Competitive Advantage PDF

BM2105 COMPETITIVE ADVANTAGE Porter's Generic Strategies (Jenkins & Williamson, 2016) Firms compete for sales revenue with other suppliers of goods and services. If a firm has a competitive advantage, its products are profitable and attractive to significant...

BM2105 COMPETITIVE ADVANTAGE Porter's Generic Strategies (Jenkins & Williamson, 2016) Firms compete for sales revenue with other suppliers of goods and services. If a firm has a competitive advantage, its products are profitable and attractive to significant buyers. A theory that can explain how sustainable competitive advantage is achieved would be the philosopher's stone of strategic management. The theories of Michael Porter offer a strong influence on this topic. Porter suggested that a firm can achieve an advantage through product differentiation or cost leadership. These two (2) sources of competitive advantage coupled with the scope of activities for which the firm seeks to achieve them lead to three (3) generic strategic positions: 1. A low-cost strategy over a broad target. 2. A differentiation strategy over a broad target. 3. A focus strategy involves either a low-cost strategy over a narrow target or a differentiation strategy over a narrow target. Porter represents these strategies, as shown in Figure 1. A crucial point in the concept of generic strategies is the need for a firm, which desires to achieve a competitive advantage to choose the type of competitive advantage it wishes to achieve. This is at the heart of Porter's argument, and to pursue his ideas, it is useful to examine his descriptions of each generic strategy. Figure 1. Generic strategic postures Source: Strategic management and business analysis, 2016, p. 89. The following are the features of the generic strategies: 1. Broad Cost Leadership Strategy. A cost leader must achieve parity or proximity based on differentiation relative to its competitors to be an above-average performer, even though it relies on cost leadership for its competitive advantage. Parity in the bases of differentiation allows a cost leader to translate its cost advantages directly into higher profits than competitors. Proximity in differentiation means that the price discount necessary to achieve an acceptable market share does not offset a cost leader's cost advantage. Hence, the cost leader earns above-average returns. The firm sets out to be the lowest-cost producer (of the industry-standard product): o The firm has a broad scope and serves many segments. 07 Handout 1 *Property of STI  [email protected] Page 1 of 8  BM2105 o Above-average profitability is achieved by the cost leader commanding prices at or near the industry average. o Proximity in differentiation. Porter also argues that in commodity industries, the cost leader gains above-average returns and those firms in the lower quartile of costs. If firms are price takers, any firm that can produce below- average costs will make above-average profits. 2. Broad Differentiation Strategy. Differentiation can be achieved in the product, its supply chain, and its marketing. Above-average profitability is achieved by differentiation that leads to a price premium greater than the cost of differentiating. A differentiator cannot ignore its cost position because an inferior cost position will nullify its premium prices. 3. Focus Strategy. This strategy requires the firm to focus on a narrow segment. It is appropriate when those firms following broad strategies do not cater to the needs of significant segments either based on cost or differentiation. For example, the specific segment may require a more differentiated product than the broad differentiator's (the product has a higher number of beneficial features or attributes). A segment may be prepared to forego some features on a broad cost leader’s product in some industries in exchange for a lower price. Porter claims that organizations need to make choices that avoid having strategies based neither on differentiation nor on cost leadership. The need for a distinct generic strategy and the dangers of being 'stuck in the middle is emphasized. A point of confusion is whether a firm is a cost leader or a differentiator or whether the products or services it offers are sold based on price or differentiation. A firm must commit its business units to one (1) generic strategy, and a unit with a multi-product offering should position each product similarly. The relationship between resources and their deployment and market positioning underlines the premise of incompatibility between cost-based and differentiation- based strategies. Thus, a firm that pursues a market position based on price can only make above-average profits if its resources are also committed to low cost. Equally, a differentiator is seemingly also committed to higher than average production costs to achieve differentiation but is rewarded for that differentiation by being able to command a higher price. Porter implicitly associates low-cost strategies with either average or near-average prices for broad cost leaders or below-average prices for focused cost leaders. Cost, Price, and Differentiation Relationships (Jenkins & Williamson, 2016) To discuss the relationship between cost, price, and differentiation, the products or services are described by three (3) variables: 1. Degree of differentiation. 2. Relative cost to the producer. 3. Relative price to the customer. For the sake of simplicity, several assumptions are made: The degree of differentiation is measured by the number of attributes of the product that give perceived customer benefits; the more perceived benefits the product has, the greater is its perceived value to the customer; the standard product or average product will have a standard range of benefits; the differentiated product will have more benefits. To identify some possible product positions, nine (9) combinations of price, cost, and differentiation (as beneficial attributes) are initially considered in the matrix shown in Table 1. To simplify the discussion, eight (8) cases where each of the three (3) variables takes two (2) values high and low, and have represented the standard product as one (1) with average price, average cost, and an average level of benefits are considered. 07 Handout 1 *Property of STI  [email protected] Page 2 of 8  BM2105 The relative level Relative Relative Identity Features of strategies proximate of perceived cost price letter to the positions benefits Differentiation strategies (fits Porter's High High High A description) High High Low B Unsustainable, internal costs too high Market differentiation with a cost High Low High C advantage Unsustainable, consumer unlikely to Low High High D choose over standard product Possible sustainable position for focus Low Low Low E cost leader. A broad cost leader would approach this position. Market differentiation with cost and High Low Low F price advantages Unsustainable; the consumer may Low High Low G choose under some circumstances; and too costly for a producer to sustain Low High Unsustainable, the standard product Low Average H Average Average Table 1. Possible strategic postures matrix Source: Strategic management and business analysis, 2016, p. 93. Low cost, low price, low benefits strategies: Positions proximate to E. Cost leadership strategies are usually associated with price-based competition. A price strategy based upon low cost requires firms to have lower than average costs, lower than average price, and the average level of benefits. Firms that charge average prices for an average product can only make above-average profits if their costs are lower. If average prices are charged, it is unlikely that more than the average market share will be achieved. If a firm wishes to achieve a relatively high market share using a price-based strategy, it will charge lower than average prices. Firms that charge lower than average prices for standard products will only make above-average profits if their costs are lower than average. A firm that reduces costs via innovative product and/or process designs can achieve lower product costs. High cost, high price, high benefits strategies: Positions proximate to A. To achieve differentiation, firms will incur costs, and thus their costs will be higher than average. Thus, both focused and broad differentiators will approximate to position A. The danger for differentiators is that they may get left behind if cost-based competitors increase product features as consumer expectations rise (consumer expectations are not static). Differentiated parts of the market risk becoming subsumed into larger segments that are more price competitive. Another danger is that in trying to maintain a differentiated position in a changing market, features that are not attractive to the segment may be mistakenly incorporated into the product to add cost without any perceived benefits. Positions that indicate both cost and differentiation dimensions: Positions proximate to C and F. Position C is market differentiation with relatively low costs and a relatively high price. Position F is market differentiation with relatively low costs and a relatively low price. These appear to be very attractive positions if they can be achieved profitably. Trying to achieve differentiation at low cost can lead to a “stuck in the middle position” by mistakenly marketing a product that exceeds the requirements of a cost leadership position but fails to meet the customer's needs with high benefit 07 Handout 1 *Property of STI  [email protected] Page 3 of 8  BM2105 requirements. However, an alternative perspective is also possible if a product with a high level of benefits is produced at a low cost because the firm has developed some skill and resource that has previously been unavailable, then two (2) possibilities exist: 1. The case where the skills and resources are imitable and transferable in some finite time. In this case, the innovator of the particular resource or skill could elect to achieve market share by using cost advantages to reduce prices and seek to change customer perceptions of the standard product. In this way, they attempt to establish a broad position based on the redefinition of both the standard product and the nature of the market. Then by the time competitors have been able to acquire the resources and skills required, the originator will have gained a position of advantage through the development of economies of scale. If economies of scale are not possible, the differentiator with a low-cost position could seek to distance itself from competitors by using superior profits to maintain advantages. This could be achieved by redeveloping the product to raise customer expectations through increased research and development and marketing. 2. The case when the skills and resources are not imitable. In this situation, the firm with this position can sustain profits unless demand for its product subsides. The firm also has the options outlined in the first scenario. Unsustainable positions: Positions proximate to B, D, G, and H. The following are the unsustainable positions that might work in the short-run but not in the long-run survival of the firm: o Position B: High benefits, high cost, low price. This is not an internally sustainable position though it may gain market share in the short term. o Position D: Low benefits, high cost, high price. This position is unlikely to gain any market share and is externally unsustainable. o Position G: Low benefits, high cost, low price. This position is unlikely to be internally sustainable or gain sustainable market share. o Position H: Low benefits, low cost, high price. This position is unlikely to gain market share but may move to a position proximate to E and adopt a focused cost leadership position by lowering the price. Competitive Advantage: A Market Perspective (Jenkins & Williamson, 2016) The ideal position for a firm is to be the only supplier in a specific market or segment. Firms seeking above- average profits would presumably wish to operate in an attractive segment where there is little competition but big enough to generate profitable sales. A market may be a commodity market like agricultural markets where few segments have appeared or the car market where several segments have appeared. In markets where segments exist, positioning by segment is possible. However, if more than one (1) competitor enters a segment, price-based competition can be fierce even amongst would-be differentiators. For example, the car industry is divided into several segments, and competition exists in each segment. In many markets, there are several products, each having features designed to appeal to particular segments. Users perceive these features to give them benefits. In the car market, products differ on several dimensions, such as engine size, comfort, body size, and brand perception. Each product has a price, and as Table 2 shows, they can differ considerably. Car make and type List price Perodua Nippa 323,680 Daewoo Matiz SE 5 door 461,650 Vauxhall Vectra 1.6 club 4 door 926,450 Ford Mondeo 1.8 L 4 door 1,025,150 07 Handout 1 *Property of STI  [email protected] Page 4 of 8  BM2105 Car make and type List price 8MW 520 4 door 1,647,800 Lexus GS 3.0 door auto 1,991,500 Mercedes SL500 2 door auto 4,825,800 Ferrari 360M Coupe Modena 2 door 7,227,360 *Note that the data was adopted from the UK and list prices are converted from pound to peso using a conversion rate of P70. Table 2. Selected car prices Source: Strategic management and business analysis, 2016, p. 97. The cars sold range from relatively high price luxury cars to relatively low-price small cars. However, the bulk of sales are generated by cars that are priced between P560,000 and P1,400,000 (see Table 3). Car Price range Units sold in 2001 Market share (%) Ford Focus 734,650 – 1,179,150 137,074 5.6 Vauxhall Astra 782,600 – 1,220,800 98,999 4.0 Ford Fiesta 613,200 – 710,500 98,221 4.0 Peugeot 206 559,650 – 1,133,650 97,887 4.0 Vauxhall Corsa 489,650 – 944,650 93,729 3.8 Ford Mondeo 1,025,150 – 1,501,150 86,559 3.5 Renault Clio 524,650 – 769,650 79,843 3.2 Renault Megane 722,750 – 1,012,900 73,577 3.0 Volkswagen Golf 750,050 – 1,513,400 67,099 2.7 Table 3. Best selling cars Source: Strategic management and business analysis, 2016, p. 97. The number of cars sold in 2001 was 2,458,769; the top 10 best-selling cars accounted for about 40 percent of sales. More expensive cars and lower-cost cars appeal to smaller segments. When trying to understand competition in a segment, it is useful to identify the product/service dimensions that form the basis of competition. Price may be critical in one (1) segment, benefits in another. In some segments, consumers are seeking a balance of price and benefits. Consider Figure 2. It can be hypothesized that customers in segments at the top right of the illustration are likely to be more benefits sensitive, and customers at the bottom left are more price sensitive. Products in the middle of these positions are likely to sell on some balance between benefits and price. However, all pricing decisions are best made with a knowledge of price elasticity. However, middle positioned products may differ like benefits they are offering, so several viable positions may be available as long as there are segments that have needs that match these benefits. Some positions may not match a segment and be “stuck in the middle.” Firms need to select market positions compatible with delivering a bundle of benefits that the consumer values. If suppliers compete in the segment offering the same benefits, they are reduced to competing on price. Working on the assumption that resource endowments are mobile, it can be argued that improvements in production techniques (i.e., using Total Quality Management, Just in Time inventory control and management, etc.) only deliver gains to consumers as competitors compete on price. So, a better strategy is to choose market positions based on offering a unique service or product. However, trade-offs are required; suppliers who try to offer a range of products giving a range of benefits at a range of prices are often doomed to failure as they try to meet the conflicting demands of different segments. 07 Handout 1 *Property of STI  [email protected] Page 5 of 8  BM2105 Figure 2. The impact of increasing price sensitivity Source: Strategic management and business analysis, 2016, p. 97. To avoid hyper-competition in segments where several competitors are pursuing similar generic strategies, Porter indicates three (3) distinct strategic positions: 1. Variety-based positioning. This occurs when a competitor offers a sub-set of services used by a broad range of segments. For example, Pru Life UK specializes in investment-linked life insurance with a wide selection of funds. Big corporations now offer life insurance benefits to their employees in the form of incentive bonuses which makes the product of Pru Life essential to a broad range of segments. 2. Needs-based positioning. This involves focusing on all the needs of a particular segment. The example Porter gives is IKEA, which meets all the needs of their identified segment for home furnishings at a reasonable price. 3. Access-based positioning. This focuses on specific customer segments that are accessible in a different way. For example, Pacific Mall strategically locates its shopping establishments in Philippine provinces to avoid competition in highly concentrated areas, such as Metro Manila. Competitive Advantage: A Resource Perspective (Jenkins & Williamson, 2016) In this approach, market positions may be imitable, but the most efficient organizations will have lower costs for all market positions. Definitions of resources and capabilities can be regarded as the assets and skills available to the firm. The resource-based perspective requires three (3) criteria: 1. Heterogeneity of resources across firms. This means that unless there are differences between firms' resources, there cannot be differences in their profitability. 2. The acquisition price of assets allows for future profits. Resources have to be acquired at a price below their discounted net present value to yield profits. Otherwise, future profits will be fully absorbed in the price paid for the resource. 3. Difficulty to imitate or substitute profit-yielding resources. Some resources such as loyalty, tacit knowledge, and relationships are developed over time and are built progressively. Trying to compress these activities into shorter periods under different conditions can prove to be unfruitful. 07 Handout 1 *Property of STI  [email protected] Page 6 of 8  BM2105 There are five (5) mechanisms at work that make it difficult for competitors to copy sources of competitive advantage. These are: o Time compression diseconomies. This occurs when a firm tries to learn quickly something that took a rival much longer to learn; or builds trust and loyalty with skeptical dealers, employees, or customers. o Asset mass efficiencies (the marginal cost of an asset falls as its level increases. This occurs when firms have high knowledge and experience in implementing their processes. This is also seen as an evolutionary process subject to trial and error, uncertainty, and learning by mistakes. o Interconnectedness of complementary assets (marginal cost falls as levels of complementary assets increase). This occurs when employees' creativity depends on how a firm is organized and on its management style. Core competence is an integrated bundle of skills and technologies that are unlikely to reside in one (1) person or team. Building a core competence involves cumulative organizational learning that is difficult to time-compress. It may also require generalists sympathetic to other disciplines because a core competence frequently requires integration across several of the firm's activities. o Erosion of assets. This occurs when existing stocks of a firm’s assets are slowly eroded or worn. o Causal ambiguity. This occurs when a firm has an uncertain knowledge of how to imitate an asset. Since resources can be accumulated over time, it may be impossible for competitors to specify which factors and their role in the accumulation process. The practical value of a resource-based perspective is that it enables managers to understand, preserve, or extend their competitive advantage (with the strategic implications being dependent on the firm's specific resource endowment). If, however, managers do not understand the resource basis of their competitive advantage, there is a danger that they are unable to develop a strategy effectively. When trying to understand how resources support advantage, it is therefore useful to first identify the organization's competencies to provide its products and services. It is also useful to ascertain whether this organization's competencies are distinctly different from its competitors and how this difference allows it to achieve an advantage in the marketplace. There must be at least an advantage in price at the same benefits level or an advantage in benefits at the same price. It must be remembered that the internal competencies of a firm are only sources of advantage when they deliver that advantage in the marketplace. An analysis of competitive advantage requires understanding both a firm's market position (external capability) and its resources (internal capability). Strategy makers must understand both aspects of strategy. The internal problem is the potential inability to understand what the sources of advantage are. In this situation, there is a danger that managers may undertake actions that destroy advantage delivering competencies. The external problem is that managers will respond to external events without a deep understanding of the historical reasons for success and hence a lack of understanding of the current requirements of success. Key Success Factors (Jenkins & Williamson, 2016) In industry, all successful firms must do the following: Develop/acquire competencies and resources that allow them to meet the needs of their customers. Identify and occupy an attractive market position and meet the needs of a significant segment. Different markets have different critical (key) success factors. A potential problem for corporate managers is that an understanding of essential success factors in one industry may lead them to believe that the 07 Handout 1 *Property of STI  [email protected] Page 7 of 8  BM2105 same success factors apply elsewhere. The concept of critical success factors is familiar to most managers. In every business, certain activities or issues are critical to performance and the creation of competitive advantage. However, success factors differ among and even within industries. A competence in consumer marketing is therefore important for food suppliers who sell under their brand. Still, competence in business-to-business marketing is important for manufacturers who make own-label brands for supermarkets. However, firms may sometimes change the game's rules, and key success factors may change - consider the revolution in cheap air travel instigated by companies like EasyJet. Nevertheless, some factors remain important, airlines always need to fill aircraft, but they can change aircraft size. Reference: Jenkins, W. & Williamson, D. (2016). Strategic management and business analysis (2nd ed.). Routledge. 07 Handout 1 *Property of STI  [email protected] Page 8 of 8