The Nature and Sources of Competitive Advantage

The Nature and Sources of Competitive Advantage

• The emergence of competitive advantage• Sustaining competitive advantage• Competitive advantage in different market

settings• Types of competitive advantage: cost and

differentiation

OUTLINE

What is competitive advantage?

• The potential to earn a persistently high rate of profit

• Not the same as profitability– Long term investments may not show up in

short term profits• Investing in market share, technology, customer

loyalty or even executive perks

How does competitive advantage emerge?

External sources ofchange e.g.:•Changing customer demand•Changing prices•Technological change

Internal sources of change

Resource heterogeneity among firms means differential impact

Some firms faster and more effective

in exploiting change

Some firmshave greater creative

and innovativecapability

The Emergence of Competitive AdvantageThe Emergence of Competitive Advantage

(Time-based competition)

Competitive Advantage from Internally-Generated Change: Strategic Innovation

Competitive Advantage from Internally-Generated Change: Strategic Innovation

• Many argue innovation is the only remaining source of competitive advantage (e.g. Hamel)

– Kao (2007) Innovation Nation: How America is Losing its Innovation Edge, Friedman (2005) The World is Flat

• Talent is everywhere, capital is everywhere, Silicon valley is everywhere

Characteristics of innovation strategies:– Associated with new entrants to an industry (e.g. Nucor in steel,

IKEA in furniture, Home Depot in DIY, Dell in PCs, American Apparel in casual clothing)

– Reconcile conflicting performance goals (e.g. Toyota’s lean production system combines low cost, high quality, and flexibility. Retailers Primark and Target combine low cost with stylishness.)

– Reconfiguring the value chain e.g.---• Nike’s system for manufacturing and distributing shoes totally different from

traditional shoe manufacturer• Southwest Airlines simplification of the normal airline value chain• Zara’s system of design, manufacture, and distribution

REQUIREMENT FOR IMITATION

Identification - Obscure superior performance

- Deterrence--signal aggressiveIncentives for imitation intentions to imitators

- Pre-emption--exploit all available investment opportunities

- Rely upon multiple sources of Diagnosis competitive advantage to create

“causal ambiguity”

- Base competitive advantage upon Resource acquisition resources and capabilities that are

immobile and difficult to replicate

ISOLATING MECHANISM

Sustaining Competitive Advantage Against ImitationSustaining Competitive Advantage Against Imitation

TRADING MARKETS

• None (efficient markets)• Imperfect information• Transactions costs• Systematic behavioral trends

• Overshooting

NoneInsider tradingCost minimizationSuperior diagnosis(e.g. chart analysis)Contrarianism

PRODUCTION MARKETS

• Barriers to imitation

• Barriers to innovation

Identify potential barriers to imitation (e.g. deterrence, preemption, causal ambiguity, resource immobility, etc.) & base strategy upon them.

Difficult to influence or exploit.

MARKET TYPE

SOURCE OF IMPERFECT

COMPETITION

OPPORTUNITY FOR COMPETITIVE

ADVANTAGE

Competitive Advantage in Different Industry Settings: Trading Markets and Production Markets

Competitive Advantage in Different Industry Settings: Trading Markets and Production Markets

Sources of Competitive AdvantageSources of Competitive Advantage

COST ADVANTAGE

COST ADVANTAGE

DIFFERENTIATIONADVANTAGE

DIFFERENTIATIONADVANTAGE

COMPETITIVEADVANTAGE

COMPETITIVEADVANTAGE

Similar product

at lower cost

Price premium

from unique product

Concept of “stuck in the middle”

Porter’s Generic StrategiesPorter’s Generic Strategies

SOURCE OF COMPETITIVE ADVANTAGE

Low cost Differentiation

Industry-wide COST DIFFERENTIATION

COMPETITIVE LEADERSHIP

SCOPE

Single Segment F O C U S

Features of Cost Leadership and Differentiation Strategies

Features of Cost Leadership and Differentiation Strategies

Generic strategy Key strategy elements Resource & organizational requirements

COST Scale-efficient plants. Access to capital. Process

LEADERSHIP Design for manufacture. engineering skills. Frequent

Control of overheads & reports. Tight cost control.

R&D. Avoidance of Specialization of jobs and

marginal customer functions. Incentives for accounts. quantitative targets.

DIFFERENTIATION Emphasis on branding Marketing. Product and brand advertising, engineering. Creativity. design, service, and Product R&D quality. Qualitative measurement

and incentives. Strong cross-functional

coordination.

Cost AdvantageCost Advantage

• Economies of experience curve and the benefits of market share

• Sources of cost advantage

• Using the value chain to analyze costs

• Current approaches to managing costs

OUTLINE

The Experience CurveThe Experience Curve

The “Law of Experience”

The unit cost value added to a standard product declines by a constant % (typically 20-

30%) each time cumulative output doubles.

Cost per unit of

output (in real $)

Cumulative Output

1992

1994

1996

1998

20002002 2004

Examples of Experience CurvesExamples of Experience Curves

100K 200K 500K 1,000K 5 10 50 Accumulated unit production Accumulated units

(millions) (millions)

1960

Yen

15K

20K

30

K

Pri

ce In

dex

50

100

20

0 3

00

70% slope

75%

Japanese clocks & watches, 1962-72 UK refrigerators, 1957-71

The Importance of Market ShareThe Importance of Market Share

If all firms in an industry have the same experience curve, then:

Change in relative costs over time = f (relative market share)

This implies that market share is linked to profitability. This is confirmed by PIMS data:

BUT: - Association does not imply causation

- Costs of acquiring market share offset the returns to market share

RO

S (

%)

-2

0 5

10

0-10 10-20 20-30 30-40 over 40Market Share (%)

Drivers of Cost AdvantageDrivers of Cost Advantage

PRODUCTION TECHNIQUES

PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

RESIDUAL EFFICIENCY

ECONOMIES OF LEARNING

ECONOMIES OF SCALE

• Organizational slack; Motivation & culture; Managerial efficiency

• Ratio of fixed to variable costs• Speed of capacity adjustment

• Location advantages• Ownership of low-cost inputs • Non-union labor• Bargaining power

• Standardizing designs & components• Design for manufacture

• Process innovation• Reengineering business processes

• Increased dexterity• Improved organizational routines

• Indivisibilities• Specialization and division of labor

Economies of Scale: The Long-Run Cost Curve for a Plant

Economies of Scale: The Long-Run Cost Curve for a Plant

Units of outputper period

MinimumEfficient Plant Size: the point

where most scale economies

are exhausted

Cost perunit ofoutput

Sources of scale economies:- technical input/output relationships- indivisibilities- specialization

The Costs Developing New Car Models (including plant tooling)

The Costs Developing New Car Models (including plant tooling)

$ billion

Ford Mondeo / Contour 6

GM Saturn 5

Ford Taurus (1996 model) 2.8

Ford Escort (new model 1996) 2

Renault Clio (1999 model) 1.3

Chrysler Neon 1.3

Honda Accord (1997 model) 0.6

BMW Mini 0.5

Rolls Royce Phantom (2003 model) 0.3

10 20 50 100 200 500 1,000

Annual sales volume (millions of cases)

Ad

vert

isin

g E

xpen

dit

ure

($

pe

r ca

se)

0.02

0

.05

0.

10

0.1

5

0.20

CokePepsi

Seven Up

Dr. PepperSprite

Diet PepsiTab

FrescaDiet Rite

Diet 7-Up

Schweppes SF Dr. Pepper

Despite the massive advertising budgets of brand leaders Coke and Pepsi, their main brands incur lower advertising costs per unit of sales than their smaller rivals.

Scale Economies in Advertising: U.S. Soft DrinksScale Economies in Advertising: U.S. Soft Drinks

Cost Advantage in Short-Haul Passenger Air Transport

Cost Advantage in Short-Haul Passenger Air Transport

Costs per Available Seat-Mile

Southwest Airlines United Airlines (cents) (cents)

Wages and benefits 2.4 3.5

Fuel and oil 1.1 1.1

Aircraft ownership 0.7 0.8

Aircraft maintenance 0.6 0.3

Commissions on ticket sales 0.5 1.0

Advertising 0.2 0.2

Food and beverage 0.0 0.5

Other 1.7 3.1

Total 7.2 10.5

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture

STAGE 1. IDENTIFY THE PRINCIPAL ACTIVITIES

STAGE 2. ALLOCATE TOTAL COSTS

PURCH-ASING

PARTSINVEN-TORIES

R&DDESIGN

ENGNRNG

COMPONENTMFR

ASSEMBLYTESTING,QUALITY

CONTROL

GOODSINVEN-TORIES

SALES &

MKITG

DISTRI-BUTION

DEALER &CUSTOMERSUPPORT

PURCH-ASING

PARTSINVEN-TORIES

R&DDESIGN

ENGNRNG

COMPONENTMFR

ASSEMBLYTESTING,QUALITY

CONTROL

GOODSINVEN-TORIES

SALES&

MKITG

DISTRI-BUTION

DEALER &CUSTOMERSUPPORT

--Plant scale for each -- Level of quality targets -- No. of dealers component -- Frequency of defects -- Sales / dealer

-- Process technology -- Level of dealer -- Plant location support -- Run length -- Frequency of

defects -- Capacity utilization under warranty

Prices paid --Size of commitment -- Plant scale --Cyclicality &depend on: --Productivity of -- Flexibility of production predictability of sales-- Order size R&D/design -- No. of models per plant --Customers’--Purchases per --No. & frequency of new -- Degree of automation willingness to wait supplier models -- Sales / model -- Bargaining power -- Wage levels-- Supplier location -- Capacity utilization

STAGE 3. IDENTIFY COST DRIVERS

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)

PRCHSNG PARTS R&D COMPONENT ASSEM- TESTING GOODS SALES DSTRBTN DLR

INVNTRS DESIGN MFR BLY QUALITY INV MKTG CTMR

Consolidation of orders to increasediscounts, increases inventories

Designing different models aroundcommon components and platforms

reduces manufacturing costs

Higher quality parts and materialsreduces costs of defects

at later stages

Higher quality in manufacturingreduces warranty costs

STAGE 5. RECCOMENDATIONS FOR COST REDUCTION

STAGE 4. IDENTIFY LINKAGES

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)

Dynamic vs. Static Approaches to Manufacturing

Dynamic vs. Static Approaches to Manufacturing

PRODUCTIONSYSTEM

MANAGEMENTOF

TECHNOLOGY

DYNAMIC(Artisan Mode)

STATIC(Scientific

Management Mode)

problem solving people matched to tasks create employee knowledge employees control production customer orientation

quest for “one best way” planning & control by staff Incentives and penalties to ensure conformity to objectives

science driven focused around corporate R&D departments emphasis on big projects

continuous, incremental improvement market needs pull technology product and process innovation teamwork and cross- functional collaboration

Recent Approaches to Cost ReductionRecent Approaches to Cost Reduction

Dramatic changes in strategy and structureto adjust to the business conditions of the 1990’sKey elements:• Plant closures• Outsourcing• Delayering and cuts in administrative staff

The fundamental rethinking and radicalredesign of business processes to achievedynamic improvements in performance. e.g.:-• Several jobs combined into one • Steps of a process combined in natural order• Minimizing steps, controls, and reconciliation• Use case managers as single points of contact• Hybrid centralization/ decentralization

CORPORATERESTRUCTURING

BUSINESSPROCESS

REENGINEERING

“Obliterate don’t automate”

Harley Davidson Case

• Identify Harley-Davidson’s strategy and explain its rationale.

• Compare Harley-Davidson’s resources and capabilities with those of Honda. What does your analysis imply for

• Harley’s potential to establish cost and differentiation advantage over Honda?

• What threats to continued success does Harley-Davidson face?

• How can Harley-Davidson sustain and enhance its competitive position?