Unit 4: Sustaining Competitive Advantage PDF

Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable?...

Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 1 Sustaining competitive advantage: Why do some companies last and others do not? Introduction Some companies sustain competitive advantage: E.g., Coca-Cola, Moleskine, Zara, Netflix, or Amazon Some companies fail to sustain competitive advantage: E.g., Yahoo, Terra, Compaq, Blackberry, or Nokia Core question we’ve answered so far: Why do some companies enjoy a competitive advantage (higher economic returns than their industry rivals)? New focus: Why do some companies sustain their competitive advantage consistently over time? 2 Let's start by looking at the battle for package delivery dominance (FedEx vs. UPS) Example Federal Express (FedEx) created the overnight package delivery service in 1973, when it began service in 25 U.S. cities. For the better part of a decade, FedEx nearly monopolized the business, and the company’s name became synonymous with overnight delivery. The success of FedEx caught the attention of UPS, the nation’s leading “longer-than- overnight” package delivery service. In the early 1980s, UPS launched its own overnight service. Unfamiliar with what it took to deliver parcels overnight, UPS decided to learn from the market leader. UPS studied FedEx procedures for taking orders, scheduling, and delivering shipments. UPS even had its drivers follow FedEx trucks to learn their methods. By 1985, UPS was able to match FedEx’s nationwide overnight service offerings and within a few years was also matching FedEx for reliability. UPS gradually won business from FedEx. Moreover, by taking advantage of the scale economies afforded by its existing fleet of delivery trucks, UPS could deliver overnight parcels at a lower cost than FedEx and enjoyed a substantially higher profit margin. FedEx responded by developing a ground delivery service of its own. https://www.youtube.com/watch?v=b6h2yhRdIg4 3 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 4 Competitive forces reduce profitability over time Effect of competitive forces on profitability Economic profits tend to zero over time: The entry of new competitors, imitation of successful strategies, and price competition reduce economic profits. New technologies, products, and innovative business practices continuously reshape industries. Pressure on Return on Assets (ROA): Competitive forces drive ROA to align with the cost of capital, diminishing excess returns. In the short term, good performance may result from luck rather than sustainable advantages. Over time, even high-performing firms typically see their profits converge towards the industry average. 5 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 6 Mueller shows how profitability persists in the short term but regresses to the mean in the long term The persistence of profitability in Mueller’s sample Mueller’s findings indicate that there are some forces that push markets towards the competitive rate of return and other forces that impede that dynamic. As a result, there remains a persistent gap in ROA between firms that begin with high profitability and those with low profitability. 7 Profitability persists in the short term but tends to decline to the industry average over time due to competition and market forces The persistence of profitability in Mueller’s sample Key findings: o Short-term persistence: Profits tend to persist in the short run due to factors like barriers to entry, firm-specific advantages, and market power. o Long-term decline: Over time, profitability regresses towards the mean due to competition, innovation, and market forces. o Variation across industries: Industries with high barriers to entry or less competition showed greater persistence in profits. Implications: o Competitive forces drive long-term profitability to average levels. o Firm strategies and industry characteristics affect the rate of profit decline. 8 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 9 Competitive advantage is sustainable when it persists despite competitors’ efforts to neutralize it Sustaining competitive advantage (i) Competitive advantage is sustainable if it persists despite competitors’ efforts to duplicate it or neutralize it. Resource based theory of the firm explains sustained competitive advantage in terms of heterogeneity in resources and capabilities. To support competitive advantage, resources and capabilities have to be: o Scarce o Imperfectly mobile o Unavailable in the open market Sustainability can occur in two ways: o Firms may differ with respect to resources and capabilities, and the differences persist. o Isolating mechanisms, analogous to barriers to entry, may work to protect the competitive advantage of firms. 10 Here are the different sources of sustainable competitive advantage Sustaining competitive advantage (i) 11 Let's explain the sources of sustainable competitive advantage Sustaining competitive advantage (i) Brand Loyalty is driven by the strength of the brand (Disney), design (Apple), products (Gillette), and loyalty programs (Target REDcard). Location in the form of prime physical locations for the given customer segments (Starbucks) or the sheer number of locations (7 Eleven). Scale over competitors that helps drive down costs and pricing, given leverage with purchasing (Walmart), volume production (Samsung), marketing (Coca-Cola), fixed costs (Costco), and partners (AT&T). Intellectual Property in the form of proprietary formulas (drug companies), processes (Toyota), and patents (Priceline). 12 Let's explain the sources of sustainable competitive advantage Sustaining competitive advantage (i) Innovation based on constant uniqueness and novel use of technology (Google) and design (Dyson). Proprietary Information, which can be in the form of knowledge (Glaxo Smith drug research), process (Tesla battery manufacturing), customer (Amazon purchase history), and many other types. Network Effects where the value of the product or service increases with the number of users or products. Typical of social (Facebook), technology (Salesforce.com), and market-based (Ebay) business models. Locked-up Supply happens when few or no alternatives exist for a product or service (De Beers Diamonds). Nike has developed all of the sources of sustainable competitive advantage in becoming the $35 billion leader in the athletic apparel, footwear, and equipment market. 13 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 14 The resource-based theory links competitive advantage to the firm’s unique internal resources and capabilities Resource-based theory of the firm 15 Now you have to identify the sources of sustainable competitive advantage of Nike Exercise “Our goal is to continually produce new and better shoes which will aid performance and reduce or eliminate injury. Today, Nike shoes have a reputation as being among the most technically innovative shoes on the market; a reputation that has been earned through an ongoing commitment to product research, development and evaluation.” Nike took the first athlete partnership with Steve Prefontaine and utilized it as a blueprint to incubate and amplify new products into huge brands, like Nike’s multi-billion-dollar Jordan and Tiger brands, along with many others. Nike has invested in their own network of scouts and partners who assess the global supply pipeline of up- and-coming athletes across almost every sport, which they are quick to sign as the prodigies mature to the professional ranks. 16 Now you have to identify the sources of sustainable competitive advantage of Nike Exercise Nike sells over 1 million shoes per day, along with countless other millions of units in apparel, socks, equipment, and accessories. The scale of Nike’s manufacturing operations is impressive with over 700 factories, in over 40 countries, employing over 1 million people. In 2017, the U.S. Patent Office issued Nike 1,213 patents, 21 times the number for Under Armour and even almost double the number for Facebook. Most people don’t equate Nike with intellectual property (IP), but, since their first patent in 1984, they have been steadily ramping up their efforts. Nike made sure to capitalize on location as a competitive advantage, locking up premier retail real estate on Michigan Avenue in Chicago, Union Square in San Francisco, and about every other prime location in the top 50 cities in the world. Nike now has over 750 stores, with an average of over $8 million in sales per store. 17 Now you have to identify the sources of sustainable competitive advantage of Nike Exercise Nike launched their Digital Sport Division which helped launch Nike+ which pairs sensors in Nike shoes with mobile apps, and FuelBand, which tracks your rate of activity and health statistics. Over the next few years, we’ll be seeing a full out battle of innovations from Nike and others in creating and harnessing data sets of the body to help us understand and make better decisions about our health, activity, nutrition, sleep, and behavior. This is arguably Nike’s weakest source of competitive advantage, but they are expected to improve it over time. They keep on coming out with new social features on the Nike+ RunClub app. With NikeiD, you can share your designs with friends. 18 Here is the solution for the exercise about Nike Solution for the exercise “Our goal is to continually produce new and better shoes which will aid performance and reduce or eliminate injury. Today, Nike shoes have a reputation as being among the most technically innovative shoes on the market; a reputation that has been earned through an ongoing commitment to product research, development and evaluation.” CONTINUOUS INNOVATION Nike took the first athlete partnership with Steve Prefontaine and utilized it as a blueprint to incubate and amplify new products into huge brands, like Nike’s multi-billion-dollar Jordan and Tiger brands, along with many others. A STRONG BRAND Nike has invested in their own network of scouts and partners who assess the global supply pipeline of up- and-coming athletes across almost every sport, which they are quick to sign as the prodigies mature to the professional ranks. LOCKED-UP SUPPLY 19 Here is the solution for the exercise about Nike Solution for the exercise Nike sells over 1 million shoes per day, along with countless other millions of units in apparel, socks, equipment, and accessories. The scale of Nike’s manufacturing operations is impressive with over 700 factories, in over 40 countries, employing over 1 million people. SCALE In 2017, the U.S. Patent Office issued Nike 1,213 patents, 21 times the number for Under Armour and even almost double the number for Facebook. Most people don’t equate Nike with intellectual property (IP), but, since their first patent in 1984, they have been steadily ramping up their efforts. INTELLECTUAL PROPERTY Nike made sure to capitalize on location as a competitive advantage, locking up premier retail real estate on Michigan Avenue in Chicago, Union Square in San Francisco, and about every other prime location in the top 50 cities in the world. Nike now has over 750 stores, with an average of over $8 million in sales per store. LOCATION 20 Here is the solution for the exercise about Nike Solution for the exercise Nike launched their Digital Sport Division which helped launch Nike+ which pairs sensors in Nike shoes with mobile apps, and FuelBand, which tracks your rate of activity and health statistics. Over the next few years, we’ll be seeing a full out battle of innovations from Nike and others in creating and harnessing data sets of the body to help us understand and make better decisions about our health, activity, nutrition, sleep, and behavior. PROPRIETARY INFORMATION This is arguably Nike’s weakest source of competitive advantage, but they are expected to improve it over time. They keep on coming out with new social features on the Nike+ RunClub app. With NikeiD, you can share your designs with friends. NETWORK EFFECT 21 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 22 The resource-based view explains competitive advantage as an interplay between demand, scarcity, and appropriability What makes a resource valuable? The resource-based view: Interplay of three fundamental market forces: o Demand: Does it meet customers’ needs, and is it competitively superior? o Scarcity: Is it imitable or substitutable, and is it durable? o Appropriability: Who owns the profits? Appropriability Scarcity Demand Value creation zone 23 Five tests determine if a resource provides a sustainable competitive advantage What makes a resource valuable? The five tests translate these general economic requirements into specific, actionable terms: o Inimitability: Can the resource or capability be easily replicated by competitors? o Durability: How long will the resource or capability provide an advantage? o Appropriability: Who captures the value—company or other stakeholders? o Substitutability: Can a different resource achieve the same outcome? o Competitive superiority: Does it provide a sustainable edge over competitors? 24 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 25 Sustaining competitive advantage depends on barriers to imitation and isolating mechanisms Sustaining competitive advantage (ii) The speed with which competitive advantage is undermined depends on the ability of competitors to challenge (imitation or innovation). Sustaining competitive advantage ➔ barriers to imitation The process of competitive imitation has four conditions: o Identification: Identify that a rival possesses a competitive advantage. o Incentives for imitation: Have an incentive to imitate it. o Diagnosis: Be able to diagnose the sources of your rivals’ competitive advantage. o Resource acquisition: Be in a position to acquire the resources and capabilities necessary for imitation. Company holding the advantage ➔ isolating mechanisms to prevent imitation. 26 Unit 4: Sustaining competitive advantage Agenda 4.1. Introduction 4.2. Effect of competitive forces on profitability 4.3. The persistence of profitability in Mueller’s sample 4.4. Sustaining competitive advantage (i) 4.5. Resource-based theory of the firm 4.6. What makes a resource valuable? 4.7. Sustaining competitive advantage (ii) 4.8. Isolating mechanisms Dr. Juan Carlos Rivera-Prieto, MBA 27 Isolating mechanisms limit the rivals from eroding a firm’s competitive advantage Isolating mechanisms Isolating mechanisms are to firms what barriers to entry are to industries. Two distinct types: o Impediments to imitation: isolating mechanisms impede existing firms and potential entrants from duplicating the resources and capabilities that form the basis of the firm’s competitive advantage. o Early mover advantage: once a firm acquires a competitive advantage, these isolating mechanisms increase the economic power of that competitive advantage over time. 28 Legal restrictions, access to inputs/customers, and economies of scale can impede competitors from imitating a firm’s resources and capabilities Isolating mechanisms These mechanisms impede the potential entrants from duplicating the resources and capabilities of the incumbent firm. Some important types of impediments to imitation are: o Legal restrictions o Superior access to inputs/customers o Market size and scale economies 29 Let’s explain the different types of impediments to imitation Impediments to imitation Legal restrictions: Legal restrictions such as patents and copyrights as well as government regulation through licensing and certification can impede imitation. They may be bought and sold. They are scarce but potentially mobile o E.g., a license Acquiring a patent or a copyright at open market prices will not yield economic profits unless the firm can deploy this asset in superior ways. 30 Let’s explain the different types of impediments to imitation Impediments to imitation Superior access to inputs/customers: Firms often achieve exclusive access to key resources (or inputs) either through vertical integration or long-term contracts. o Distribution channels, exclusive contracts, etc. Economic profits can be expected only if access was obtained at favorable prices. 31 Let’s explain the different types of impediments to imitation Impediments to imitation Market size and scale economies: When the minimum efficient scale is large relative to market demand. Scale based barriers are likely to be effective when the market demand can be met by one producer (markets for specialized products). Economies of scale may limit the number of companies that are in the market. o ING Direct Spain Scale based barriers may come down if the market experiences growth and entry becomes profitable. o PC industry in the 90s 32 Early-mover advantage arises from learning curves, reputation, switching costs, and network effects Isolating mechanisms Early-mover advantage Some important types of early mover advantage are: o Learning curve o Reputation and buyer uncertainty o Switching costs o Network effects 33 Let’s explain the different types of early-mover advantage Early-mover advantage Learning curve: A firm that sells more than its competitors in the early periods moves further down the learning curve and achieves lower unit costs than its rivals. The lower unit cost allows the firm to undercut its rivals, increase volume, and further move down the learning curve. o Boeing and Airbus 34 Let’s explain the different types of early-mover advantage Early-mover advantage Reputation and buyer uncertainty: For experience goods, a firm’s reputation for quality provide a significant early mover advantage. o With uncertainty, consumers unwilling to try a new (unknown) product if had a good experience. Pioneering brands can influence the formation of consumer preferences and present the attributes of the brand as the ideal for the product category. Brand can be an important isolating mechanism. 35 Let’s explain the different types of early-mover advantage Early-mover advantage Switching costs: In some situations, buyers end up incurring significant switching costs if they change to another supplier. o Consumers who make brand specific investments (for example, learning to use a software program). o When sellers develop buyer specific knowledge (for example, in banking). o Customers who belong to loyalty programs in grocery stores or frequent flyer programs of airlines. 36 Let’s explain the different types of early-mover advantage Early-mover advantage Network effects: Product shows network effects if customer values the product depending on how many others are using the product. Network externalities: o There are actual networks whose usefulness depends on the number of customers already on it. § Telephone networks, or social networks § Direct externality o Virtual networks arise from the use of complementary goods. § Computer operating systems, video gaming (e.g., Sony PlayStation), or smartphones § Indirect externality A large customer base provides a substantial advantage over the network externalities. 37