The Nature and Sources of Competitive Advantage

OUTLINE
The emergence of competitive advantage Sustaining competitive advantage Competitive advantage in different market settings Types of competitive advantage: cost and differentiation

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

The Emergence of Competitive Advantage

How does competitive advantage emerge?

External sources of change 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 firms have greater creative and innovative capability

(Time-based competition)

Competitive Advantage from InternallyGenerated 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. Toyotas 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.-- Nikes system for manufacturing and distributing shoes totally different from traditional shoe manufacturer Southwest Airlines simplification of the normal airline value chain Zaras system of design, manufacture, and distribution

Sustaining Competitive Advantage Against Imitation

REQUIREMENT FOR IMITATION Identification

ISOLATING MECHANISM - Obscure superior performance - Deterrence--signal aggressive intentions to imitators - Pre-emption--exploit all available investment opportunities - Rely upon multiple sources of competitive advantage to create causal ambiguity

Incentives for imitation

Diagnosis

Resource acquisition

- Base competitive advantage upon resources and capabilities that are immobile and difficult to replicate

Competitive Advantage in Different Industry Settings: Trading Markets and Production Markets
SOURCE OF IMPERFECT COMPETITION None (efficient markets) Imperfect information Transactions costs Systematic behavioral trends Overshooting OPPORTUNITY FOR COMPETITIVE ADVANTAGE None Insider trading Cost minimization Superior diagnosis (e.g. chart analysis) Contrarianism 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

TRADING MARKETS

Barriers to imitation PRODUCTION MARKETS Barriers to innovation

Sources of Competitive Advantage

COST ADVANTAGE COMPETITIVE ADVANTAGE DIFFERENTIATION ADVANTAGE

Concept of stuck in the middle

Porters Generic Strategies

SOURCE OF COMPETITIVE ADVANTAGE Low cost Differentiation Industry-wide COMPETITIVE SCOPE Single Segment FOCUS COST LEADERSHIP DIFFERENTIATION

Features of Cost Leadership and Differentiation Strategies

Generic strategy COST LEADERSHIP Key strategy elements
Scale-efficient plants. Design for manufacture. Control of overheads & R&D. Avoidance of marginal customer accounts.

Resource & organizational requirements

Access to capital. Process engineering skills. Frequent reports. Tight cost control. Specialization of jobs and functions. Incentives for quantitative targets.

DIFFERENTIATION

Emphasis on branding and brand advertising, design, service, and quality.

Marketing. Product engineering. Creativity. Product R&D Qualitative measurement and incentives. Strong cross-functional coordination.

Cost Advantage
OUTLINE
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

The Experience Curve

The Law of Experience

1992 1994
Cost per unit of output (in real $)

The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles.

1996 1998 2000 2002 2004

Cumulative Output

Examples of Experience Curves

Japanese clocks & watches, 1962-72

1960 Yen 15K 20K 30K Price Index 50 100 200 300

UK refrigerators, 1957-71

75%

70% slope

100K 200K 500K 1,000K Accumulated unit production (millions)

10 50 Accumulated units (millions)

The 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:

ROS (%) -2 0 5

10 0-10

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

over 40

BUT: - Association does not imply causation - Costs of acquiring market share offset the returns to market share

Drivers of Cost Advantage

ECONOMIES OF SCALE Indivisibilities Specialization and division of labor Increased dexterity Improved organizational routines Process innovation Reengineering business processes Standardizing designs & components Design for manufacture Location advantages Ownership of low-cost inputs Non-union labor Bargaining power Ratio of fixed to variable costs Speed of capacity adjustment Organizational slack; Motivation & culture; Managerial efficiency

ECONOMIES OF LEARNING

PRODUCTION TECHNIQUES

PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

RESIDUAL EFFICIENCY

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

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

Cost per unit of output

Minimum Efficient Plant Size: the point where most scale economies are exhausted

Units of output per period

The Costs Developing New Car Models

(including plant tooling)

$ billion
Ford Mondeo / Contour GM Saturn Ford Taurus (1996 model) Ford Escort (new model 1996) Renault Clio (1999 model) Chrysler Neon Honda Accord (1997 model) BMW Mini Rolls Royce Phantom (2003 model) 6 5 2.8 2 1.3 1.3 0.6 0.5 0.3

Scale Economies in Advertising: U.S. Soft Drinks

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.
Advertising Expenditure ($ per case) 0.20 0.15 0.10 0.05 0.02

Schweppe s SF Dr. Pepper Diet 7-Up

Tab Diet Pepsi

Diet Rite Fresca Seven Up

Sprite

Dr. Pepper Pepsi

Coke
1,000

10

20

50

100

200

500

Annual sales volume (millions of cases)

Cost Advantage in Short-Haul Passenger Air Transport

Costs per Available Seat-Mile
Southwest Airlines (cents) Wages and benefits 2.4 Fuel and oil 1.1 Aircraft ownership 0.7 Aircraft maintenance 0.6 Commissions on ticket sales 0.5 Advertising 0.2 Food and beverage 0.0 Other 1.7 Total 7.2 United Airlines (cents) 3.5 1.1 0.8 0.3 1.0 0.2 0.5 3.1 10.5

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

STAGE 1. IDENTIFY THE PRINCIPAL ACTIVITIES

PURCHASING

PARTS INVENTORIES

R&D TESTING, COMPONENT ASSEMBLY DESIGN QUALITY MFR ENGNRNG CONTROL

GOODS INVENTORIES

SALES DISTRI- DEALER & & BUTION CUSTOMER MKITG SUPPORT

STAGE 2. ALLOCATE TOTAL COSTS

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)
STAGE 3. IDENTIFY COST DRIVERS
--Plant scale for each component -- Process technology -- Plant location -- Run length -- Capacity utilization -- Level of quality targets -- Frequency of defects -- No. of dealers -- Sales / dealer -- Level of dealer support -- Frequency of defects under warranty

PURCHASING

PARTS INVENTORIES

R&D COMPONENT ASSEMBLY TESTING, DESIGN QUALITY MFR ENGNRNG CONTROL

GOODS INVENTORIES

SALES & MKITG

DISTRI- DEALER & BUTION CUSTOMER SUPPORT

Prices paid --Size of commitment depend on: --Productivity of -- Order size R&D/design --Purchases per --No. & frequency of new supplier models -- Bargaining power -- Supplier location

-- Plant scale -- Flexibility of production -- No. of models per plant -- Degree of automation -- Sales / model -- Wage levels -- Capacity utilization

--Cyclicality & predictability of sales --Customers willingness to wait

Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture (continued)
STAGE 4. IDENTIFY LINKAGES

Consolidation of orders to increase discounts, increases inventories

Designing different models around common components and platforms reduces manufacturing costs

PRCHSNG

PARTS INVNTRS

R&D DESIGN

COMPONENT MFR

ASSEMBLY

TESTING GOODS QUALITY INV

SALES DSTRBTN DLR MKTG CTMR

Higher quality parts and materials reduces costs of defects at later stages

Higher quality in manufacturing reduces warranty costs

STAGE 5. RECCOMENDATIONS FOR COST REDUCTION

Dynamic vs. Static Approaches to Manufacturing

DYNAMIC (Artisan Mode)
problem solving people matched to tasks create employee knowledge employees control production customer orientation continuous, incremental improvement market needs pull technology product and process innovation teamwork and crossfunctional collaboration

STATIC (Scientific Management Mode)

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

PRODUCTION SYSTEM

MANAGEMENT OF TECHNOLOGY

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

Recent Approaches to Cost Reduction

Dramatic changes in strategy and structure to adjust to the business conditions of the 1990s Key elements: Plant closures Outsourcing Delayering and cuts in administrative staff The fundamental rethinking and radical redesign of business processes to achieve dynamic 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

CORPORATE RESTRUCTURING

BUSINESS PROCESS REENGINEERING

Obliterate dont automate

Harley Davidson Case

Identify Harley-Davidsons strategy and explain its rationale. Compare Harley-Davidsons resources and capabilities with those of Honda. What does your analysis imply for Harleys 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?