Strategy - Chapter 6: Business Strategy: Differentiation, Cost Leadership and Integration Business Level Strategy - How to Compete for

Advantage? Business level strategy details the actions managers take in their quest for competitive advantage when competing in a single product market. It may involve a single product or a group of very similar products that use the same channel. To formulate an appropriate business level strategy, managers must answer the following questions: o Who - which customer segments - will we serve? o What customer needs, wishes, and desires will we satisfy? o Why do we want to satisfy them? o How will we satisfy our customers' needs? To formulate an effective business strategy, managers need to keep in mind that a firm's competitive advantage is determined jointly by industry characteristics and firm characteristics. Managers need to be certain that the business strategy is aligned with the five forces that shape competition. They can evaluate performance differences among clusters of firms in the same industry by conducting a strategic group analysis.

Strategic Position A firm's competitive advantage is based on the difference between the perceived value a firm is able to create for customers (V), captured by how much consumers are willing to pay for a product or service and the total cost (C) the firm incurs to create that value. The greater the economic value V-C, the greater the firm's competitive advantage. A firm's business level strategy determines its strategic position. A firm's strategic position is its strategic profile based on value creation and cost. The goal is to create as large a gap as possible between the value the firm's product or service creates and the cost required to produce it (V-C). To achieve a desired strategic position, managers must make strategic trade offs - situations that require choosing between a cost or value position. Managers must address the tension

between value creation and the pressure to keep cost in check to not erode the firm's economic creation. A business strategy is more likely to lead to a competitive advantage if it allows firms to either perform similar activities differently or perform different activities than their rivals that result in creating more value or offering similar products or services at a lower cost.

Generic Business Strategies There are two fundamentally different generic business strategies: o A differentiation strategy seeks to create higher value for customers than the value that competitors create, by delivering products or services with unique features while keeping cost at the same or similar levels. o A cost leadership strategy seeks to create the same or similar value for customers by delivering products or services at a lower cost than competitors, enabling the firm to offer lower prices to its customers. These two strategies are called generic strategies because they can be used by any organization - manufacturing or service, large or small - in the quest for competitive advantage, independent of industry context. Differentiation and cost leadership require distinct strategic positions in order to increase a firm's chances to gain and sustain a competitive advantage. When considering different business strategies, managers also must define the scope of competition - whether to pursue a specific, narrow part of the market or go after the broader market. The focused versions of the strategies - focused cost leadership strategy and focused differentiation strategy - are essentially the same as the broad generic strategies except that the competitive scope is narrower.

Differentiation Strategy: Understanding Value Drivers The goal of a generic differentiation strategy is to add unique features that will increase the perceived value of goods and services in the minds of the consumers so that they are willing to pay a higher price. A company that uses a differentiation strategy can achieve a competitive advantage as long as its economic value created (V-C) is greater than that of its competitors. Although increased value creation is a defining feature of a differentiation strategy, managers must also control cost. If cost rises too much as the firm creates more value, the value gap shrinks, negating any differentiation advantage.

Value Drivers Managers can adjust a number of different levers to improve a firms strategic position. These levers either increase perceived value or decrease costs: o Product Features Managers can adjust the product features and attributes, thereby increasing the perceived value of the product or service offering. o Customer Service Managers can increase the perceived value of their firms' product or service offerings by focusing on customer service and responsiveness. To excel at customer service, managers must be able to identify unmet customer needs and find ways to satisfy them or exceed customer expectations. o Customization Customization allows firms to go beyond merely adding differentiating features to tailoring products and services for specific customers. Advances in manufacturing and information technology have even made feasible mass customization - the manufacture of a large variety of customized products or services done at relatively low unit cost. o Complements Complements add value to a product or service when they are consumed in tandem. Finding complements, therefore, is an important task for managers in their quest to enhance the value of their offerings.

Cost Leadership Strategy: Understanding Cost Drivers The goal of a cost leadership strategy is to reduce the firm's cost below that of its competitors. The cost leader focuses its attention and resources on reducing the cost at which it is able to offer a product or service. The cost leader optimizes all of its value chain activities to achieve a low cost position. Although staking out the lowest cost position in the industry is the overriding strategic objective, a cost leader still needs to offer products and services of acceptable value. While companies successful at cost leadership must excel at controlling costs, this doesn't mean they can neglect value creation.

Cost Drivers The most important cost drivers that mangers can manipulate to keep their costs low are: o Cost of Input Factors One of the most basic advantages a firm can have over its rivals is access to lower cost input factors such as raw materials, capital, labour and IT services. o Economies of Scale Larger firms might be in a position to reap economies of scale, decreases in cost per unit as output increases. Economies of scale allow firms to Spread their fixed cost over a larger output o Larger output allows firms to spread their fixed costs over more units. Drives down per unit cost. Employ specialized systems and equipment o Larger output allows firm to invest in more specialized systems and equipment such as enterprise resource planning (ERP) software or manufacturing robots. More efficient - lower cost. Take advantage of certain physical properties o Economies of scale occur because of certain physical properties. o Minimum efficient scale (MES) is an output range needed to bring down the cost per unit as much as possible, allowing a firm to stake out the lowest cost position that is achievable through economies of scale. o The concept of MES applies not only to production processes but also to managerial tasks such as how to organize work. o Scale economise are critical to driving down a firm's cost and thus strengthening a cost leadership position. o Diseconomies of scale might occur. As firms get too big, the complexity of managing and coordinating raises the cost, negating any benefits to scale; large firms tend to become overly bureaucratic, with too many layers of hierarchy and thus grow inflexible and slow in decision making. Monitoring the firm's cost structure closely over different output ranges allows managers to fine tune operations and benefit from economies of scale.

Learning Curve Learning by doing can also drive cost down. As individuals and teams engage repeatedly in an activity, they learn from their cumulative experience. The steeper the learning curve, the more learning takes place.

There are some important differences between economies of scale and learning effects.

Experience Curves The concept of an experience curve attempts to capture both economies of scale and learning effects. In this perspective, economies of scale allow movement down a given learning curve based on current production technology. By moving further down a given learning curve than competitors, a firm can gain a competitive advantage. Taken together, learning by doing allows a firm to lower its per unit costs by moving down a given learning curve, while leveraging experience based on economies of scale and learning allows the firm to leapfrog to a steeper learning curve, thereby further driving down per unit costs.

Business Level Strategy and The Five forces Benefits and Risks The five forces model help managers assess the forces that make industries more attractive than others. With this understanding of industry dynamics, managers use one of the generic business level strategies to protect themselves against forces that drive down profitability. The business level strategies allows firms to carve out strong strategic positions that the relationship between competitive positioning and the five forces.

Benefits and Risks of the Cost Leadership Strategy A cost leader is fairly well isolated from threats of powerful suppliers to increase input prices because it is more able to absorb price increases through accepting lower profit margins. A cost leader can absorb price reductions more easily when demanded by powerful buyers. Should substitutes emerge, the low cost leader can try to fend off by further lowering its prices to reinstall relative value with the substitute. If a new entrant with new and relevant expertise enters the market, the low cost leader's margins may erode due to loss in market share while it attempts to learn new capabilities. The risk of replacement is particularly pertinent if a potent substitute emerges due to an innovation. Powerful suppliers and buyers may be able to reduce margins so much that the low cost leader could have difficulty covering the cost of capital and thus lose the potential for competitive advantage. The low cost leader faces significant difficulties when the focus of competition shifts from price to non price attributes.

Benefits and Risks of the Differentiation Strategy A successful differentiation strategy is likely to be based on unique or specialized features of the product, on an effective marketing campaign, or an intangible resources such as reputation for innovation, quality and customer service. Threat of entry is reduced: competitors will find intangible advantages time consuming and costly and maybe impossible to imitate.

If differentiator is able to create significant differences between perceived value and current market prices, the differentiator will not be so threatened by increases in input prices due to powerful suppliers. A strong differentiated position reduces the threat of substitutes because the unique features of the product have been created to appeal to customer preferences. The viability of a differentiation strategy is severely undermined when the focus of competition shifts to price rather than value creating features. This happens when products become commoditized and an acceptable standard of quality has emerged across rival firms. A differentiator needs to be careful not to overshoot its differentiated appeal by adding product features that raise costs but not perceived value. A differentiator needs to be vigilant that its costs of providing uniqueness do not rise above customer's willingness to pay.

The success of each business strategy is dependent on: How well the strategy leverages the firm's internal strengths while mitigating its weakness How well it helps the firm exploit external opportunities while avoiding external threats

Integration Strategy: Combining Cost Leadership and Differentiation A successful integration strategy requires that trade-offs between differentiation and low cost are reconciled. This is often difficult because differentiation and low cost are distinct strategic positions that require the firm to effectively manage internal value chain activities fundamentally different from one another. If successful, an integration strategy allows a firm to offer a differentiated product at a low cost. Although quite difficult to execute, a successfully implemented integration strategy allows firms two pricing options: o First, the firm can charge a higher price than the cost leader, reflecting its higher value creation and thus generating greater profit margins. o Second, the firm can lower its price below that of the differentiator; it thus can gain market share and make up the loss in margin through increased sales. An integration strategy is difficult to implement. It requires the reconciliation of fundamentally different strategic positions which in turn require distinct internal value chain activities that allow the firm to increase value and lower cost at the same time.

Value and Cost Drivers of Integration Strategy 1. Quality: The quality of a product denotes its reliability and durability. Quality can increase a product's perceived value, but also can lower its cost. By building in better quality, companies lower the cost of both production and after sale service requirements. 2. Economies of Scope: Savings that come from producing two(or more) outputs at less cost than producing each output individually, despite using the same resources and technology. 3. Innovation: Describes any new product and process or any modification of existing ones. Innovation is frequently required to resolve existing tradeoffs when companies pursue an integration strategy.

4. Structure, Culture and Routines: These are critical when pursuing an integration strategy. The challenge that the managers faces is to structure their organizations so that they both control cost and allow for creativity that can lay the basis for differentiation. The goal for managers who want to pursue an integration strategy should be to build an ambidextrous organization, one that enables managers to balance and harness different activities in tradeoff situations. Integration Strategy at the Corporate Level Corporate level strategy concerns the overall competitiveness of a multibusiness company or a conglomerate. Corporate level strategy concerns decisions about which industries a company should compete in and which types of business level strategies each unit ought to pursue to maximize overall shareholder value. Conglomerates and other companies may decide to coordinate an integration strategy at the corporate rather than the business level.

The Dynamics of Competitive Positioning Strategic positions are not fixed but can and need to change over time as environment changes. Companies that successfully implement one of the generic business strategies are more likely to attain competitive advantage. To do so, companies seek to reach the so called productivity frontier, which is the value cost relationship that captures the result of performing best practices at any given time. Firms that exhibit effectiveness and efficiency reach the productivity frontier, while others are left behind.

In summary, strategic positioning is critical to gaining competitive advantage. Well formulated and implemented generic business strategies enhance the firm's chances of obtaining superior performance.