Unit 3 - Competitive Advantage PDF

Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr....

Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr. Juan Carlos Rivera-Prieto, MBA 1 Let’s explain and understand the emergence of competitive advantage The emergence of competitive advantage A company can earn superior profitability either by being located in an attractive industry or by establishing a competitive advantage over its rivals. Establishing a competitive advantage is the most important. Primary goal of a strategy is to establish a position of competitive advantage for the company. 2 What are the competitive advantages of these airlines? Examples 3 Does Apple or Samsung have a competitive advantage in the smartphone market? Examples 4 Does Apple or Samsung have a competitive advantage in the smartphone market? Examples 5 What is competitive advantage? How do companies achieve it? The emergence of competitive advantage Defining competitive advantage: “When two or more companies compete within the same market, one company possesses a competitive advantage over its rivals when it earns (or has the potential to earn) a persistently higher rate of profit”. Companies achieve a competitive advantage by creating and delivering more economic value than their rivals, capturing a portion of that value as profit. 6 How do competitive positioning and market attractiveness relate to economic profitability? The emergence of competitive advantage Economic attractiveness of the market + competitive position in that market à Economic Profitability Be more successful than rivals à Competitive advantage à More economic value à higher profits + higher net benefits to consumers 7 Let’s explain how competitive advantage emerges The emergence of competitive advantage 8 Adapting to external changes has an impact on a company’s competitive position The emergence of competitive advantage External Sources of Change: The competitive advantage that arises from external change depends on firms’ ability to respond to change. Responsiveness involves one of two key capabilities: o Ability to anticipate changes in the external environment. o Speed. § Information. § Short cycle times. § Internet, real-time electronic data exchange, or wireless communication. 9 Internal innovation drives a company’s competitive advantage The emergence of competitive advantage Internal Sources of Change: The changes that create competitive advantage may also be generated internally through innovation. Innovation not only creates competitive advantage; it provides a basis for overturning the competitive advantage of other companies Schumpeter’s view of competition as “a gale of creative destruction”. Strategic innovation typically involves creating value for customers from novel products, experiences, or modes of product delivery. 10 Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr. Juan Carlos Rivera-Prieto, MBA 11 Let’s explore the key concepts of value creation Value creation Businesses that create more value than competitors will hold an advantaged position in the marketplace. Key concepts: o Maximum willingness-to-pay o Consumer surplus o Producer surplus 12 Maximum willingness-to-pay is the highest price a consumer is willing to pay Value creation Maximum willingness-to-pay The highest price a consumer is willing to pay for a good or service. It reflects the perceived value of the product to the consumer. Why is maximum willingness-to-pay important? Helps businesses understand consumer preferences. Guides pricing strategies to maximize sales. 13 The consumer surplus is the the difference between what consumers are willing to pay and what they actually pay Value creation Consumer surplus The difference between what consumers are willing to pay and what they actually pay. It represents the benefit that consumers receive when they purchase a product for less than their maximum price. Why is consumer surplus important? Measures consumer benefit in the market. Indicates overall market efficiency. 14 The producer surplus is the difference between the price producers receive and their minimum acceptable price Value creation Producer Surplus The difference between the actual price producers receive and the minimum price they are willing to accept. It measures the benefit to producers from selling at a market price higher than their minimum acceptable price. Why is producer surplus important? Reflects producer profitability. Signals market conditions and helps in production decisions. 15 Here is a visualization of the consumer surplus and producer surplus Value creation 16 What is the consumer surplus? Exercise Imagine a consumer who starts without an automobile. One day, she receives a Fiat 500 (the market price is $17,000) as a gift, completely free of charge. This new possession makes her better off compared to her previous situation without a car. Now, we gradually take money away from her. We find that at a specific point—let’s say $20,500—she feels that her current situation with the Fiat 500 is no better or worse than when she had no car at all. $20,500 is her maximum willingness to pay for the Fiat 500. This value (B) represents the total benefit she expects to gain from owning the vehicle. 17 What is the consumer surplus? Exercise Calculating Consumer Surplus à The consumer surplus is calculated as the difference between the benefit the consumer derives (B) and the price of the product (P) Consumer Surplus = B − P B = Benefit the consumer expects to derive from the product (in this case, $20,500) P = Price of the product (let’s assume the market price of the Fiat is $17,000) Consumer Surplus = 20,500 − 17,000 = 3,500 18 What is the consumer surplus? Exercise This means the consumer experiences a surplus of $3,500, which reflects the extra satisfaction or benefit she gains from purchasing the car at a lower price than what she was willing to pay. Decision-making based on consumer surplus à A consumer will only choose to purchase a product if the consumer surplus is positive (B > P). This surplus indicates that the perceived value exceeds the actual price paid. When faced with options between multiple products, the consumer will choose the one that offers the highest consumer surplus (B – P). 19 This is a value map Value creation 20 Let’s explore the value map Value creation The value map illustrates the competitive implications of consumer surplus. Solid upward-sloping line is called an indifference curve. Any price–quality combination along the indifference curve yields the same consumer surplus. When companies’ price–quality positions line up along the same indifference, we say that the company have achieved consumer surplus parity. 21 Here are the components of value creation Value creation 22 Let’s explain the components of value creation Value creation Economic value is created when a producer combines inputs to make a product whose perceived benefit (B) exceeds the cost (C) incurred in making the product. The producer then sells the product at a given price (P), which should be higher than the cost (C) to obtain profits. Value-Creation = Consumer Surplus + Producer Surplus = (B – P) + (P – C) = B – C o Value-creation = B – C o Consumer surplus = B – P o Producer surplus = P – C 23 Creating more economic value than rivals is key to profitability in competitive markets Value creation and competitive advantage Just because a company sells a product whose value creation (B–C) is positive is no guarantee that the company will make a positive profit. Existing companies and new entrants will compete for consumers by bidding down their prices to the point at which all producers earn zero profit. In such markets, consumers capture all the economic value. To earn positive profit in a competitive industry, the company must create more economic value than its rivals. 24 Let’s analyze value creation Analyzing value creation 1. Foundation of competitive advantage: The first step in diagnosing a company’s potential for achieving a competitive advantage in its market. 2. Understanding the business: Identify why the business exists and the core economic factors that drive its success. 3. Key value drivers: What drives consumer benefits and what drives costs? 4. Economic evolution: Analyze how the business’s core economics may change over time (consonance analysis). 5. Challenges of predicting the future: Future evaluation is complex due to uncertainty and the risks involved in acting on forecasts. 25 There are two different ways to create more economic value than rivals Value creation, resources and capabilities Two ways: A company can create more value by configuring its value chain differently from competitors, offering unique products or services. A company can generate more value by performing the same activities as its competitors, but more efficiently, reducing costs or increasing productivity. 26 Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr. Juan Carlos Rivera-Prieto, MBA 27 Companies achieve higher profits through cost leadership or differentiation Types of competitive advantage: Cost and Differentiation A company can achieve a higher rate of profit over a competitor in one of two ways: Cost advantage: identical product or service at a lower cost. Differentiation advantage: product or service that is differentiated in such a way that the customer is willing to pay a price premium. Cost Leadership Competitive Advantage Differentiation 28 Cost leadership and differentiation are mutually exclusive strategies Types of competitive advantage: Cost and Differentiation Porter views cost leadership and differentiation as mutually exclusive strategies. A company that attempts to pursue both is “stuck in the middle” Features of cost leadership and differentiation strategies 29 For Porter, there are three generic strategies: cost leadership, differentiation, and focus Types of competitive advantage: Cost and Differentiation By combining the two types of competitive advantage with the company’s choice of scope, Porter has defined three generic strategies: Cost leadership Differentiation Focus 30 Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr. Juan Carlos Rivera-Prieto, MBA 31 Cost advantage has evolved over time Types of competitive advantage: Cost advantage Traditional focus on cost advantage: o Historically, companies relied on cost advantage as the main source of competitive advantage. o Price was the key factor in competition. Experience curve: o During the 1970s and 1980s, the experience curve was a popular tool for strategic cost analysis, showing how costs decline as companies gain experience. In recent decades, companies have adopted new approaches to reduce costs: o Outsourcing: Shifting non-core activities to external providers. o Process re-engineering: Redesigning workflows to improve efficiency. o Organizational delayering: Removing layers of management to cut costs and improve decision- 32 making speed. What are the drivers of cost advantage? The drivers of cost advantage 33 Let’s explain the key factors driving cost advantages The drivers of cost advantage Economics of Scale: Refer to the cost advantages that a company can achieve when it produces a larger volume of goods or services. Figure shows a typical relationship between unit cost and plant capacity. The point at which most scale economies are exploited is the Minimum Efficient Plant Size (MEPS). The long-run average cost curve for a plant 34 Let’s explain the key factors driving cost advantages The drivers of cost advantage Arise from three principal sources: Technical input-output relationships: In many activities, increases in output do not require proportionate increases in input. Indivisibilities: Many resources and activities are unavailable in small sizes. Specialization: Increased scale allows greater task specialization that is manifest in greater division of labor. Specialization promotes learning, avoids time loss from switching activities, and assists mechanization and automation. o Mass production à breaking down the production process into separate tasks (1) dividing and specializing human labor, and (2) using tools and machines, often automated, to make standardized, interchangeable parts and products. 35 Let’s explain the key factors driving cost advantages The drivers of cost advantage Economics of Learning: The experience curve is based primarily on learning-by-doing on the part of individuals and organizations. More complex (process/ product) à greater the potential for learning. Learning occurs: At the individual level, through improvements in skills and problem solving. At the group level, through the development and improvement of organizational routines. 36 Let’s explain the key factors driving cost advantages The drivers of cost advantage Process Technology and Design: New process technology may radically reduce costs. Process innovation is embodied in new capital equipment, so diffusion is likely to be rapid. Full benefits of new processes typically require system-wide changes in job design, employee incentives, and/or product design. Business Process Re-engineering (BPR). Hammer and Champy note the existence of a set of “commonalities, recurring themes, or characteristics” that can guide BPR. These include: o Allowing workers to make decisions. o Recognizing that processes can vary to take into account different situations. o Decentralized decisions can be made while allowing for overall coordination. 37 Let’s explain the key factors driving cost advantages The drivers of cost advantage Product design: Designing products for ease of production rather than simply for functionality and esthetics can offer substantial cost savings (Design-for-manufacture). Input costs: There are several sources of lower input costs: o Locational differences in input prices: Prices of inputs may vary between locations. o Ownership of low-cost sources of supply: In raw material-intensive industries, ownership or access to low-cost sources can offer crucial cost advantage. o Nonunion labor: Labor unions result in higher levels of pay and benefits and work restrictions that lower productivity. 38 Let’s explain the key factors driving cost advantages The drivers of cost advantage Capacity utilization: Profitability is highly sensitive to shortfalls in demand. Pushing output beyond normal full-capacity operation also creates inefficiencies. The ability to quickly adjust capacity to shortfalls in demand can be an important source of cost advantage. Residual Efficiency: Refers to the extent to which the company is approaching its optimal operating efficiency frontier, which depends on the company's ability to eliminate its “organizational slack” or “X-inefficiency”. These costs, known as “organizational fat”, accumulate over time because employees tend to keep some slack instead of always working at full efficiency. 39 But how can we use the value chain to analyze costs? The drivers of cost advantage Analyzing the cost position of a company requires looking at individual activities. The analysis of the company’s value chain aims to identify: The relative importance of each activity with respect to total cost; The cost drivers for each activity and the comparative efficiency with which the company performs each activity; How the costs of one activity influence the costs of another; Which activities should be performed within the company and which activities should be outsourced. 40 Application of the value chain Exercise for automotive manufacturing How can the application of the value chain to automotive manufacturing yield to suggestions for possible cost reductions? 41 How do McDonalds, Primark or Ryanair achieve their competitive advantage? Exercise Cost leadership is a competitive strategy where a company aims to be the lowest-cost producer in its industry. This allows the company to either lower prices to gain market share or maintain average prices with higher profit margins. 42 This is the economic logic of cost leadership Figure By reducing costs, a company can either lower prices to attract more customers or maintain average prices to increase its profit margins. This dual approach can maximize profitability. 43 Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr. Juan Carlos Rivera-Prieto, MBA 44 Let’s explore the concept of differentiation Types of competitive advantage: differentiation A company differentiates itself from its competitors “when it provides something unique that is valuable to buyers beyond simply offering a low price”. Differentiation advantage occurs when a company is able to obtain from its differentiation a price premium in the market that exceeds the cost of providing the differentiation. The range of differentiation opportunities depends on the characteristics of the product. For example, a car or a restaurant offers greater differentiation potential than commodities such as cement or wheat. Yet, even commodity products can be differentiated in ways that create customer value: “Anything can be turned into a value-added product or service for a well-defined or newly created market” 45 Differentiation is not simply about offering a product with different characteristics Types of competitive advantage: differentiation Differentiation is about: o Identifying and understanding every possible interaction between the company and its customers. o Asking how these interactions can be intensified or modified to offer additional value to the customer. o Look both towards the company (supply side) and towards its customers (demand side). o Critical issue: whether that differentiation creates value for customers and whether that value created exceeds the cost of differentiation. o Understanding what customers want, how they choose, and what motivates them. 46 Customer insight and creativity drive successful differentiation Types of competitive advantage: differentiation Differentiation strategies are not about pursuing uniqueness for the sake of being different. Differentiation is about understanding customers and how our product can meet their needs. Establishing differentiation advantage requires creativity. There are two requirements for creating profitable differentiation: o On the supply side, the company must be aware of the resources and capabilities through which it can create uniqueness. o On the demand side, the key is insight into customers and their needs and preferences. 47 Supply-side factors shape a company’s uniqueness Supply side The drivers of uniqueness Differentiation is concerned with the provision of uniqueness. Opportunities for creating uniqueness in its offerings to customers are not located within a particular function or activity. Porter identifies the following drivers of uniqueness: o Product features and product performance. o Complementary services (such as credit, delivery, repair). o Intensity of marketing activities. o Technology embodied in design and manufacture. o The quality of purchased inputs. o The skill and experience of employees. o Location. o The degree of vertical integration. 48 Effective signaling and reputation strengthen differentiation Supply side Consistent and effective. Complementary package of differentiation attributes is required. Signaling and reputation. Differentiation is only effective if it is communicated to customers. But information about the qualities and characteristics of products is not always readily available to potential customers. The economics literature distinguishes: Search goods: qualities and characteristics can be ascertained by inspection. Experience goods: qualities and characteristics are only recognized after consumption. 49 Brands guarantee quality and foster customer trust Supply side Brands. A brand provides a guarantee by the producer to the consumer of the quality of the product. o Basic: a brand identifies the producer of a product. o Brand represents an investment that provides an incentive to maintain quality and customer satisfaction. The traditional role of the brand as a guarantor of reliability is particularly significant in e-commerce. 50 Differentiation adds costs, but efficiency can be maintained Supply side The costs of differentiation. Differentiation adds costs. o The direct costs of differentiation include higher quality inputs, better trained employees, higher advertising costs and better after-sales service. o The indirect costs of differentiation arise through the interaction of differentiation variables with cost variables. One means of reconciling differentiation with cost efficiency is to postpone differentiation to later stages of the firm’s value chain. Economies of scale and the cost advantages of standardization are frequently greatest in the manufacturing of basic components. 51 Identifying demand-side opportunities enhances differentiation Demand side Identifying differentiation potential: the demand side 52 Tangible and intangible aspects contribute to differentiation Types of competitive advantage: differentiation In analyzing differentiation opportunities, we can distinguish tangible and intangible dimensions of differentiation: o Tangible differentiation is concerned with the observable characteristics of a product or service that are relevant to customers’ preferences and choice processes. o Opportunities for intangible differentiation arise because the value that customers perceive in a product or service does not depend exclusively on the tangible aspects of the offering. 53 Differentiation is about how a company competes, not just where Differentiation vs. Segmentation Differentiation is concerned with how a company competes—the ways in which it can offer uniqueness to customers. Such uniqueness might relate to consistency (McDonald’s), reliability (Federal Express), status (American Express), quality (BMW), and innovation (Apple). Companies can target a single segment, without necessarily differentiating themselves from their competitors within it. Segmentation is concerned with where a company competes in terms of customer groups, localities, and product types. While segmentation is a feature of market structure, differentiation is a strategic choice by a company. 54 Differentiation provides a more secure basis for competitive advantage The sustainability of differentiation advantage Differentiation offers a more secure basis for advantage than low cost. Cost advantage is highly vulnerable to unpredictable external forces. Cost advantage is also vulnerable to new technology and strategic innovation. Sustained high profitability is associated more with differentiation than cost leadership. 55 This is the economic logic of differentiation Figure A company can achieve higher profits by offering unique products or services that customers value more, allowing it to charge a price premium that exceeds the additional costs of differentiation 56 Unit 3: Competitive advantage Agenda 3.1. The emergence of competitive advantage 3.2. Value creation 3.3. Types of competitive advantage: cost and differentiation 3.4. Types of competitive advantage: cost advantage 3.5. Types of competitive advantage: differentiation 3.6. VRIO Analysis Dr. Juan Carlos Rivera-Prieto, MBA 57 VRIO analysis helps evaluate resources for competitive advantage VRIO Analysis 58 VRIO assesses value, rarity, inimitability, and organization of resources Definition Analytical technique for the evaluation of company’s resources and thus the competitive advantage. Term VRIO comes from the words value, rarity, inimitability, and organization. o Valuable: How expensive is the resource and how easy is it to obtain on the market (purchase, lease, rent,...)? o Rare: How rare or limited is the resource? o Inimitable: How difficult is it to imitate the resource? o Organized: respectively arrangement - Is the resource supported by any existing arrangements and can the organization use it properly? 59 Different types of resources can be analyzed using VRIO Types of resources With VRIO, different types of resources can be analyzed to assess their contribution to competitive advantage: Financial resources: Capital, investments, cash flow, and funding sources. Human resources: Skills, expertise, experience, and employee knowledge. Material resources: Equipment, physical assets, and inventory. Non-material resources: Information, intellectual property, and organizational knowledge. 60 A four-step process ensures effective VRIO analysis How to make the VRIO Analysis? 4-Step process: 1. Identify Resources. 2. Conduct a VRIO Analysis. 3. Protect Resources: some potential strategies include making these resources harder to obtain, difficult to duplicate, and impossible to substitute out for alternatives. 4. Bi-Annual Review: take a breeze through this at least once every 6 months. This way you should be able to sustain that competitive advantage for as long as possible. 61 Let’s explore how the VRIO model works VRIO model 62 Let’s do a VRIO analysis of Tesla Exercise Type of Valuable Rare Inimitable Organized advantage Electric technology Supercharger network Autonomous driving and AI Gigafactories for batteries Brand image 63 Let’s do a VRIO analysis of Tesla Exercise Type of Valuable Rare Inimitable Organized advantage Electric Competitive technology parity Supercharger Sustainted network comp. adv. Autonomous Temporary driving and AI comp. adv. Gigafactories Sustainted for batteries comp. adv Brand image Sustainted comp. adv 64 VRIO helps companies maximize and sustain their competitive resources How to do a VRIO Analysis? VRIO analysis helps companies identify the resources and capabilities they possess. Resources and capabilities help the company to differentiate itself from other competitors. It can also help the company leverage resources and capabilities optimally. 65