price promotions or actual demand, with product shipments based on orders placed by stores and distributors up the value chain.
Orders
Actual Sales Data Actual Sales Data
JIT Shipments JIT Shipments
Orders
Products Products
Traditional and Continuous Replenishment Processes
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Manualdelivery(fax, mail)
Direct datalink (EDI)
Discrete &Variable
Continuous &Consistent
ORDERING PROCESS INNOVATIONS
TECHNOLOGICALINNOVATIONS
Traditional
TechnologyInnovation
ProcessInnovation
BusinessProcessRedesign
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Manualdelivery(fax, mail)
Direct datalink (EDI)
Discrete &Variable
Continuous &Consistent
ORDERING PROCESS INNOVATIONS
TECHNOLOGICALINNOVATIONS
EDI CRP
Traditional EDLCManual
CRP
HKUST Business School
Manualdelivery(fax, mail)
Direct datalink (EDI)
Discrete &Variable
Continuous &Consistent
ORDERING PROCESS INNOVATIONS
TE
CH
NO
LO
GIC
AL
INN
OV
AT
ION
S
EDI
Traditional EDLC
CRP
Manual CRP*
0-10% 0-10%
50-100% <0%
50-200%
50-200%
50-100%
Figure 12 - Performance Improvements from Innovations
* Manual CRP refers to using CRP processes and policies without using EDI for data transmission. Although technically possible, all attempts at using CRP without EDI have been terminated due to the high costs involved.
HKUST Business School
Redefining Interorganizational Linkages
BEFORE PROCESS CHANGE AFTER PROCESS CHANGE
Seller
Buyer
Customer Service Team
Category Manager
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Increasing Interdependencies: IT, Strategy, and Organizational Design
IT Infrastructure
and Applications
OrganizationalStructure and
Incentives
Business Strategy(and Resources)
Limits or Enables
Requires
Limits or Enables
Drives
Facilitate or Discourage
Redesign andEnhance
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Evolutionary versus Revolutionary Change: Conflicting Views Hammer & Champy advocated radical change
“Obliterate, don’t automate!” was their slogan BUT, P&G example most cited is EVOLUTIONARY!
Harvard Business School study of successful reengineering found that evolution dominated Study was REJECTED initially for publication This view has become more accepted as
reengineering itself has lost its zealots Punctuated Equilibrium Model of Change
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Success in Value Chain Transformation Value Chain Transformation is even harder
than BPR One factor associated with successful BPR is strong
support from CEO and top management However, a value chain involves several firms and
has NO SINGLE DECISION MAKER IN CHARGE! Thus, changing value-chain operations can be as
difficult as doing business within a JV in China. Value chain transformation requires new
business models and visionary leaders